How are hospitality properties valued?

By Tom Little on 21 February 2018

When considering buying a business in the tourism sector, you need to understand how properties are valued.

We called upon the expertise of Keith Mitchell of chartered surveyors Edwin Thompson, about how valuers make their decisions.

Red Book valuations & income projections

These are properties that are normally bought and sold on the basis of their trading potential, such as hotels, pubs and bars, restaurants and other forms of leisure property.

The essential characteristic is that it has been designed or adapted for a specific use, and the resulting lack of flexibility usually means that its value is intrinsically linked to the returns that an owner can generate from that use.

This is in contrast with generic property that can be occupied by different business types such as standard office, industrial or retail.

Key indicators

In assessing the value the valuer will be seeking to establish these key indicators:

1. Adjusted net profit ‐ This is the valuer’s assessment of the actual net profit of a currently trading operational entity. It gives the valuer guidance when assessing the fair maintainable operating profit (FMOP).

2. Earnings before interest, taxes, depreciation and amortisation (EBITDA). This relates to the actual operating entity and may be different from the valuer’s estimated FMOP.

3. Fair maintainable operating profit (FMOP). This is the level of profit, stated prior to depreciation and finance costs relating to the asset itself (and rent if leasehold), that the reasonably efficient operator (REO) would expect to derive from the fair maintainable turnover (FMT) based on an assessment of the market’s perception of the potential earnings of the property.

4. Reasonably efficient operator (REO). This is a concept where the valuer assumes that the market participants are competent operators, acting in an efficient manner, of a business conducted on the premises.

Over to the valuer

With the information to hand the valuer takes the following steps:

1. Assess the FMT that could be generated at the property by an REO.

2. Where appropriate, an assessment is made of the potential gross profit, resulting from the FMT.

3. Assess the FMOP. The costs and allowances to be shown in the assessment should reflect those to be expected of the REO.

4. Assess the market value of the property. In assessing market value the valuer may decide that an incoming new operator would expect to improve the trading potential by undertaking alterations or improvements.

Next steps

There is a distinction between the market value of a trade‐related property and the investment value – or its worth – to the particular operator. The operator will derive worth from the current and potential net profits from the operational entity operating in the chosen format.

While the present operator may be one potential bidder in the market, the valuer will need to consider the requirements and achievable profits of other potential bidders, along with the dynamics of the open market, to come to an opinion of value for that particular property.

When assessing future trading potential, the valuer will exclude any turnover and costs that are attributable solely to the personal circumstances, or skill, expertise, reputation and/or brand name of the existing operator.

However, the valuer should reflect additional trading potential that might be realised by a REO taking over the property at the valuation date.

The actual trading performance should be compared with similar types of trade‐related property and styles of operation. Finally, changes in competition can have a dramatic effect on profitability, and hence value. The valuer will be aware of the impact of current and expected future levels of competition.

Outside influences, such as the construction of a new road or changes in relevant legislation, can also affect the trading potential and hence value of the property. Click here if you need a hospitality mortgage.