Intangibles in Going Concerns
Client & Valuation Perspectives
Presenter: Leslie P. Sellers MAI SRA
Objectives of Presentation
1.
2.
3.
4.
5.
Review definitions and fundamentals
Show examples of Going Concerns
Identify Clients for this type of appraisal assignments
Assist clients in understanding the requirements
Recognize that controversies exist
a) Identify where the controversy exist
b) Bring clarity with facts and personal opinions on the issues
6. Review of “some” methods with reviews and examples
7. Provide resources for further study
8. Provide framework for moving forward
Definitions
• Going Concern: A going concern is an established and
operating business with an indefinite future life. For certain
types of property (e.g., hotels and motels, restaurants,
bowling alleys, manufacturing enterprises, athletic clubs, land
fills), the physical real property assets are integral parts of an
on-going business. (The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 63)
• NOTE: Going Concern is an entity description – not a value
(e.g. ‘going concern value’ in NOT an appropriate term)
-Market value of a going concern
-Market value of total assets of the business
-Market value of specified assets of the business (must specify)
Definitions
• Real Property Characteristics: Items that have been installed
or attached to the land or building in a permanent manner. All
real estate improvements were once personal property; when
attached to the land, they become real estate.
Examples:
Land
Buildings
Fixtures e.g. plumbing, lighting, HVAC, etc.
(The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 7)
Definitions
• Personal Property Characteristics: Movable items of property
that are not permanently affixed to, or part of, the real estate.
Personal property is not endowed with the rights of real
property ownership.
Examples:
Furniture and furnishings not built into the structure
Equipment installed by the tenant under specific lease terms
removable at end of the lease
(The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 7)
Definitions
• Intangible Asset Characteristics: Those assets that are not tangible
real property, tangible personal property, or financial assets. An
intangible is something that is not material, not corporeal, not
substantially real.
Examples:
Franchises and licenses
Good will
Skilled workforce
(The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 7)
Definitions
• Intangible Business Value: Whenever the income to a property includes
payments for goods or services other than real property rents, the
property potentially includes non-real property assets that needed to be
addressed appropriately. The presence of services that generate income
over and above rent on the real property may create intangible property
value.
(The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 703)
•
Nomenclature is abundant in real world:
–
–
–
–
–
–
–
Intangible Business Value …aka
Intangible Personal Property …aka
Business Enterprise Value …aka
Enterprise Value …aka
Blue Sky …aka (more appropriate for only good will)
Business Value …aka…XXXXXX
Economic Profit …….
Definitions
Source:(The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, Illinois, U.S., 2013, page 705)
Examples
Examples
Typical Clients
•
•
•
•
•
•
•
Owners of Going Concerns
Buyers of Going Concerns
Accountants and Auditors (VFR)
REITS, Pension Funds, Insurance Companies
Attorneys, Property Assessors
SBA Lenders if a “Qualified Source”
Commercial Banks, Credit Unions (Federally Regulated)
Typical Clients
•
•
•
•
•
•
•
Owners of Going Concerns
Buyers of Going Concerns
Accountants and Auditors (VFR)
REITS, Pension Funds, Insurance Companies
Attorneys, Property Assessors
SBA Lenders if a “Qualified Source”
Commercial Banks, Credit Unions (Federally Regulated)
Allocation or Not?
Allocation of Value Opinions
Standard Rule 1-2(e) requires an appraiser to:
• Identify the characteristics of the property that are relevant to the type and
definition of value and intended use of the appraisal, including;
– Any personal property, trade fixtures, or intangible items that are not real
property but are included in the appraisal.
Standard Rule 1-4(g) states:
• When personal property, trade fixtures, or intangibles are included in the
appraisal, the appraiser must analyze the effect on value of such non-real property
items. (USPAP 2014-2015, The Appraisal Foundation)
Allocation or Not?
Scope of Work Rule
1. First, appraiser must figure out problem to solve
a) Identify assignment elements (Through Consultation)
b) Standard Rule 1-2(e) identification of relevant property
characteristics (FF&E, Intangible, RE, etc.)
2. Second, determine appropriate scope of work needed to
solve the problem for the intended use and user.
• NOTE: The scope of work is the responsibility of the appraiser
according to USPAP.
Allocation or Not?
• USPAP – FAQ 193 - Question: There are also occasions when the client
does not specifically request separate valuations of non-real property assets, even
though they may be present. Is the appraiser still required to value those assets
separately?
Allocation or Not?
• Answer: No. This is a scope of work decision to be made by the
appraiser; Standards Rule 1-4(g) does not require separate appraisals of
these different types of assets. Some appraisers and users of appraisals
believe the requirement that the appraiser must analyze the effect on
value of such non-real property items in SR 1-4(g) is a requirement for the
separate appraisal of those items in all assignments. That is incorrect.
Analyzing the effect on value might be appropriately made through the
selection of comparable properties used in the sales comparison approach
or the deduction of certain line items of expense for management fees,
maintenance or replacements in the income approach, for example.
Allocation or Not?
• Standard Rule 1-4(g) to value versus to identify and analyze is
a scope of work issue.
• Appraiser must produce a “credible” work product for the
intended use.
NOTE: USPAP definition of credible is “worthy of belief.”
• The key is client communications…
Interagency Appraisal Guidelines
Interagency Appraisal Guidelines
Interagency Appraisal Guidelines
SBA Lending Guidelines
SBA Lending Guidelines
SBA Lending Guidelines
Ad valorem Property Assessment
(Attorneys and Property Assessors)
• An ad valorem tax (Latin for "according to value") is a tax
based on the value of real estate or personal property.
• “Typically” intangible business value is not a part of it.
– (Business tax is a separate tax)
– Allocation of real property and personal property is required
• Ad valorem property tax rules are on a jurisdiction-byjurisdiction basis
• Intended use and Intended User may affect the value as a
result. (Law states what is Real Property and what is not)
Ad valorem Property Assessment
(Attorneys and Property Assessors)
The Controversy
• The controversy is not the valuation of a going concern.
• The controversy is in the allocation of the component values
in two areas.
1.
Allocation of the total market value (aka - contributing value)
2.
Which method is proper for the allocation
The Controversy
• When you participate in the discussion of allocation…..
The Controversy
• Independent market value of component or allocated contributive value
of the component to the whole? Some have opinions…
• Wilson book “Going Concern Valuation”
• Wilson RICS presentation stated the “Value construct”:
• The “value construct” states for value to exist there must be:
1. Demand
2. Utility
3. Scarcity
4. Transferability (actual sales)
• Wilson conclusion:
Therefore, if one of these elements is missing
there is no value.
The Controversy
• Wilson RICS presentation:
– “Far too long we have been duped into believing because the math is
correct there must be value. That is simply not the case. Just
because an appraiser can perform a mathematical formula, such as
the Excess Earnings Method, they need to understand that if there is
no market support for that conclusion then the math becomes a
magical mathematical manipulation, and not a representation of
market participants. ”
The Controversy
• My opinion: I disagree with Wilson
– (in most cases the scope requires “allocation” or “contribution”)
– But, intended use “could” require independent market value
• Why disagree?
– The “value construct” is for “market value” (independent)
– Most cases the values are “allocations or contributing value”
– Scope of work and intended use and user are critical
– USPAP FAQ-194 – “Analyzing the effect on value might be appropriately made through
the selection of comparable properties used in the sales comparison approach or the
deduction of certain line items of expense for management fees, maintenance or
replacements in the income approach, for example.” (NOTE: does not state
comparable sales must exist)
The Controversy
• Example of accepted theory with no sales:
– We value real property interest all the time based on “the present
value of future benefits”
– What about sub leasehold or sandwich lease position value?
– “Although the market values of leased fee and leasehold positions are often said to be
“allocated” between the two (or more) interests, each interest must be valued on its
own merit. The results can then be compared with the valuation of the fee simple
interest. Because a leasehold or a leased fee interest is based on contract
rights, appraisers differentiate between lease provisions that are generally
representative of the market and other elements of a contract that are
not typical of the market.” (The Appraisal of Real Estate, 14th Ed, page 441)
The Methods
• 60+ different methods and counting…
– Many are slight variations of each other
– Appendix of Course 830 has listings and sources on all noted
• Cost – Cost Extraction
• Management Fee
• Parsing
• Market Participants
Cost Extraction Method
• Based on the extraction between Cost Approach (fee simple) and the
reconciled value from other approaches which is going concern. The
extraction is the residual business value.
• Particularly useful in situations where sales of total assets of going
concerns are the only sales available.
• Care must be taken when using this approach because cost is not always
equal to market value.
• Amount and type of depreciation existing in the asset play a role in the
effectiveness of this approach.
Source: The Appraisal of Real Estate, 14th edition, Chapter 35.
Cost Extraction Method
• A six-year-old, 90-bed assisted-living facility has an estimated market
value of the going concern equal to $6,750,000. The land value has been
estimated at $900,000, and the depreciated value of the improvements
is estimated at $5,200,000. The estimated value of FF&E is $450,000.
What is the allocated market value of the intangible assets?
Source: Course 830 Fundamentals of Separating Real Property, Personal Property, and Intangible Business Assets course materials
(Chicago: Appraisal Institute, rev. 2012)
Management Fee Method
• Based on the theory that once the revenue attributable to
intangible assets is deducted, all other remaining income is
attributable to the real property and other tangible assets.
• By removing management fees and franchise fees from the
revenue, appraisers reason that the influence of intangible assets
has been eliminated.
• Critics state flawed because:
– the value of intangible assets and rights cannot be removed by
merely deducting the related expenses from the income stream to be
capitalized; allowing a deduction for the associated expense does not
allow for a return on the capital expenditure.
Source: The Appraisal of Real Estate, 14th edition, Chapter 35.
Management Fee Method
Step 1
Management Fee Method
Step 2
Source: Adapted from the article, “Why the ‘Rushmore Approach’ is a Better Method for Valuing the Real
Property Component of a Hotel” by Stephen Rushmore, A Business Enterprise Value Anthology, 2nd ed.,
2011.
Parsing Method
• Based on the business valuation methodology called the excess earnings
method, which was developed by the US Department of Treasury in the
1920s. Parse income and expenses into different asset classes then
capitalize
• Good applicability for odd property types especially – income always
available on going concerns because that is what they generate
• Critics state flawed because:
– identification of appropriate cap rate difficult
– for using a percentage deduction from income to quantify the value of both the
franchise and residual intangibles.
– the deductions for a return on the various components of the going concern, which
create an opportunity for double-counting unless caution is exercised by the appraiser.
– Must be careful with parsing “priorities” in the factors of production
Source: Critics statements are taken from The Appraisal of Real Estate,
14th edition, Chapter 35 on all but the last bullet point which is added by
the author.
Parsing Method
Step 1
Source: Appraisal Institute Course 830 – Fundamentals of Separating Real Property, Personal
Property, and Intangible Business Assets, rev. 2012.
Parsing Method
Step 2
Market Participants Method
• Based on the interviews with market participants and, in some cases,
regulatory filings may be used to assist in understanding value allocated
to intangibles on sales.
• Appraisers interview market participants to ascertain how buyers and
sellers of those properties value or allocate intangible assets in pricing
decisions. Goal is to determine the thinking of market participants on
these issues
• Critics say flawed because:
– survey responses of buyers and sellers may be influenced by tax or financial
considerations
– Buyers and sellers may not have a need or motivation to allocate
– Not really a method at all but only part of normal verification requirements of
standards
Source: The Appraisal of Real Estate, 14th edition, Chapter 35.
Valuation Resources
Appraisal Institute Lum Library
Valuation Resources
Other Sources
Valuation Resources
Other Sources – Appraisal Institute Course 830
• Has 3 Main Goals (Teaching points)
1. Recognize Indicators that BV may exist
2. Recognize how BV changes over time
3. Goes over basic allocation methodologies
Proposed Framework for Solutions
Advancing with 8 agreed principles
1. Rights supported by contracts versus real property
generally have higher risk (all other being the same)
2. Investment premise requires return on and return of the investment
3. Going concern premise means contributing value of the whole versus
independent value for each part
4. Method used for allocation should pass test of reasonableness
5. Encourage more than one method and reconcile when possible
6. No black boxes and no rules of thumb (Daubert)
7. Each property analyzed independently based on merits
8. Professional responsibility for proper application of the methodology
Questions & Answers