What is Additional Income Really Worth?
One of the comments often heard around my workplace is ‘what is it really worth?’
(mostly from one person whose identity I am sworn to protect!).
Ultimately, the answer is that an asset is worth what the fully informed buyer is willing to pay. When a number of transactions occur for a pool of comparable assets this reflects the market for those assets. As time passes the changes in value for the pool of assets becomes the market trend. If prospective buyers form the view that an asset is not worth what sellers are asking, that asset will fall in value; if this is repeated across the asset pool the trend will be down.
Where buyers perceive there is value in the asset or the ability to grow the income (‘upside potential’) they are more willing to pay the asking price. Depending on the perceived amount of upside potential in the asset, this may even drive prices up, with buyers willing to pay a premium in order to acquire the asset.
The growth potential for management rights can be separated into two areas: ‘core’ income streams associated with the building under consideration and those that are outside of the traditional income streams.
A buyer is more likely to pay a premium for a site that has upside potential through growth of the core income streams than a building that generates income external to the site’s main activities. For example, a building that has a number of outside managed units or lock-ups for a holiday complex clearly has income growth potential. Increases in the letting pool lead to higher commission income, along with increases in other traditional income streams of letting fees or cleaning, linen and tour sales.
Non-traditional or external income streams also contribute to the net profit of the business and occasionally make their appearance on accountants’ reports when a site changes hands. These may include management of individual units in neighbouring buildings, commission on property sales and income from food and beverage sales. These all clearly provide an income to the operator and the challenge is how to value their contribution.
If there are only one or two offsite units managed by the site operator, the amount that flows through to the profit figure may be only a small proportion and it is not really worth the time to value them separately to the main business. However, where the number of offsite units makes up a larger portion of the letting pool, their value should be considered separately to the main business.
There is a strong case for considering these units as a rent roll, as they are less likely to generate ancillary income and also more likely to leave the letting pool. Rent rolls are usually valued by applying a multiplier as for management rights but the income that is used and the multipliers that are applied differ to the management rights benchmarks.
A formal value is less likely to be applied to the additional income stream for a site that is generating income from sales commission. In fact, it is quite possible that the valuer will exclude this income altogether. However, if the purchaser has their sales licence and sales have been occurring on a regular basis they may be willing to pay a small premium given the opportunity for additional income.
Another consideration when it comes to values and the appropriate multiplier, is the site that may operate their letting pool with leaseback arrangements in place. These arrangements give the lot owner and rights operator some certainty through knowing how much the lot owner will be paid per week or per month. However, they may end up costing the operator if they are unable to let the unit and earn more in rent or tariffs than they are paying the lot owner.
Again, like the offsite units where there are only one or two leasebacks, the income may not be separated. Where this number grows the valuer will consider a different multiplier to the non leaseback income. From past experience the multiplier for leaseback income generally falls between a rent roll and a traditional management rights figure.
Sometimes, a building includes real estate beyond the manager’s unit. This may be a function room, kitchen, games room or gym. These will change hands as part of the management rights purchase but will have a separate real estate contract. Essentially these areas should be considered as commercial space and be valued accordingly. This means that their value is already reflected in those contracts and should not result in a significant premium in the price or multiplier paid for the business. These additional facilities may be driving up income through higher occupancy levels and other spending by guests using these spaces. This may prompt a buyer to offer more for such a business but it would be difficult to work out exactly how much these facilities are contributing to the site’s income.
As the management rights industry continues to evolve and buyers become more educated, views of the value of management rights businesses will continue to change. Applying the one multiplier to the entire profit produced by a business should only be done once the income streams are fully understood. Where the income sources diverge from the traditional business model this should be considered and the appropriate multipliers used.
When in doubt it is best to consult sales agents, lenders and valuers that have a strong understanding of the industry and the market forces at play.
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