How to Value a Real Estate Management Business

Written by jordan on . Posted in Blog

By Ronald F. Hammond, CCIM, RPA, PPM

The owner of a real estate management business may have many reasons to establish the precise value of the company. Selling may seem the most obvious, but valuation done for the asset allocation for tax or other purposes— estate planning, acquiring a loan or other funding—are equally important. Although the sale of the real estate management business may include other non-management operations, such as in house mortgage lending, leasing, brokerage, insurance, maintenance, construction and other functions that contribute to the gross income of the business, this discussion has been limited to the valuation of the property management function alone.


THE VALUATION PROCESS
The methods of valuation used most frequently with property management companies are:

1.Capitalized Earnings Method
This is the most common method of valuing a real estate management business.  It is based on a capitalization rate applied to the adjusted gross. The most difficult part of this method is selecting the appropriate capitalization rate. The rate would be an assessment of the risk factors, the stability of the management accounts and fees, longevity of the company and its reputation in the market place. You would of course need to adjust the owner compensation to what a non-owner manager would earn. With these adjustments, you can now calculate a net earnings value used to compute the capitalized earnings. As a guideline, Mr. Berry suggested a range from 2.5 to 5 times net earnings for an all cash transaction, while sales involving notes and/or contingencies will range from 3.5 to 6 times net earnings.

2.Gross Revenue Method
This method looks at the financial data. To establish a value, you must select a profit rate, typically this is in the 10-20% range and the capitalization rate discussed above. You divide the profit rate by the cap rate to determine the multiplier used to calculate the value. For example, if you want a 15% profit rate and a 20% cap rate, the multiplier is .75. Now multiply that by the annual gross revenue. A good rule of thumb is, 50% of the gross income goes to pay salaries and benefits. Another 20% goes for accounting and bookkeeping costs. Still another 30% goes for office rent and general expenses, advertising, promotion and profit.  If one expects to make a normal profit of 10-15%, then the rest of the expenses must not exceed 15%. This may be very difficult if not impossible to achieve. If, however, the buyer can combine his gross income with the seller’s, he may be able to achieve economies in salaries, benefits, administration and other expenses which will give him the return he seeks. However, this does not always happen and the seller should not be misled into expecting a higher price than a sale to one who is not combining income.

3.Market Data/Comparable Method
We are all familiar with this method when used to sell homes or other real estate, but there is a wide range of values when we compare the sale of property management companies. In 1988, the Institute of Real Estate Management analyzed approximately 120 sales of property management companies throughout the United States. They came up with a “typical” median multiplier of 55% of the annual gross revenue or 6.5 times one month’s gross revenue. Although this is the median value, it should be noted that the values went the full range with the value for full-contingency sales averaging almost 100% of annual revenue. These prices were for the sale of an entire company and not just the individual contracts. The fair market value of the separate accounts would be approximately 50% of the price paid for an entire company or 2-3 times one month’s gross revenue.

VALUING A REAL ESTATE MANAGEMENT BUSINESS
Each owner of real estate management company appreciates its uniqueness as far as the staff, size of operation and its portfolio, geographic location and other elements. The methods of valuing the business discussed above look at value from different perspectives, which often result in a “wide range” of value for a specific company. It is clear that some of the steps in the process involve a degree of subjectivity and understanding of what a potential buyer is willing to pay based on the terms and conditions offered. Y

About the author
Ronald F. Hammond, CCIM, RPA, PPM is the Broker/Owner of Hammond & Hammond, Inc., a professional real estate management company in Chatsworth, CA. Ron is a nationally recognized leader in the real estate management field and is regularly consulted by attorneys and the media for his input on matters relating to real estate management.
Hammond & Hammond, Inc. is currently in the market to purchase property management accounts. If you are interested in selling all or part of your portfolio contact Ron Hammond at (818) 998-0546.

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