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How does one truly define value? According to the IRS, the standard of value is Fair Market Value, which is defined as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
By Scott Wright, director of mergers and acquisitions
In simple terms, this definition says, “you’re only worth as much as what somebody is willing to pay.” At REAL Trends, our goal as valuators is to determine this worth. There is a myriad of factors that go into this process.
Before these factors are considered; however, it’s important to recognize the precarious nature of the residential real estate brokerage business. This is a business where the primary asset is not a tangible product, but rather an independent contractor sales professional who may freely move from one brokerage to another. Add this to the fact that the housing market is subject to a high degree of seasonality and cyclicality, and it is only then that you can establish a baseline upon which to build value. Thankfully, despite the overlying risks associated with this industry, brokerages are still marketable businesses with transactional value.
One of the first major factors we consider is financial performance. We always look at a multi-year trend, but what matters the most is the performance over the last 12 months. It is this performance that guides the approach to valuation, with the most common these days being the Income Approach.
Size and Concentration of Sales
Some other factors that naturally affect marketability are size and concentration of sales, which often go hand-in-hand. Larger brokerage firms are usually going to have a premium over smaller firms, all things being equal. With a large firm, there are more sales associates and thus a greater volume of transactions, which often leads to a more robust cash flow. With a larger volume of transactions spread across a larger agent pool, you also don’t typically run into concentration of sales issues. The loss of a top agent or team has much more of an impact on smaller brokerage firms.
Location and Competition
Location and competition are other factors to consider when applying the value. Firms in larger metropolitan areas will typically get a premium simply because there is more inventory and, in all likelihood, a lot more market share to gain. Also, the bigger the city or region serviced the more competition. More competition means more available buyers.
Availability of Buyers
Not surprisingly, the availability of buyers is one of the more important factors that affects marketability. The fewer available buyers; the more a firm’s value can be discounted. Remember, you are only worth as much as someone is willing to pay. And, it is this willingness to pay that is hands down the most important factor that drives value. Doing what we do on the mergers and acquisition front allows us to see what the buyers are actually paying to buy brokerage firms. This knowledge is invaluable and allows us to pin down Fair Market Value.
There are, of course, many other factors that we consider in the valuation process, including compatibility, brand, culture, leadership, economy and longevity. The bottom line is the factors mentioned above and more are all taken into account when determining value.
At REAL Trends, thousands of brokers have trusted us to conduct their valuations. Whether it’s for the sale of the company, the sale of partial shareholder interest, insurance, estate, legal or partnership issues, business planning, or simply wanting to know what your firm is worth, you can count on REAL Trends to be your trusted source.
This article originally appeared in the February 2017 issue of the REAL Trends Newsletter and is reprinted with permission of REAL Trends Inc. Copyright 2017