Do you have a brokerage firm doing about 500 transaction sides a year? Your real estate brokerage value depends on several key factors, including whether you, the owner, is contributing a material portion of the firm’s revenues.
The financial results of small- to medium-sized real estate brokerage firms don’t fit neatly into the Income Approach to valuation, thus, according to Steve Murray, senior advisor to RealTrends and owner of RTC Consulting, the Gross Margin Approach is commonly used for these firms, doing 500 or fewer transactions sides a year.
“The Gross Margin or Company Revenue Approach is used mostly for firms that have little or no earnings or are small firms to medium-sized companies or where the owner contributes a material portion of the revenues of the firm,” says Murray.
Knowing that, one of the most important factors to a brokerage valuation for a company this size is the role of the owner. “The owners of these firms often have strong relationships with the firm’s employees and sales agents, contribute a material amount to the Gross Revenues from commissions (generally over 10% of company total), often leave most of their Gross Revenues or Commissions in the company and are running various expenses through the company as a matter of convenience.”
There are other key factors that influence value for small- to medium-sized brokerage firms. Here are the top five:
Terms of the Transaction
Simply put, the more the buyers pay in cash at close, the more risk the buyers assume in the transaction. Therefore, the less they may be willing to pay. On the other hand, when sellers can give more generous terms (less cash at close, more time to pay off obligations), it’s likely that the seller will receive a higher price.
Maximum value for sellers is achieved when both parties have some risk in a transaction. The optimal terms are usually a modest portion of cash at closing with a two- to four- year earnout contingent payment to the sellers.
When sellers seek to achieve an all-cash transaction, buyers usually determine that there’s either too much risk in the transaction or that the sellers are worried about something that causes them to seek all cash. In either case, buyers usually lower prices when the sellers seek no risk after the close of a transaction.
Location of the Firm
The location of a firm does have an impact on real estate brokerage value. When a firm is in a major metropolitan area, with potential synergy with larger local, regional or national realty service a firm, value will likely be higher than for a similarly sized firm in a small rural or suburban community.
Further, when a firm is in a key geographic location within a metropolitan area, has an attractive office location or has an important share of a key market sought after by other firms, then this kind of firm would likely carry higher value than a firm that lacked these attributes.
Size of the Firm
Larger firms usually carry higher values than do firms that are smaller in size. Buyers are interested mainly in growth through acquisition. When the costs of completing a transaction are the same without regard to the size of a firm being acquired, then buyers will usually pay relatively more for a firm that is larger.
With the variety of realty service firms expanding rapidly over the past 10 years, buyers look carefully at the operational benchmarks of a firm they’re interested in acquiring, especially when they’re planning to combine the sellers’ operations with their own existing operations.
Operational Similarities with Buyers
Such factors as the average commission rate charged by the firm, the Gross Margin/Company Revenue percentage rate, policies regarding shared expenses and consumer fees can have an impact on the value of a firm.
By example, when purchasers want to expand through acquisition in a market, and they have a Gross Margin/Company Revenue percentage of 30%, the buyers will not be as interested in a firm that has a Company Revenue percentage of 22%. Any combination of two such organizations would be fraught with challenges, and the potential of the loss of sales professionals, as the company with 22% is clearly paying more to its agents.
Retention and Position of the Owners/Sellers
Many buyers desire to retain the owners/sellers to assist in the transition and limit the potential loss of sales associates and build good will with the management team of the sellers. In some cases, the sellers continue to have a positive influence on each of these parties.
When owners/sellers desire to remain involved with their firm after a sale, the overall real estate brokerage firm value is often higher. Retaining the owners/sellers reduces risks to the purchasers, potentially raising the value.
Affiliation with a National Brand
Obviously, a national or regional affiliation may bring value to a residential realty services firm during a franchise agreement. However, the value of a firm that is under a franchise agreement may be lower than one that does not have a franchise agreement at the time of the sale.
This is because franchise agreements may limit or restrict the ability of a residential brokerage firm owner firm to sell to parties other than a buyer who will retain the franchise agreement or is already with that particular franchise system.
The value is not so negatively affected at or near the time of expiration of a franchise contract. The effect on value is solely due to the restrictions of a sale included in most franchise contracts by national and regional franchisors.
The restrictions of a sale in these contracts during the duration of the franchise contract reduce the number of potential purchasers. As such, the potential market for the firm is reduced.
Sellers within the same brand have fewer restrictions and value is not impacted as frequently.
This information originally appeared in the RealTrends booklet “Valuing Small- to Medium-sized Brokerage Companies.”