Understanding the value of your business is vital. Not only is it needed if you were considering selling your funeral home or cemetery, but it is also important to know to operate strategically and efficiently. One of the major components in your valuation is the property value. We asked Senior M&A Analyst, Jarod Bernat to further elaborate on this significant element of your business valuation.
Question: Why do you value my property at “X” amount in your valuation when surrounding commercial real estate is worth X+100?
Jarod Bernat: Real estate values seem like a straightforward topic since it is public record to see the exact sales price of recently sold comparable properties in your market. Thus, it would make sense to think your property would be comparable to those in value. However, this real estate value is decided by the market’s desire and ability to pay, called the “Fair Market Value”. This means the property is valued based upon its “highest and best use”. Because a funeral home may not be the most profitable use of a property, we cannot use the “Highest and Best Use” real estate value in a valuation of a funeral home business. In this case, we instead must use a “Special-Use” valuation.
A “Special-Use” valuation assigns value to the real estate based on the amount of revenue the tenant business is able to produce. Specifically, for the funeral industry, we know it is widely accepted that a standard “triple-net lease” can be charged at 8% of the total revenue produced by a business in a year. Then, multiplying the year’s rent by a capitalization rate of 10x, this gives us the “Special-Use” value of the real estate at 80% of total revenue. Therefore, businesses in high-priced real estate markets often include significantly lower real estate values as part of the business valuation due to a funeral home not being able to produce as much revenue as other businesses could by occupying the same space.
For example, let’s say a luxury apartment building can be built in the same space as your funeral home, but the apartment would produce five times the annual revenue of that same space. It would be unfair to assign that funeral home business the same real estate value as you would to the apartment building in an apartment business valuation. The rising value of real estate nationwide throughout the pandemic made this extraordinarily apparent in this industry, as many funeral homes were deciding to close their doors and sell the real estate off to condominium and apartment enterprises.
Another way to think of this is, based on the business operating out of a building, will the cash flows of that business cover the loan costs to purchase the building? In the case of a funeral home which often is not the highest revenue producing business that can be operated in any space, the cash flow may not cover the cost of purchasing a business at its “Highest and Best Use” fair market value.
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