It’s important to determine whether a business valuation also calls for a real estate appraisal. While the decision may be relatively straightforward for real estate holding companies, it becomes more nuanced for operating businesses that own or lease real property.
In many cases, real estate isn’t just a backdrop for business activity — it’s a core driver of enterprise value. Overlooking real property assets (and any associated income and expenses) can result in misleading or inaccurate valuation results. To ensure a well-supported, defensible value conclusion — especially when the business valuation will be subject to scrutiny from the IRS, courts or outside buyers — start by asking these key questions.
How critical is real estate to the business’s earnings?
Understanding the role of real estate in the subject company’s business model helps determine who should be involved in the valuation process: a business valuation professional, a real estate appraiser — or both.
When real estate is incidental to the operating business. Real estate that supports the business’s operations but doesn’t significantly affect its profitability — such as a software company that owns its office building — is generally considered a passive asset. In these cases, the business valuation professional typically takes the lead, and the value of the real estate may be accounted for separately or adjusted using market-based rent assumptions.
When real estate supports the core business. Some businesses rely heavily on real estate to drive or enhance earnings, even though it isn’t the sole income source. Examples include hotels, golf courses, marinas, farms, cemeteries and similar operations where the property’s location, physical condition or uniqueness contributes meaningfully to revenue generation. This also may be true for hospitals or certain manufacturers that rely on specialized equipment, fixtures and structural accommodations that aren’t readily moved or duplicated. These cases may call for the expertise of both a business valuator and a real estate appraiser to capture the full economic picture.
When real estate is the business. A real estate appraiser may take the lead when valuing companies that generate income primarily from owning, leasing or selling property — such as real estate development or investment entities. However, when valuing a noncontrolling interest in the entity, a business valuation professional may also be needed to consider entity-level issues and apply valuation discounts.
Who owns the real estate?
For operating companies, ownership of real property assets plays a critical role in how they should be treated within the business valuation. When an operating company owns real estate, a business valuator may impute a market-based rent to normalize earnings. A real estate appraiser can assist by determining the property’s fair market rental value. This approach separates operating income from real-estate-based return and helps isolate the value of the business as a going concern.
If the business leases property from a related party — such as a separate limited liability company owned by the same shareholders — the lease terms may not reflect market rates. Adjustments are often necessary to reflect an arm’s length rental arrangement. These adjustments, which typically fall within the expertise of the business valuator, ensure the company’s earnings accurately reflect what a hypothetical buyer would expect if it were leasing the property at market rates.
If the business rents space from an unrelated third party under market terms, the lease is typically treated as a standard operating expense, and no adjustments are necessary. However, the lease terms may still have implications for long-term risk or cost structure, which the valuator may consider in cash flow projections and discount rates.
Does the situation require valuation discounts?
In certain scenarios — such as valuing a minority interest in a family limited partnership or a fractional share of a real estate holding entity — valuation discounts are essential to estimate fair market value.
The discount for lack of control (DLOC) applies when the interest being valued doesn’t give the holder control over key decisions, such as selling assets, declaring distributions and managing operations. The discount for lack of marketability (DLOM) reflects the limited ability to sell a noncontrolling interest in a privately held company or entity.
These discounts are generally calculated by business valuation professionals using market data, empirical studies and professional judgment. Factors affecting the magnitude of the discounts may include the entity’s governance structure, contractual restrictions, the asset’s liquidity and current market conditions.
One size doesn’t fit all companies
Valuing a business that owns or relies on real estate requires a tailored approach. Whether a business valuation expert, a real estate appraiser or both are needed depends on how the real estate contributes to earnings, who owns it and the structure of the business entity. Contact us today to discuss your specific situation. We can help determine the right professionals to involve and ensure the valuation reflects the business’s true economic realities.
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