Business Enterprise Value

Much of what we engage in as established practice may seem to make sense at the start but later prove less practical. For a hundred years, we have made use of a typewriter keyboard with the familiar Q-W-E-R-T-Y arrangement of letters on the belief that this arrangement promotes fast typing, only to find lately that other arrangements are much faster. Since the agrarian revolution that turned us from hunter-gatherers into farmers, we have based our diet on starches like potatoes and grains. Now we learn that these same starches are prime culprits in diabetes. Looking for safety in cars, many of us chose SUVs. But later it turns out that, of all cars, SUVs have the worst tendency to flip and roll. 

We may do a thing one way for a long time, only to find that the thing makes less sense in the end than it did at the start. So it is with the valuation of hotels. As appraisers, we have traditionally presented our hotel analyses as valuations of real estate. A hotel is clearly real estate, at least in part. But in recent decades something else has become clear: a hotel has a business component. Part of the value of an operating hotel is a going concern. The distinction can be important: the real estate is taxable as real estate and the furnishings (a second component) as personal property. But the business, the third component, is not taxable. We don't impose a real estate tax on the billiard parlor, the hair salon, or the convenience store that operate out of a retail strip. Why should we impose a real estate tax on the business component of a hotel? 

If the world were arranged to make life easy for real estate appraisers, all the information needed to make a good appraisal would be available, in abundance. To help the lender who wants an appraisal of just the hotel's real estate, not its business component, we would have numerous comparable sales of hotel buildings that are stripped of their furnishings and are out of business. We would have comparable leases of hotel buildings, so that we could analyze them as we do retail and industrial properties, through the Income Approach. We would have local construction cost data for all the various types of hotels. But as it happens, information as useful as that is rarely available for hotel valuation. 

The primary data for the valuation of a hotel is the hotel's history of income and expenses. This is the data on which the market of buyers makes its decisions. It allows buyers and appraisers to value the hotel as a whole. For some purposes, that answer is all that is needed. For others, it is not. What that valuation leaves un-answered is, what is the value of the real estate? 

To separate out the "FF and E" component (the furnishings) is relatively simple: for this, book value likely provides a reasonable approximation. To separate out the business can be more complex. 

A hotel restaurant that produces more than break-even income is a business, and its value requires extraction. The same goes for other profit centers like the news stand and the fitness center. Bookings have value. So does the working capital without which the hotel could not function. The investment in the training of a fully trained staff is a business asset. One by one, these items and others can be isolated and allocated to the business. Appropriate methods for measurement and allocation are discussed in an extensive literature on the topic of BEV, or business enterprise value, published in The Appraisal Journal and other industry outlets since the 1980s. Analysts argue that the business component of a hotel may bear a value that exceeds 30% of the value of the whole. 

What is true for a hotel can be true for other assets that mix business and real estate. Gas stations, car washes, and restaurants all involve equipment and may involve going concerns. Having created the tools for measurement of BEV, appraisers can apply them to other types of real estate. Some make a strong argument that BEV is a component of a thing that seems as exclusively real estate as a shopping mall. The question arises, then: is BEV a component of the value of all real estate? 

Certainly, all real estate benefits from good management. But good management and a going concern are different things. Most real estate has a value that is independent of the value of the businesses that operate from it. Three identical office buildings that are occupied by businesses with differing worths likely have very similar values. For most investment real estate where business and real estate are already well separated, the answer to the question, "Is BEV part of the value that you have measured through your traditional methods?" is "no." 

Eric T. Reenstierna, MAI