PE Valuation - Profits Method Flashcards
Is the profits method used for specialist or specialised properties?
Specialist
What type of properties might you use the profits method for?
Fuel stations
Hotels
Pubs
Healthcare
Care homes
Does the RICS provide any guidance on profits valuations?
Lots - Guidance Note on Capital & rental valuations of public houses, bars, restaurants and nightclubs, Red Book Global and UK
Why would you use the profits method?
Because the property is a trading entity or occupies a monopoly position
What does a profits valuation include?
Land and buildings
Trade fixtures, fittings, furniture and equipment
Market’s perception of the trading potential, together with an assumed ability to obtain or renew existing licences, consents and certificates
What is another name for the goodwill relates to the business profitability?
Intangible goodwill
What is turnover?
Total income/revenue/sales
What is the first step in a profits valuation?
Assess Fair Maintainable Turnover (FMT) generated by a Reasonably Efficient Operator (REO)
What is Fair Maintainable Turover (FMT)?
The level of trade that an REO would expect to achieve on the assumption that the property is properly equipped, repaired, maintained and decorated
What is a Reasonable Efficient Operator (REO)?
A concept where the valuer assumes that the market participants are competent operators, acting in an efficient manner, of a business conducted on the premises.
It involves estimating the trading potential rather than adopting the actual level of trade under the existing ownership, and it excludes personal goodwill
Does the assessment of the REO include both personal goodwill and trading potential?
Only trading potential
What is personal goodwill?
The value of profit generated over and above market expectations that would be extinguished upon sale of the trade related property, together with financial factors related specifically to the current operator of the business, such as taxation, depreciation policy, borrowing costs and the capital invested in the business
What is trading potential?
The future profit, in the context of a valuation of the property, that an REO would expect to be able to realise from occupation of the property
If you are valuing a Michelin star restaurant would the current operator form the basis of your assessment of the REO?
No - you would look at who would be the most likely operator/purchaser in the open market
What is Fair Maintainable Operating Profit (FMOP)?
The level of profit, stated prior to depreciation and finance costs relating to the asset itself (and rent, if leasehold), that a reasonably efficient operator (REO) would expect to derive from the FMT based on an assessment of the market’s perception of the potential earnings of the property
What is the second step in a profits valuation?
Assess potential gross profit, resulting from the Fair Maintainable Turnover (FMT) and then assess Fair Maintainable Operating Profit (FMOP)
What shoudl FMOP reflect?
It should reflect all of the costs and outgoings of the REO and an appropriate annual allowance for periodic expenditure such as deterioration, refurbishment and renewal of the trade inventory
What does EBITDA stand for?
Earnings before interest, taxes, depreciation and amortisation
What is EBITDA?
A term that relates to the actual operating entity and may be different from the valuer’s estimated FMOP
How would you assess the market rent?
Make an allowance from FMOP to reflect return on tenant’s capital invested in the operational entity (e.g. cost of trade inventory, stock and working capital), the remaining sum if the divisable balance which is split between the landlord (i.e. rent) and tenant
What is the third step in a profits valuation?
Capitalise the FMOP at an appropriate rate of return (mutliplier/YP) to find Market Value
What might affect the level of rent?
Attractiveness and style of property
Availability of finance
Economic and regulatory matters
Length of lease and lease terms
Location
Provision of domestic accommodation
Quantum of profit
Supply of similar properties
Surplus or obsolescent accommodation/amenities
Terms of, and restrictions on, trading
Trading potential and risk
Type of operation
How do you know what multiplier to capitalise FMOP with?
Comparable evidence and market knowledge
How coudl you value a non-trading pub?
RLV if it has development potential
Sales comparison (based on land values)
What type of accounts would you need to request?
Ideally at least 3 years’ audited accounts
