Added value
Does the profits method of valuing pubs gauge the property or the business value? Robert May explains the subtle differences.
There are some trading properties, including pubs, which are valued by direct comparison of earnings potential. The use of Profit & Loss (P&L) accounts by property valuers to assess open-market values and open-market rents has led the Trade-related Valuation Group of the Royal Institution of Chartered Surveyors (RICS) to review guidance to its members.
In addition to RICS property valuers there is another community of business valuers; typically accountants practising brokerage of businesses which are going concerns and advising on action for businesses with trading difficulties. For both types of professional, the best measure of value is derived from understanding a P&L account.
This enables the business valuer to assess the affordability of the present business and the property valuer to consider market value by constructing a P&L that reflects its projected earnings. This takes into account the lease, terms of trading, competition, communications and customer behaviours for the property.
Property valuers assess their valuations by constructing a P&L account for the future maintainable business. Such accounts must be constructed using a recognised accounting approach, and the valuer must therefore have some accounting skills as well as property knowledge.
There are three distinctions to be made between property valuation and business valuation:
- the entirety of the business including current assets and liabilities
- the property valuation hypotheses - the forward view
- the availability of specific comparables, and consideration of alternative uses.
The entirety of the business
The business valuer looks at the whole of the business. This is based on past accounts including factors such as how they run the business, including their financing, tax treatment, current assets and current liabilities.
A business valuer does not use a hypothetical P&L. He or she will start from the actual accounts and assume that the present business can be sold "lock, stock & barrel" on that basis. The valuer's opinion is then used to set a multiplier of net profit, or an internal rate of return, adjusted downwards if they think that the current profits would not be sustainable, or upwards where maybe more than one bidder would recognise growth potential in a poor-performing business.
The property valuation hypotheses
Property valuers use the concept of the hypothetical "reasonably efficient operator" running the property as it stands. They assume it is fully fitted, properly repaired, ready to trade and with the benefit of adequate working capital.
The actual trading accounts are only a guide as the property valuation is essentially forward looking, having little regard to the accounts of the vendor and greater regard to the views of the prospective purchaser.
The potential for future profits is known as goodwill. There are two types of goodwill - personal and inherent.
The property valuer seeks to ensure that only inherent goodwill is reflected in the property valuation. The RICS guidance defines this as: "A market-based concept whereby a potential purchaser and thus the valuer, estimates the maintainable level of trade and future profitability that can be achieved by a competent operator of a business conducted on the premises, acting in an efficient manner.
The concept involves the trading potential rather than the actual level of trade under the existing ownership so it excludes personal goodwill."
The business valuer would include the personal goodwill of the proprietor when assessing the value of the going concern, a property valuer would not.
Use of comparables
Property valuers base their understanding of the market on actual previous deals done between buyers and sellers or between landlords and lessees, called comparables. Business valuers don't use comparables in this way. They use the current cost of money, adjusted for perceived risks and opportunities attaching to that class of business and to the actual P&L accounts for the present business.
The property valuer should also consider whether any alternative use of the property would give a higher value, unless the instruction specifically excludes other uses - such as in a lease rent review. Lease rent comparables will need to be properly adjusted if lease terms for liquor and machine ties, for example, are different.
Conclusion
Business valuers may consider whether the current business is affordable at the proposed cost of purchase or rent, even if that person is a poor- quality operator, insufficiently invested or is putting the business to a strange use.
Property valuers do not look for the affordable P&L for any one particular person; their valuations are based on the best use of the property and the P&L account in the hands of a new bidder creating a new P&L.
The profits method is just a means to an end - a tool that can be used to value either the business or the trading property, knowing that the value of the business and of the trading property will not necessarily be the same.
- Robert May is chair of the RICS Trade-related Valuation Group.
The Cott Inn is held on a Greene King lease at a current rent of £75,000 per annum and agent Bettesworths is seeking offers of £299,950 for the leasehold interest. Call 01803 212142 for details.
