What valuation methods should I be using to value a real estate company?
What valuation methods should I be using to value a real estate company? How do I gather data for this?
I would recommend working with one or more specialists for the type of Real Estate Company that you are considering. Be aware that some experts may have connections that give them a bias or potential conflict of interest. More specific information would be helpful, but I hope the following ideas offer some perspective.
Look at current yields and potential returns over time. Make sure you consider the risks of the company. If you like real estate specifically compare these and other metrics to competitors. The more the competition is in the same area and types of underlying properties the more useful the comparison is.
If a competitor has a lower yield that could mean you found a bargain, but it could also mean that your company has much higher risk. (And vice versa) Assuming you can afford to lose some or all the investment, Risk is fine as long as you may be compensated for it. Risk cuts both ways. It can increase your potential returns, but it can also increase the chances and severity of losing money.
Is the company diversified? Having exposure to different sectors of real estate can lower risks if management has expertise in multiple areas. One sector can underperform without it being the only source of return. Is the company invested in a few large projects where the failure of one has a huge impact on the company? Or a lot of smaller ones? Diversification both across and within real estate types can lower your risk.
Learn about the specifics of the type of real estate. A few oversimplified examples. For rental properties things like occupancy rates, upkeep costs, property ages and management effectiveness. For new home builders you might focus on profit margin, average inventory turnover, cost of debt, average build time. Real estate evaluation methods have some commonalities but are very specific and tailored to their types. Understand enough of these kinds of details to poke a few holes into the story of any sales pitch.
If the company is private you may have to commit to a significant time period without the ability to get any of your money back. If you can get your investment back it may be through a complicated process at a discount before the underlying projects have had a chance to bear fruit. (Comparing a private company to a public one is much less meaningful.) You should generally expect to earn a higher return from a private investment for a lot of reasons including the illiquidity of your ownership stake.
If you feel that the company is underappreciated it may be undervalued. It is difficult to have genuine insight that the valuation experts don’t. If you do possess this insight you can earn higher returns relative to that average market. Keep in mind lots of experts are always looking.
David Nash, CFA, CFP®
Unfortunately, there is no easy answer to this question. Business valuation is a specialty that relatively few CPAs, and even fewer financial advisors, are qualified to do. In my practice as a divorce financial consultant, I often use the work product of a business valuator and am familiar with the details, research, and alternative methods of valuation they must consider before forming their conclusions. It's complicated. The professional you need will have at least one of the following credentials: ABV (Accredited in Business Valuation), CVA (Certified Valuation Analyst) or AVA (Accredited Valuation Analyst).
You don't mention exactly why you need a valuation or if the business is your own. In any event, if a valuation is important enough to do, then I believe it is important enough to do it right. Find a professional business valuator in your area.
Consider valuing it based on yield. Yield is the net rental income (after property taxes and insurance) divided by the fair market value of the property. A high yield means that the price of the real estate is attractive. For example, when I was doing real estate in 2008, yields were at 15%! This means, you could buy property extremely cheap. Now, yields are 4%. When you look at real estate through the lens of yield and compare to other choices and historical numbers, you are able to make a better business decision.