I have built quite a few real estate models. Most have to do with underwriting property and driving down to NOI, exit value, DCF Analysis, and cash-on-cash return after IRR hurdle waterfalls. However, I have also done a real estate brokerage feasibility model that looks at the operational side and drives fee revenues based on volume of properties closed over time / all the commission splits, has operating expense assumptions...…and a valuation at exit. Here today I'm going to talk about some general rules of thumb when valuing a real estate brokerage.
Real estate brokerages can use a variety of valuation methods to determine the value of their business. If you are trying to buy a brokerage, or sell one, here are some common methods to look into:
- Income approach: This method values a business based on the income it generates. To use this method, the brokerage would estimate its future income (annual), apply a capitalization rate to that income, and divide the annualized income by the cap rate to arrive at a valuation. This is often used to value property, but can be used for a business that produces steady cash flows. More on this:
- Focuses on the income generated by the business as the primary driver of its value.
- To use the income approach, the brokerage first estimates its future income based on historical data, market trends, and other relevant factors (you can use a financial model). Once you come up with an annual income amount you think the brokerage can produce in the next 12 months, apply a cap rate to that.
- The capitalization rate is a rate of return that investors would expect to receive on their investment in the business. It is typically based on the risk associated with the business and the expected rate of return in the market.
- Once the capitalization rate is determined, the future income is divided by the rate to arrive at the estimated present value of the business.
- The income approach is useful in valuing businesses that generate significant income and have a proven track record of stable cash flows. However, it is less useful for businesses that are highly cyclical, have significant seasonality, or have uncertain future cash flows. It is important to use the income approach in conjunction with other valuation methods to arrive at an accurate estimate of a business's value.
- Market approach: This method values a business based on what similar businesses are selling for in the market. To use this method, the brokerage would research recent sales of similar brokerages and use those sales prices to estimate the value of the business.
- Asset approach: This method values a business based on the value of its assets, including real estate, equipment, and other tangible assets. To use this method, the brokerage would value its assets and subtract any liabilities to arrive at a net asset value. This is pretty simple if you look at the current financial statements of the business and do some simple math. Performing due diligence on the numbers you are seeing is another story and important to do as well.
- Discounted cash flow: This method estimates the present value of future cash flows of the business. This method is more commonly used in the valuation of companies as a whole, but can also be used for real estate brokerages. Note, you will first need a financial forecasting model that needs to be filled out in order to see the expected cash flows based on a wide range of operational assumptions.
- Rule of thumb: This is a simple method of valuation that uses a multiple of annual revenue or net income to estimate the value of a business. This method is less accurate than the others mentioned above, but can be useful as a starting point for valuation. I use this in most of the forecasting models you will find on the site that are for general brick-and-mortar or e-commerce businesses.
It's important to note that the most appropriate valuation method will depend on the specific characteristics of the brokerage and the purpose of the valuation. It's recommended to consult with a professional business appraiser or accountant to determine the most suitable valuation method.
Due Diligence
- Financial records: Reviewing the financial records of the brokerage is crucial to understanding its financial health and profitability. You should review financial statements, tax returns, bank statements, and other relevant financial documents. Understanding these figures is important for the income valuation approach.
- Client base: Understanding the client base of the brokerage is important as it can impact future revenue streams. You should review client lists, contracts, and marketing materials to determine the type of clients the brokerage serves and their loyalty to the brokerage.
- Sales history: Examining the sales history of the brokerage can provide insight into its sales volume, market share, and growth potential. You should review sales records, sales contracts, and commission agreements to gain a thorough understanding of the brokerage's sales history. This is another important piece to use when creating a forecasting model for the business you are trying to buy.
- Licensing and permits: Ensuring that the brokerage has all necessary licenses and permits to operate in its jurisdiction is important to avoid potential legal issues. You should review all licenses and permits, including real estate broker licenses, business licenses, and professional liability insurance policies.
- Reputation: The reputation of the brokerage is important as it can impact future revenue streams. You should research the brokerage's online reviews, testimonials, and referrals to understand the level of customer satisfaction and brand recognition.
- Employee and agent contracts: Reviewing the contracts of employees and agents can provide insight into the brokerage's personnel management practices and potential liabilities. You should review employment contracts, independent contractor agreements, and commission agreements to understand the terms and conditions of these agreements.
- Employee / Agent Retention: Are the agents happy there and have they been there a long time? This is an important stability measure.
- Market and competition: Understanding the market and competition in the area where the brokerage operates is important to assess growth potential and identify potential threats. You should review market data, competitor information, and marketing strategies to understand the brokerage's competitive position in the market.
- Technology and systems: The technology and systems used by the brokerage can impact its efficiency and profitability. You should review the brokerage's website, CRM systems, and marketing platforms to understand the level of technology and automation utilized. This can be a good source of value-add if good systems are not in place.
You may also be interested in a property management financial model.
Article found in Real Estate.
