Do Business Valuations Include Real Estate? How to Value Real Estate When Selling a Business
You may be selling your business for any number of reasons. Whether you’re closing shop, dissolving a partnership, retiring, or reacting to unexpected demand, remember to consider the value of owned real estate as you determine purchase price. Not all businesses own commercial real estate, but for sellers who do, it often makes sense to consider its property value and decide whether or not it should be included with the sale.
As you consider its market value, think about it from all angles. Get advice from professionals. Partnering with a business appraiser and a real estate appraisal specialist can help ensure that the real estate assets are carefully considered as part of the business valuation.
How to Value a Business
Valuing a business can be emotional for both the buyer and seller. Do your best to remain impartial as you evaluate real estate market conditions and assess the business value.
There are three widely accepted valuation methods. You may use one method or a combination of methods as you perform a valuation on a business:
- Market-Based Business Valuation: A comparison between your business and other businesses in the same industry that have recently sold.
- Asset-Based Business Valuation: A way of valuing an unprofitable business, considering only its assets like inventory, equipment, and intellectual property. This also factors in the depreciation of fixtures and equipment (FF&E) and intangible assets.
- Income-Based Business Valuation: The income approach looks at gross income and operating expenses, then projects earnings to help buyers understand their own expected profitability and rate of return. It considers the capitalization rate and the business’s discounted cash flow.
Unique Valuation Considerations for Business Owners with Real Estate Holdings
A business with real estate doesn’t need to be sold as a package deal. There are many reasons a seller may include or exclude real estate from the transaction. From complex property tax implications to outstanding lease agreements, any real estate professional will caution you to explore all the factors that can influence valuation.
The most common considerations include:
- Property Appraisal: The property type, its condition, location, and potential can dictate fair market value.
- Income Potential: If the real estate generates rental income, the income-based business valuation will have you consider factors like rental income, vacancy, and income potential.
- Environmental or Zoning Issues: Factors like contamination (even from long before you owned the property) can affect the real estate value and a lender's willingness to loan to a potential buyer. A seller may need to conduct costly environmental tests to prove that it is saleable.
- Lease Agreements: Real estate housing multiple tenants takes into account how long the tenants have been leasing. While long-term tenants may help the valuation favorably, short-term leases or vacancies can reduce the real estate valuation.
- Outstanding Debts or Liens: Debts against a property can affect the sale price and the valuation. Be sure to consider the terms of outstanding loans and their impact on cash flow.
- Financial Planning and Exit Strategies: Real estate assets require the seller to consider the portfolio, tax planning, and asset strategy. Consult with a professional who can help you understand whether commercial real estate holdings will fit into your exit plan.
Normalizing Rent Adjustment
During the business valuation, a real estate professional will take a close look at rental expenses. Rent adjustment is common and helps ensure that the rental expenses and leases are properly normalized and representative of the business, not inflated, deflated, or distorted to misrepresent the business’s value and profitability.
Understanding standard rent to revenue ratios for your industry is important when evaluating rental expenses, as it helps determine whether current rent costs are sustainable for the business's revenue.
During the valuation, the real estate professional will look at comps in the area and review data to understand industry and local rates, including cost per square foot. They may recommend adjustments to level the playing field which helps small and large businesses have the same chance of a fair valuation.
Real Estate’s Impact on Specific Industries and Sectors
Commercial real estate influences business values, but the impact is different from industry to industry.
In the retail and restaurant industries, it’s all about location, location, location. A good location is more likely to support sales, but a bad location can reduce the property valuation. Location is also important for gas stations and convenience stores, as is the roadway infrastructure and proximity to local competition.
Office real estate values often take into consideration the occupancy rates and surroundings. Walkability is increasingly important for employees in many cities, as is parking. Medical buildings like doctors offices, dentists, and other clinics factor patient accessibility and quality of the facilities into their real estate value.
Hospitality businesses like hotels heavily rely on factors like the quality of the real estate and its proximity to restaurants and tourist attractions. Valuation may even include the overall guest experience.
Assembling a Team: Business Appraiser | Real Estate Appraiser
If you’re considering selling your business, connect with a team of business valuation service professionals and advisors who can help you objectively plan next steps.
You can start by getting referrals from other business owners. You should also interview prospective valuators and real estate experts to learn about their experience in your industry and understand their process.
Business appraisers and real estate appraisers may have different areas of focus, but they work together to help you get all the information you need to make informed decisions. With their collaborative insight, you will be able to understand fair market value of your business and real estate property being considered as part of the sales transaction.
The value of real estate can impact the overall value of a business in a variety of ways. Assembling a team of advisors to navigate your real estate options when selling your business is essential for ensuring a proper valuation and smooth transaction. Visit BizBuySell’s Broker Directory to find a business broker to help you prepare your business, and commercial real estate, for sale.