How do you Value your Real Estate Business???
Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes
How do you Value your Real Estate Business???
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Developer · Covington, LA · Member since 2017 · 224 posts · 124 votes
9y@David Zheng In another life I was a banker/M&A specialist. A lot of what you asked depends mainly on the size of your operation, the management systems in place, and the skills and smarts of your management team. A lot of small businesses, especially in the construction space, are simply one to five man operations, with the owner playing an integral roll. Remove the owner, and the enterprise shuts down. These types of businesses, even if they are wildly successful have little value beyond the book value of the assets.
When we would consult with these types of companies we would invariably recommend the owner endeavor to divorce himself from the business over time. This process would include developing or buttressing management systems, delegating most of the owner's current activities to other staff members, grooming a second and third in command, and instructing the owner to take a lot of days off. Over a reasonable amount of time, the company would begin to run itself. In a way it would be similar to what we call in rentals a "turnkey" investment.
This is how a business builds value over and above its assets. We call this intangible value. Without it, most small businesses will be worth no more than the book value of their assets.
19 Replies
- Developer · Covington, LA · Member since 2017 · 224 posts · 124 votes9y
@David Zheng In another life I was a banker/M&A specialist. A lot of what you asked depends mainly on the size of your operation, the management systems in place, and the skills and smarts of your management team. A lot of small businesses, especially in the construction space, are simply one to five man operations, with the owner playing an integral roll. Remove the owner, and the enterprise shuts down. These types of businesses, even if they are wildly successful have little value beyond the book value of the assets.
When we would consult with these types of companies we would invariably recommend the owner endeavor to divorce himself from the business over time. This process would include developing or buttressing management systems, delegating most of the owner's current activities to other staff members, grooming a second and third in command, and instructing the owner to take a lot of days off. Over a reasonable amount of time, the company would begin to run itself. In a way it would be similar to what we call in rentals a "turnkey" investment.
This is how a business builds value over and above its assets. We call this intangible value. Without it, most small businesses will be worth no more than the book value of their assets.
- Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes9y
@Rogers Smith
I very much respect and appreciate your answer! I guess my processes aren't much more than any other landlords right now (though I think I keep a more organized operation)
So lets say I have $2 million of real estate in "Book Value" (though I technically only have $500,000 equity) but after all Expenses, PITI, CAPEX Reserves etc. I cashflow $10,000/month
Would you still value my company the same as someone with similar financial holdings who only has $2,000 of net cashflow? - Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9yDavid Zheng I think it comes down to if you have a "practice" or a "business". An individual lawyer can have a great practice, an admin, client base, etc. but when she/he retires there's very little value there. Clients (like tenants) can just leave when the new prospective owner takes over or when the lease is up. A true business is a completely different animal. I have no idea what state your portfolio is in and if you've built a successful practice or a successful business. Either option is great. Choosing one over the other really is just a choice. That said, it drastically impacts the value of the entity.
- 9yAlexander FelicePro MemberGuy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
valuation of business varies but @Rogers Smith is correct.
the business is worth what the next guy will make on it at some agreed upon rate (example 3x net income). If you leave will the business and processes run by themselves? The less systemized your business and the less infrastructure you have in place then you rely more on the next guy having to recreate processes. How much of the business income is on you showing up every day vs how much it will produce automatically.
The more a business relies on an owner to individually generate income, the more the valuation will fall on book value.
This is why franchises cost so much. They aren't selling on valuation of assets, they are selling processes. Your rental business is the exact opposite.
(I do commercial loan analysis for small businesses)
- 9yChris ClothierBusiness MemberRental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
@David Zheng, Do you actually have a business or are you managing your own portfolio of properties? You've gotten some excellent input from @Alexander Felice and @Rogers Smith from the business valuation piece, but in reality, you may not really have a business. I love the way @Andrew Johnson addressed that issue with the term "practice". My families' company went about taking the steps a few years ago to actually build value in our company and much of what Rogers mentioned is what we have done. There are now multiple layers of leadership, redundancy of process, fine-tuned marketing including the use of the word residents instead of tenants (you'd be surprised at how big a difference something like that makes), hundreds of thousands spent in infrastructure and IT systems, and a fully marketed brand that is beyond the owners and even beyond just a name. It is actually a Brand that conjures up an image and a feeling.
Those are all things that raise the value of a company. That being said, we are not selling and have no intention of selling and the be fair, would probably "value" what we have built way more than a 3rd party buyer would value it should someone want to purchase the company. But we have some pretty solid value-adds to boost our value up. If you want to actually build a business and build value, you will need to replace yourself in every process as soon as possible and look to continue to replace over and over and over again as you grow. Best of luck as you go. ~
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9y
@David Zheng Good input from @Chris Clothier and the net result is that everything Chris' family has done to build a business costs money. It's not an insignificant amount of hard capital and that doesn't factor into the soft costs like losing out of deals because you had to deal with "the IT guy" instead of vetting deals. If you're a "practice" your CRM system can be a series of Google Sheets (free), if you're a "business" you've probably sucked it up and bought seat licenses for Salesforce or another SMB focused CRM solution. If you build a "practice" there's far less sustainable value but you extract value (read: cash) much, much, MUCH easier than if you're building a business. That's why I don't believe there's a right or wrong answer. A practice has less overhead, less risk, cash today is worth more than cash in 5 years, and you probably end up with fewer ulcers ;-)
- Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes9y
Thank you guys! That makes much more sense
Just for numbers sake, cause I like numbers. Let's say if I left, the business could still run at the net income I was making before. Should I then just value it at 3x Net income as one of you have mentioned? Is that usually the multiplier used for this market? - Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9y
@David Zheng Here's another way to do look at it. Anyone can install a property manager for around 10% of gross revenues. They can put tenants in place, have their own systems, network of contractors, management systems they use for reporting, etc. What's still a little unclear is what about your business or practice make it superior to a property management company. Is it the selection of the properties? That goes out the door when you leave unless there's someone else that does the deals. What's the sustainable value that I'm buying other than the properties themselves and property management?
- 9yAlexander FelicePro MemberGuy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
Originally posted by @Andrew Johnson:
@David Zheng Here's another way to do look at it. Anyone can install a property manager for around 10% of gross revenues. They can put tenants in place, have their own systems, network of contractors, management systems they use for reporting, etc. What's still a little unclear is what about your business or practice make it superior to a property management company. Is it the selection of the properties? That goes out the door when you leave unless there's someone else that does the deals. What's the sustainable value that I'm buying other than the properties themselves and property management?
this!
the question you're really trying to answer is: "what is the premium of buying your set of assets and procedures together, over just buying the assets"
As Andrew said, can someone just come in and buy your assets and install a PM and make the same money you're making? What is the value-add you provide by selling your pre-built infrastructure over just the bulk assets.
- Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes9y
@Alexander Felice
@Andrew Johnson
Unfortunately in reality, I do not think many people can replicate what I do as an individual. I have a better sense of better places to buy and ways of getting higher rents than the other landlords around me. Sadly, I would have to go by book value at that point...
But I'm looking at it from a selling point for investors. I want to give them big numbers (and as legit as possible) so they would want a piece of the pie. - 9yAlexander FelicePro MemberGuy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
Originally posted by @David Zheng:
@Alexander Felice
@Andrew Johnson
Unfortunately in reality, I do not think many people can replicate what I do as an individual. I have a better sense of better places to buy and ways of getting higher rents than the other landlords around me. Sadly, I would have to go by book value at that point...
But I'm looking at it from a selling point for investors. I want to give them big numbers (and as legit as possible) so they would want a piece of the pie.If a real estate investor came to you and wanted to sell you a volume of cash flowing properties, would you want to pay a premium, or would you want a discount for buying in bulk?
;)
- Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes9y
haha! As I am from a very strict finance background, I hold true to the "Buy Low, Sell High" motto. when buying I try to get every discount but I could turn around and pitch everything I can to sell at a premium in the same sentence
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9y
@David Zheng So it sounds like the value that you're offering the investor is the same value as a REIT, just on a smaller scale. You're going to identify the asset, purchase it, make it as marketable as possible, manage it, and rent it out for as high as possible. You will want to market it to investors that buy a "share of the portfolio" instead of buying an individual property. The post-purchase value proposition for the investor is dividends based on how the assets perform. The investor gets to diversify their risk across a range of properties. So, are you trying to model yourself as a tiny REIT?
- Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes9y
@Andrew Johnson
Not exactly as I know that will bring a whole lot of SEC and legal things that I don't want to deal with. Its more that I want to attract private investors to be my loan sharks. I don't really like equity partner deals.
but if I go to someone who doesn't know me but I want their money, I want to be like. "Yeah my company is a million dollar business. Invest with me."
Which I think weighs heavier than "yeah I generate 9k/month. Invest with me" - Developer · Covington, LA · Member since 2017 · 224 posts · 124 votes9y
@David Zheng your question about 3x Net Income or other rule of thumb multiple raises an interesting point, at least for us numbers geeks. In real estate, a common capitalization rate is 10% (as discussed ad nauseam on these boards), which equates to a 10x multiplier. After all, the multiplier is simply the reciprocal of the capitalization rate.
In small to middle-market business valuations, a rule of thumb multiplier is 5x, or a cap rate of 20%. Keep in mind, a higher cap rate reflects higher risk. Considering the capitalization is simply the percent return an investment must generate to attract investment capital. Real estate investments are considered lower in risk than small business investments, hence the 10x vs, 5x multiplier.
Which circles around to my point of interest. If you build the perfect management systems, hire rock star managers, divorce yourself from operations and build the perfect self-sustaining business, you've created a small business that can sell for 5x cash flow. Yet, if the real estate may garner a multiple that is closer to 10x...why bother.
Yes, capital structure (debt and equity financing) of the company come into play, but that's another discussion for another day.
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9y
@David Zheng Maybe message a few hard money lenders on BiggerPockets and ask what message lands best with them. It could wrapped around ROI, deals done, number of units in your portfolio today, portfolio value, etc. More than likely it's all of the above and more. The only message that probably won't land well is if you describe yourself as a million dollar business and subsequently find that you generate $9K/month. What you could legitimately do is graph out things like revenue growth, cash-flow growth, return on capital growth, etc. over the months and years you've been investing. Hopefully those numbers have been constantly growing. So if they're investing in your business/practice then they're adding fuel to a fire. Or just take their money and secure it with a property with a high equity position so they know that they're getting their money back one way or another!
- Real Estate Investor/Broker · Irving, TX · Member since 2015 · 520 posts · 263 votes9y
@David Zheng I didn't read through this whole thread but I'm thrown off by the term valuing your rental "business". I would use the term "portfolio". If that's the case you'd underwrite your portfolio just like any other business or real estate asset. Real estate is proforma driven and value is based on the current and proforma NOI. We underwrite and broker Single Family Rental (SFR) portfolios across the country and we value them just like all the apartment communities we broker.
- Investor · Chattanooga, TN · Member since 2016 · 146 posts · 108 votes9y
@David Zheng I know this is off topic but could you explain a couple of tactics of how you get higher rents then others in the same area? Not trying to hijack the thread or steal your secret sauce but I'm interested in hearing what you do and see if I can implement it in my area.
- Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes9y
Comment and opinions in generalities only...
In Kiyosaki - speak, you are running your business as an "S". There is no reason to think that any other "S" would be valued at anything other than book value. To put things in perspective, American Homes for Rent (AMH) is at 1.37 Price/Book.
One falacy of the "S" quadrant is that often the 'operator' believes the product or service they provide is better/cheaper/faster than everyone else. Most operators have not compared their operations against all other operators. But the obvious takeaway is 'wow, you must be getting paid a lot more than your competitors.' Which leads to the follow on question 'Numbers about generating $Xk/month.... is after you are paid for your services, right?'
Highwoods Properties, Inc. (HIW) has a price to book of 2.5x. It is a complete falacy to think an "S" operator would be valued above some of the top publicly held SFR and business REITs.
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