Real Estate in Business Valuation: Operational or not?
When valuing a company, real estate frequently plays a significant role. It is important to determine whether this real estate is operationally bound or non-operational. This distinction has a major impact on the valuation and the final value of the company.
Operational versus Non-operational Real Estate
Operationally bound real estate is closely intertwined with the company’s operations and business activities. Examples include a marina, golf course, or indoor swimming pool. These assets cannot easily be used for other purposes, and the business cannot be relocated to another location without significant problems.
Non-operational real estate, on the other hand, can be relatively easily repurposed for other activities. An office housing an architectural firm, for example, could also be used by a law firm or an internet company. Moreover, the business can relocate to another location without major issues.
Impact on Business Valuation
The distinction between operational and non-operational real estate is important because the risk and liquidation value of the real estate differ from those of the operations themselves. With operationally bound real estate, the risk of the property exploitation equals that of the business operations. For example, when a swimming pool or golf course operates at a loss, this directly affects the value of the associated real estate. However, when an architectural firm is not profitable, the value of its real estate remains largely dependent on the office space market.
Valuation of Operationally Bound Real Estate
When valuing a company with operationally bound real estate, the free cash flows of the company, or the consolidated free cash flows if the real estate is held in a separate entity, are used. This approach is often necessary for tax purposes and may also be relevant for bank financing.
In situations where it is less clear whether the real estate is operationally bound, such as with certain factories with specific machinery, it is advisable to engage a real estate expert. They can help determine the property’s value without rent or use, as well as the expected time for sale or lease.
Conclusion
The distinction between operational and non-operational real estate is crucial for accurate business valuation. This determines not only the valuation method to be used but also the risk profile and liquidation value of the company. Engaging a real estate expert can often be valuable in obtaining a thorough and well-supported valuation.