How to model real estate cost with business?

June 30, 2021

by a searcher from The University of Michigan - Stephen M. Ross School of Business in Rockford, MI, USA

I have a business under LOI and I'm planning to buy the real estate along with the business. I'm curious to hear how people model real estate cost into the deal. For example, if you had been looking at an asset purchase of a business for $1M at a 3X EBITDA multiple ($333K EBITDA), and the real estate costs $333K, how would the combined $1.333M price tag be viewed? A total of business valuation of 4X EBITDA? Or a 3X business valuation + real estate, with the real estate portion being viewed in a different light from business operations?

The main reason I'm asking is thinking about modeling returns for equity holders.

5 Likes

25 Replies

315 Views

Replies

Reply by a searcher
from University of Pennsylvania in Chicago, IL, USA

Peter - The real estate is an asset that must be approached in a separate valuation and has different risks than the business - in some cases, the real estate can be a better long term investment than the business itself! It can also be an unwanted asset that a seller is trying to unload. So to clarify - look at it completely independently - as if you were buying the real estate alone. Could you lease it quickly if it were an empty box? For industrial, things like ceiling height, access from interstates, loading docks really matter. Landlord Capex varies widely across asset types: Office/Industrial/Retail. Office and Retail typically incur a lot of landlord concessions to build out spaces to meet tenant preferences. Industrial - it is mainly roof / parking lot / HVAC for capex - but those expenses can be allocated to the tenant in an absolute net lease.

In a different comment, capitalization of NOI was described as a valuation method. Definitely - but keep in mind cap rates are tied to the credit of the underlying tenant. For search type businesses, cap rates are going to be higher, driving real estate value lower (all else equal). Think Chick-fil-a vs. a local restaurant with 1 location - the value of those two leases are very different. If you are going to buy the real estate - first ensure it passes the common sense test: "Do I want to own real estate in location XYZ?" If yes, then get a broker opinion of value, or a full appraisal from someone that knows both the metro area and submarket and use this as a basis of negotiation. Bundling business + real estate often gives you a superior negotiating position in relation to buyers that only want the business.

Reply by a searcher
from University of Southern California in Orange County, CA, USA

Peter, lots of good advice I agree with above. One thing that hasn’t been mentioned which I think is an important consideration: are you able to realize any value arbitrage by buying the business and real estate simultaneously? Sellers can often be very motivated to sell everything together. You can always acquire the assets into a one or separate entities, depending on what is in your best interest (the SBA extended amortization is pretty compelling IMO), even within one asset purchase agreement. Owner-occupied real estate can often be undervalued - you should base your valuation off of market rents for comparable properties. If there is no arbitrage opportunity and no ability to realize extended amortization I would question whether it makes sense to buy the real estate especially if you can negotiate a right to purchase or right of first refusal into the lease agreement.

+23 more replies.

Join the discussion