Mixed commercial valuation

Common Mistakes

 Lack of Data

 Going Concern Valuation

 FFE Allocation

 Unloaded Cap Rate

 Wrong Approach to Value

Lack of Data

 Actual historical Income and Expense

 Comparable I&E information
 Hospitality specific Ch. 91’s
Going Concern Valuation

AKA Business Value

Operator Affect
Deduction from Net Income
Furniture, Fixture, and Equipment

 Return of
 Return on
Capitalization Rate

 Removal of Property Taxes from Expenses

 Inclusion of tax rate into typical cap rate

 Only Ad Valorem and Tax Appeal

Wrong Approach

Income Approach
Income Approach
Income Approach
Everything else is a benchmark
Other then Rushmore

 Rushmore did not invent the income approach or the valuation model, he

expanded it, applied it, documented it with expertise

 The Appraisal of an Amusement Park by Russell R. Rogers, The Appraisal

Journal, April 1951

 Restaurant Valuation by Brock J. Rule, MAI, The Appraisal Journal, Spring

2014
 1951
• Amusement Park article quotes
• “….enterprise would be evaluated almost
entirely on the basis of the capitalized value of
its stabilized income”
• “Moreover, the reproduction cost of a
concession or ride was found to have little or, in
some cases, no relation to value….”
 Brock J. Rule, MAI

 Calls it “Excess Earnings Method”.

 All about the income approach applied the same way as Rushmore

does it: difference is language

 Cost approach is not a good measure of value

 Sales comparison approach useful for benchmarks

Definition of market value
Market value is defined as the most probable price which a property should bring in a competitive and open
market under all conditions requisite to a fair sale, the buyer and seller each acting prudently,
knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the
consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions
whereby:
 
 Buyer and seller are typically motivated;

 Both parties are well informed or well advised, and acting in what they consider their own best interests;
 
 A reasonable time is allowed for exposure in the open market;

 Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable
thereto; and
 
 The price represents the normal consideration for the property sold unaffected by special or creative
financing or sales concessions granted by anyone associated with the sale.

The Office of the Controller of Currency under 12 CFR, Part 34, Subpart C-Appraisals 34.42Definitions [g]
What are the property rights?

 Land use regulation - zoning

 If there is a liquor license, it expands the property rights beyond existing
zoning
 If there is a riparian license, that expands the property rights
 If there was a variance granted or it is a legal, non-conforming use, property
rights are expanded
Consistent Use Theory

The principal of consistent use holds that

land cannot be valued based on one use while
the improvements are valued based on
another.

The Appraisal of Real Estate, 14th Edition, pp. 345-346

Valuation Rationale
“Restaurants are retail businesses that create and
dispense a product from a specific location. The elements
that make up an operating restaurant include land,
building, furniture, fixtures, and equipment, business,
and operating supplies. The appraiser must first identify
the element to be included in the valuation and
determine how they affect the valuation process.”
(Hotels, Motels, and Restaurants, Valuations and Market Studies, Stephan
Rushmore, MAI, The Appraisal Institute, page 269)
Valuation Rationale (continued)
The three traditional approaches to value described in the prior section are
considered.

“Of the three approaches to value, the cost approach

probably yields the least reliable indication of a
restaurant’s value. Restaurants, like hotels, are income-
producing properties purchased to realize future profits,
so reproduction cost often bears little relation to a
restaurant’s value.”
(Hotels, Motels, and Restaurants, Valuations and Market Studies, Stephen
Rushmore, MAI, The Appraisal Institute, page 271)
Valuation Rationale (continued)
(The sales) “This approach will provide a reliable
indication of value if sufficient data on similar
properties are available….The common units of
comparison for a restaurant are value per
restaurant (total price) and value per seat”
(Ibid)
Valuation Rationale (continued)

“The income capitalization approach generally is preferred for valuing

income-producing properties because it reflects the usual rationale of
investors.”
 
“By estimating the total revenue of a restaurant and applying the appropriate
percentage rent, the appraiser can project a market rent to be capitalized
into real estate value.”

(Hotels, Motels, and Restaurants, Valuations and Market Studies, Stephen

Rushmore, MAI, The Appraisal Institute, page 271-272)
Valuation Rationale (continued)

“Rent is the income required to service the real estate assets (irrespective of
whether the property is actually leased or not).”

(Restaurant Valuation, Brock Rule, MAI, The Appraisal Journal, Spring 2014, page
119)
My valuation rationale conclusion

Income producing = Income Approach

Cost Approach fails to capture value

Sales Approach is a real world test

Questions?
Restaurant sales Amount Percent
Food $2,000,000 73%
Beverage $750,000 27%
Total sales $2,750,000 100%
Cost of sales
Food & beverage $1,100,000 40%
Gross profit $1,650,000 60%
Operating expenses
Payroll $750,000 27%
Other expenses $410,000 15%
Real estate taxes $75,000 2.7%
To tal operating expenses $1,235,000 45%
Net income to real estate, furniture, fixtures, & equipment, business including liquor license $415,000 15.1%
Less: Rent to the real estate, 7% of gross sales NNN $192,500 7.0%
Net income to furniture, fixtures, & equipment, business including liquor license $222,500 8.1%
Income to the F, F, & E (return of, return on) $137,500 5.0%
Net income to the business incl. liquor license $85,000 3.1%
Valuation
Net income to real estate, furniture, fixtures, & equipment, business including liquor license $415,000
Less: Rent to the real estate, 7% of gross sales NNN $192,500
Net income to furniture, fixtures, & equipment, business including liquor license $222,500
Income to the F, F, & E (return of, return on) $137,500
Net income to the business incl. liquor license $85,000
Rent $192,500
Capitalized at 7 percent, justified in the market 7%
Indicated real estate value $2,750,000
Income to the business $85,000
Capitalized at 25 percent 25%
Indicated business value including the liquor license $340,000

Real estate $2,750,000

F, F, & E (separate analysis based on replacement cost and economic life) $100,000
Business value including liquor license $340,000
To tal asset value $3,190,000
 Thriving restaurant Typical restaurant Hanging in there
Amount Percent Amount Percent Amount Percent
To tal sales $2,750,000 100% $1,500,000 100% $1,000,000 100%
Cost of sales $1,100,000 40% $600,000 40% $400,000 40%
Gross profit $1,650,000 60% $900,000 60% $600,000 60%
Operating expenses $1,237,500 45% $675,000 45% $500,000 50%
Net income to RE, FFE, BIZ $412,500 15% $225,000 15% $100,000 10%
Less: Rent to the real estate, 7% of gross sales NNN $192,500 7.0% $105,000 7.0% $70,000 7.0%
Net income to FFE, BIZ $220,000 8.0% $120,000 8.0% $30,000 3.0%
Income to the F, F, & E (return of, return on) $137,500 5.0% $75,000 5.0% $50,000 5.0%
Net income to BIZ $82,500 3.0% $45,000 3.0% -$20,000 -2.0%

Real estate value $2,750,000 $1,500,000 $1,000,000

FFE $100,000 $75,000 $50,000
Business value $330,000 $180,000 $0
To tal asset value $3,180,000 $1,755,000 $1,050,000
Gross sales multiplier 1.16 1.17 1.05
Rule of Thumb

 Presently, real estate cap rates approximate percentage rents, so that the
real estate component alone is worth one times sales

 7% divided by a 7% cap rate means the real estate is worth the gross sales

 Gross sales = $2,750,000, real estate = $2,750,000

It makes sense…

 Land is to infinity
 Restaurant improvements have an expected economic life of 25 years or
more
 Furniture, fixtures, and equipment has an economic life of 5 – 15 years
 Business value extends from a surplus over real estate, F, F, & E
Credible gross sales estimate

 3 years historical income and expenses

 Number of guests served, 3 years
 Calculate: Gross sales per guest
 Calculate: Gross sales per seat
 Calculate: Gross sales per square foot of gross building area
Competitive set

 Income and expense comparisons

 Gross sales per guest = average check
 Gross sales per seat
 Gross sales per square foot of gross building area
 Expense ratios
The Restaurant Industry Operations Report - 2010
 
The Restaurant Industry Operations Report is based on financial reporting
and operating data provided by members of the National Restaurant
Association and members of various state restaurant associations. Data
processing was performed by Deloitte & Touche, LLP. Select pages are
copied in the addenda.
© National Restaurant Association – Deloitte - Restaurant Industry
Operations Report 2010

More than 650 respondents form the basis of the report using mostly data
from 2008. Full service restaurants are the focus segregated by average
check of less than $15 per person, average check per person $15 to
$24.99, and average check per person equal or greater than $25 per
person. The report presents operating results as amounts per restaurant
seat and as ratios to total sales, which are the most common bases used
in the industry
Among survey respondents for full service - $25 and over (Section C), the
following is indicated:
 
• 76 percent were independent restaurants, the balance being mostly
chain restaurants (the subject is an independent restaurant)
• 47 percent reported they were the sole occupant of their location as is
the subject
• About half had an average check of over $33 per person; the subject is
$31 per person
• 28 percent own their real estate; 39 percent rent their real estate; 33
percent did not specify: the subject is an owner occupant
• Majority were private corporations, as is the subject
• 5.4 percent had 400 or more seats: the subject is exceptionally large
• 26 percent had restaurants larger than 7,500 square feet; the subject
is exceptionally large
Survey section Lower quartile Median Upper quartile Subject

C-10: Total sales per square foot 210/per SF $415 $638 $524
C-15: Sales volume, $2 million and over $15,000/per seat $18,929 $24,587 $25,396
C-16: Ratios (to total sales) $2 mil plus
Restaurant occupancy costs (rent, RE tax, RE ins) NA 5.5% 7.4% 6.0%
C-22: Average check, $25-$32.99, occupancy costs NA 5.6% 8.0% 6.0%
C-22: Average check, $33 plus, occupancy costs NA 6.5% 9.5% 6.0%
Return on/return of FFE
Return of investment:
$500,000 divided by 10 years = $ 50,000
Return on investment:
$250,000 X 7% (Overall rate) = $17,500
Income attributable to personal property:
$50,000+$17,500 = $ 67,500, Rounded to $ 70,000
164 Seat Rest au ran t
Pro ject ed co vers
Din n er Fri-S at No. Fri-Sat S u n -Th u r No. Su n -Th u r To t al
Month No. seats Covers days sub-total Covers days sub-total Covers
January 164 50 8 400 40 23 920 1,320
February 164 50 8 400 40 20 800 1,200
March 164 60 8 480 50 23 1,150 1,630
April 164 75 9 675 50 21 1,050 1,725
May 164 175 8 1,400 75 23 1,725 3,125
June 188 175 8 1,400 100 22 2,200 3,600
July 188 200 9 1,800 200 22 4,400 6,200
August 188 200 8 1,600 200 23 4,600 6,200
September 188 200 10 2,000 100 20 2,000 4,000
October 164 175 8 1,400 80 23 1,840 3,240
November 164 100 8 800 60 22 1,320 2,120
December 164 100 10 1,000 40 19 760 1,760
102 13,355 261 22,765 36,120
Pro ject ed g ro ss sales -main d in in g ro o m o n ly
Seats: 164
Covers: 36,120
Avg check: $20
Gross sales: $722,400
164 Seat Rest au ran t
Pro ject ed co vers
L u n ch Fri-S at No. Fri-Sat S u n -Th u r No. Su n -Th u r To t al
Month No. seats Covers days sub-total Covers days sub-total Covers
January 164 50 8 400 40 23 920 1,320
February 164 50 8 400 40 20 800 1,200
March 164 60 8 480 50 23 1,150 1,630
April 164 75 9 675 50 21 1,050 1,725
May 164 125 8 1,000 75 23 1,725 2,725
June 188 150 8 1,200 100 22 2,200 3,400
July 188 200 9 1,800 200 22 4,400 6,200
August 188 200 8 1,600 200 23 4,600 6,200
September 188 175 10 1,750 100 20 2,000 3,750
October 164 125 8 1,000 80 23 1,840 2,840
November 164 75 8 600 60 22 1,320 1,920
December 164 75 10 750 40 19 760 1,510
102 11,655 261 22,765 34,420
Pro ject ed g ro ss sales -main d in in g ro o m o n ly
Seats: 164
Covers: 34,420
Avg check: $10
Gross sales: $344,200
Description Comp 1 Comp 2 Comp 3 Comp 4 Comp 5
Restaurant known as former Waterfront,
Sails, now Baia Ye Old Anglesea C-View Inn Lobster Loft Pilot House
Address 998 Bay Avenue 116 W 1st 1380 Washington 314 42nd 142 Decatur Street
Somers Point N. Wildwood Cape May Sea Isle City Cape May
Sale price $4,250,000 $2,400,000 $3,200,000 $2,750,000 $3,100,000
Real estate $1,600,000 $2,100,000 $2,150,000 $1,697,000 $1,300,000
FFE $2,250,000 $0 $400,000 NA $200,000
Liquor license $400,000 $300,000 $600,000 NA $1,000,000
Goodwill $0 $0 $50,000 NA $600,000
Date of sale Oct-03 Nov-05 May-07 Feb-06 Jun-14
Property rights Fee Fee Fee Fee Fee
Financing Normal Normal Normal Normal Normal
Condition of sale Biz restart Normal Normal Normal Normal
Market conditions Same Same Same Same Same
Adjustment 0% 0% 0% 0% 0%
Adjusted sale price $4,250,000 $2,400,000 $3,200,000 $2,750,000 $3,100,000
Adjusted SP/SF of GBA $320 $582 $842 $406 $517
Adjust ed SP/Seat $12,143 $26,667 $42,667 $14,323 $25,833

Location Inferior Similar Similar Inferior Similar

Waterfront Yes No No Yes No
Site area, SF 74,488 11,143 8,160 9,500 4,888
Zoning HVB GB C-5 C-3 C-1
Stories 2 2.5 2 2 3
Construction Frame Frame Frame Frame Frame
Condition at sale Inferior Inferior Similar Inferior Similar
Gross building area, SF 13,298 4,124 3,799 6,772 6,000
No. seats 350 90 75 192 120
USPAP

Standards Rule 1-4 ( g )

When personal property, trade fixtures, or intangible items are included in the
appraisal, the appraiser must analyze the effect on value of such non-real
property items