Knowing When you Can be Better Served by a More In-depth Valuation Expert
While any type of commercial property appraisal is a multifaceted task, going-concern appraisals of special purpose properties are particularly complex. Distinguishing between a generalist appraiser, and a going-concern appraiser is tricky, as there is no official certification or affiliation that recognizes their expertise. However, experience in going- concern valuation is crucial, as the valuation process is so strikingly different than a simple cost or sales comparison appraisal.
Going-concern value is defined as the value created by a proven property operation; it includes the incremental value associated with the business concern, which is distinct from the value of the real estate. Going-Concern value includes an intangible enhancement of value of an operating business enterprise, which is produced by the assemblage of the land, building, labor, equipment, and marketing operation. This assemblage creates an economically viable business that is expected to continue.
Going Concern Valuation VS General Valuation
Going-concern appraisals evaluate the market value of the real estate, operating business, and machinery and equipment, owned by the same entity, generally with an indefinite lifespan. A thorough valuation considers real estate along with the tangible and intangible assets associated with the business. It is the going-concern appraiser’s task to objectively determine if business operations support the real estate and related tangible and intangible assets, i.e. highest and best use. If the business cannot generate sufficient cash flow to cover its real property assets, then the land may be better served by a different use.
Going-concern appraisals present a unique challenge, as the appraiser must assess whether the cash flow from business operations is sufficient to sustain the overall cost of operation. A going-concern appraiser not only evaluates building, land, equipment and intangible assets, they must also determine how the respective health of the business contributes to the overall value. Factors that contribute to the maximum utility of the real estate include, type of business, location, neighborhood demographics, traffic, existing competition, and so on.
Most generalist appraisers value going-concerns using traditional valuation approaches including cost, sales, and income, but could do so inappropriately leading to an inaccurate valuation. A going-concern valuation demands an appraiser to have expertise in the valuation approaches used by market participants, such as brokers and owner-operators.
When assessing a going-concern, such as a gas station, the appraiser begins by first considering the cost of the land and improvements from the ground up in formatting a cost approach similar to what a generalist appraiser would do for any commercial property. Depreciated costs (including any functional and or external obsolescence) are used to support allocation to real property assets such as land, fueling station, removable M & E (Machinery and Equipment), and building and site improvements. For the most part, a generalist appraiser performs the cost approach valuation based on available manuals with little knowledge of fueling systems and costs for necessary M & E. Generalist appraisers do not have access to actual gas station costs and cannot reasonably support or identify functional and or external obsolescence, as a going-concern appraiser would.
A going-concern appraiser will employ a sales comparison approach based on sold fee simple real estate including an operating business. Sales comparison is a useful tool in determining the value of the real estate as well as the going-concern. However, most generalists incorrectly employ this approach by using a per unit analysis such as price per building square foot or price per pump. Operating gas stations are purchased based on volume and cash flow potential, not physical units of comparison. As an example you have two gas stations that are physically the same but one has twice the volume and cash flow as the other. The generalist appraiser’s analysis on a physical per unit basis would not take into consideration the added value attributed to higher volumes and cash flow. The appraiser should mirror the market and value going-concerns based on cash flow and volume relationships as do buyers and sellers.
Lastly, and what is arguably the most crucial difference between a generalist appraiser and going-concern specialist, is their ability to evaluate business cash flow in the income approach. In going-concern valuation, the business operations include a return on the real estate, removable M & E, and the business. Most generalist appraisers when employing an income approach on a gas station tend to use the income the property would generate if leased, and not the actual cash flow being generated by the business operator. Capitalizing income from real estate only (i.e. leased gas station rents) is not a sound methodology as it excludes income attributable to removable M & E and operating business. Furthermore, the subject property is not leased and should not be compared to leased real estate. It is critical that the appraiser keep the interests of the appraised property the same as the comparables. An appraiser experienced in going-concern valuation will have the background knowledge to accurately assign income and value to real estate, business (intangible assets), and removable M & E.
Generalist appraisers may face challenges or simply overlook necessary information for an accurate income approach valuation. Factors such as type of business, ownership interest, and financial ratios, are often ignored by generalist appraisers.
In leased fee valuation the appraised assets are those owned by the landlord and typically include land, fueling station, and improvements with the tenant owning the business and any related M & E. A leasehold valuation would include the tenant’s business and M & E. A going-concern appraiser must consider factors including lease terms, tenant credit rating, tenant cash flow, and M & E assets, where applicable. A going-concern appraiser relies on cash flow statements and lease terms to provide accurate valuations.
Consider a hypothetical operating gas station in a wealthy beach town. A cost approach would ascribe a premium to the real estate due to high underlying land, materials, permitting, and labor costs. A per unit analysis may also assign similar premiums. But how does one know the cash flow from the operating gas station is sufficient to support the high underlying land and improvement values as arrived at by cost approach? When does the gas station represent an interim use, meaning the improvements are near the end of their economic life? Without expert analyses of volume, income, and expenses of the operating business these questions cannot be answered and the appraiser cannot render credible results or support highest and best use. Simply stated, gas station use is considered the highest and best use when when capitalized going-concern cash flow yields a value in excess of depreciated cost.
Because going-concern appraisal of special purpose property is so meticulous, the accuracy of the valuation is best served by an appraiser with expertise in this field. Just as you wouldn’t hire a psychologist for dental work, a going-concern appraiser’s knowledge spares everybody from having to reevaluate the property, or unknowingly rely on improper valuation of real estate, business, and removable M & E.