The majority of motel sales depend upon
bank finance. Banks
in turn depend upon the report of a professional valuer.
Therefore, the most sensible way to examine the methods
of valuing a motel is to examine the methods used by
professional valuers.
There is little point in a buyer and seller agreeing upon
a price if that price is way above the price in a valuer’s
report. This leads
to the absurd situation where a buyer expends all his energy
talking the price down in negotiations with the seller, and then
is forced to talk the price up in an effort to convince his bank
that the valuer’s report is too conservative.
Banks lend a percentage of the price in a valuer’s
report, not a percentage of the price agreed by the buyer and seller.
If, for example, a bank is currently lending 65% on motel purchases,
a motel with an agreed price of $1,100,000 and a valuation of $1,000,000
will receive a loan of $650,000.
Valuers try to understand the motel market by looking
for examples of other motels that have recently sold.
Most valuers conclude that at the moment:
Coastal freehold motels sell for returns on investment
between 12% and 14%
Rural freehold motels sell for returns on investment
between 13% and 15%
Leasehold motels sell for returns on investment between
28% and 33%
At Pacific Rim Business Brokers we keep an updated list
of past sales, so our clients know how valuers are likely to view their
potential purchases.
The best way to understand a professional valuer’s
valuation is to read a valuation report.
The reports are usually divided into the following
major sections.
Title Details
Statutory and Council Details
Site Identification
Improvements
Qualifications
Comparative Market Data
Trading Anal
Valuation Methods
Replacement and Insurance Value
Valuation
1.
Summary
In the summary the valuer sets out his instructions –
who asked him to value the property – the date of inspection and the date of
valuation and whether the property represents suitable security for lending
purposes.
2.
Title Details
Title details include the Lot Number, Deposited Plan
Number and Folio Identifier. If
there are any encumbrances, encroachments, restrictions or covenants these
are noted as they may adversely affect the rights of the owner and hence the
value.
3.
Statutory and Council Details
Statutory and Council details include the zoning and
highest and best use description.
Highest and best use is defined as the most profitable legal use to
which the land may be put. In
most cases a motel operation represents the highest and best use, but there
are cases where conversion to strata units or even demolition and
redevelopment may be more profitable.
4. Site Identification
The site identification includes the physical
description of the motel’s boundaries, the distance from the motel to major
centres and developments in the surrounding area.
Services and amenities, such as water, sewerage, telephone and
electricity are identified. The
road system, access and exposure are also noted.
5. Improvements
Improvements include a physical description of the
motel including details of the construction, furnishing, accommodation type,
restaurant, manager’s residence and office.
If any major structural defects are apparent these are noted,
although most valuations include a disclaimer stating that the valuer is not
a structural engineer and therefore not an expert in this area.
6. Qualifications
In this section the valuer tells the client what he has
not done. For example, he may
not have sighted a certificate of compliance, an environmental report or
unregistered leasing agreements.
While the valuer may have been told that all plant and equipment is
unencumbered and in good working order he will point out that he has not
tested all equipment or sighted any license, hire purchase or lease
agreements. The valuer is
basically relying upon the statements of the owner or manager.
7. Comparative Market
Data
Comparative market data includes information from
external sources – usually the Australian Bureau of Statistics, the NRMA
Accommodation Guide and the local tourist authority - regarding the number
of motels in the area, visitor arrivals, length of stay, occupancy rates
etc. This information is
compared with data from the motel.
8. Trading Analysis
The valuer analyses the trading figures of the motel
and notes the amounts that should be added back to the net profit.
Add backs usually include interest, depreciation, management wages
(depending on the size and nature of the operation) repairs, maintenance and
replacements that are of a capital nature, or are non-repeatable expenses,
and abnormal losses or profits (eg sale of assets).
9. Valuation Methods
In this section, the meat of the valuation, the valuer
uses a number of methods to arrive at a value for the subject property.
The standard methods employed are:
a.
Traditional Capitalisation Approach
By examining comparable sales of similar motels, the
valuer sets out a range of yields, or returns on investment.
The yield is the average annual net profit before interest,
depreciation and owner’s wage divided by the sale price.
Yields tend to vary with size and location.
Large
While the traditional capitalisation method is probably
the best way to value a motel, it does have a number of drawbacks, namely:
There may be no comparative sales data.
Comparative sales data may be misleading.
The registered sale price of a motel may not be its true price.
There may be a secondary contract for the sale of the goodwill, plant
and equipment which is not a public document.
The owner’s wage may have to be adjusted.
Motel A may be run by a husband and wife team working 100 hours a
week, while Motel B is run by a single owner working few hours with high
staff wages. If the valuer is
not aware of these operational considerations, he may not correctly compare
the two yields.
The net profit may be high or low in one year for
reasons not usually associated with normal motel trading results.
(Floods, bushfires etc).
The motel operation may be improving or declining,
in which case the valuer should focus on the last year’s trading results and
likely future profits, not the average of the last few years.
The motel may be under performing due to poor
management. If reasonable
management can quickly turn around its performance the valuer will take this
into account. Naturally there is
a bit of guesswork in this area.
b. Direct Comparison
Method
This method examines recent sales of other motels on a
price per room basis. As the
price per room varies between $20,000 and $200,000 it is important that the
valuer compares properties of a similar age, physical condition, location
and profit stream.
If Motel A has 20 rooms and sells for $1,000,000 ($50,000 per room) it
cannot be compared to Motel B with 20 rooms and twice the net profit.
c. Hypothetical
Lessor’s and Lessee’s Interest
This valuation method divides the motel into a
landlord’s passive investment and a lessee’s active investment.
If the commercial return a landlord in the motel market expects is
9%, and the return a lessee expects is 30%, then with a little mathematical
juggling the valuer can produce a price that will satisfy both a lessor and
lessee.
The first thing a valuer must know is the industry
rental standard, and here he will encounter difficulties.
There are various rules of thumb for defining rental standards and
none of them are very satisfactory.
Rules that define rent as a percentage of revenue are misleading
because they do not take into account the effect of a restaurant.
If Motel A has no restaurant and revenue of $400,000 it will be more
profitable than Motel B with a restaurant and revenue of $400,000.
This is because the cost of food and restaurant staff will reduce the
profit of Motel B.
An industry standard which is reasonably widely
accepted states that rent should be no more than 45% of profit.
Once again, all the problems relating to profit are encountered
(owner’s hours of work, increasing or declining profits, underperformance
due to poor management etc). If,
however, the valuer overcomes these difficulties and sets the net profit at
$400,000, then rent should be no more than $180,000.
For a 9% return the landlord would be prepared to pay
$2,000,000. The tenant, who will
enjoy a net profit after rent of $220,000, would be prepared to pay $733,333
for a 30% return. The total
value of the motel would therefore be $2,733,333.
With a net profit of $400,000 to an owner operator,
this price produces a 14.6% yield using the capitalisation method in section
a.
10. Replacement and
Insurance Value
In the current market, the cost of building a motel
greatly exceeds the cost of purchasing an existing operation.
Therefore replacement value generally does not resemble market value.
Insurance value depends upon the type of policy.
As replacement value exceeds market value and an insurance policy
aims at replacing lost property, insurance value should also exceed market
value.
11. Valuation
In the final section, the valuer brings all the strands
together and sets out what he considers to be the current market value.