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Business Valuations: Diversifying Your Appraisal Business

by Isaac Peck, Editor

In a world where automated valuation models (AVMs) are being touted as the “solution,” Fannie Mae and Freddie Mac are offering appraisal waivers, and hybrid appraisals are growing in popularity, many appraisers are rightly concerned about relying solely on lender work and are looking to diversify into more specialized niches within the appraisal profession itself. If you’re one, read on.

While there is an increased interest in non-lender appraisal assignments with attorneys, agents/Realtors®, CPAs, prelisting appraisals, divorce and other litigation work, estate appraisals, and more, one seldom discussed way for appraisers to diversify and earn higher fees is to branch out into business valuations. This is a highly specialized niche that frequently combines real estate appraisal techniques with more modern business valuation practices.

While the work is not for everyone, some appraisers have found it to be fascinating, offering the opportunity
to build on the analytical skills they’ve developed as appraisers while keeping them challenged—as the ever-changing complexity of the assignments keeps the
job interesting.

What’s a Business Appraiser?
A business appraiser is someone who answers the question: what is a business worth? Because privately held businesses don’t have an exchange where you can buy, sell and trade shares, business appraisers are relied on by a variety of interested parties to provide an opinion of value on the business, or even a part of the business.

Shawn Hyde, Executive Director of the International Society of Business Appraisers (ISBA), explains how small
businesses throughout the United States—restaurants, hardware stores, flower shops, and others—can need a business valuation for a variety of reasons. “Small businesses all throughout the country often have partnerships; the partners might buy each other out, or someone might buy in or sell the business, or get a divorce, or there might be an estate or gift tax, or even a shareholder oppression case. There are all kinds of reasons why a small business may need to have a valuation. With AT&T, Proctor and Gamble and other publically traded companies, you can just look up their value on the stock exchange, but for small businesses, there’s no way of knowing the true value without a business valuation performed by an expert,” says Hyde.

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In terms of how many business appraisers there are, Hyde says the industry’s best estimate is roughly 10,000–
12,000 in the U.S., making it a much smaller professional segment than traditional real estate appraisal. The practice attracts professionals from many different backgrounds. “Some enter the profession by starting out as business brokers and then adding business valuation to their services. Others began by studying finance and accounting, so there’s a fair number of CPAs. We’ve worked with a chiropractor who sold his practice and then moved into valuation. We saw a dentist do that too. And of course, there’s a fair number of real estate appraisers
who’ve found their skills translate nicely into this space,” Hyde reports.

There is a wide variety of assignments and types of businesses that need valuation. Across the spectrum, real estate appraisers tend to have a unique advantage and perspective compared to practitioners from other backgrounds. The reason is that many times there are projects where the real estate is part of the going concern.
Business appraisers are not typically trained on how to appraise the real estate portion of a business, and in cases where the loan is insured by a federally insured financial institution, they may not be allowed legally to appraise the real estate without a real estate appraisal license.

The result is that a business appraisal performed by a non-real estate appraiser would include (1) an appraisal of the business, and (2) an appraisal of the real estate, performed by a licensed real estate appraiser. Then the business appraiser would work the value of the real estate into the value of the going concern.

Therefore, those real estate appraisers who can learn to perform business valuations are able to perform both pieces of this process, bringing a truly unique skillset and perspective to their clients. They are also better able to comply with USPAP.

“A business appraiser values intangible assets, goodwill, trademarks, furniture, fixtures, equipment and other things like that. A typical real estate appraiser may not be strong in financial analysis. They are used to dealing
with pre-tax income streams. But business appraisals, using an after-tax income stream and Cap Rates, are developed differently. A real estate appraiser who is trained in both aspects knows how to do it right. So there’s a huge advantage for real estate appraisers who learn to value the business side,” says Hyde.

From Real Estate Appraiser to Business Appraiser
Bruce Jones is a real estate appraiser who began diversifying into business appraisals in early 2015. Jones started out as a residential real estate agent in 1987 before transitioning into commercial real estate brokerage in 1994. For the next 10 years he was the New Jersey broker of record for a brokerage and asset management company where he stabilized, managed and sold distressed commercial real estate, while also overseeing 20 licensed agents. In 2004, Jones became a commercial appraiser and was awarded the MAI designation with the Appraisal Institute in late 2009.

Jones’ interest in commercial appraisal work is what made him realize the value that he could bring if he also knew how to value the business side of a transaction. In 2014, Jones connected with the International Society of Business Appraisers (ISBA) and went through the business valuation coursework they offer. “The concepts I learned really resonated with me because they come from a different perspective and I saw how the combination of the two skillsets were well suited to address the unique valuation challenges associated with business-oriented, special-purpose properties,” says Jones.

As a commercial appraiser, Jones explains how his business valuation knowledge helped him use the appropriate methods to appraise special purpose properties. “There are many real estate properties that are wrapped in a business that have furniture, fixtures and equipment (FF&E) involved as well. Special purpose properties like bowling alleys, movie theaters, funeral homes, car washes, and gas stations are very challenging for most traditional real estate appraisers because they are infrequently leased, so the traditional income approach based on deriving a market rental rate from lease comparables is often not possible— yet buyers and sellers absolutely consider the income generating capacity of the real estate. A lot of times in order to appraise one component, you have to appraise the whole thing, then use techniques to pull apart the components to figure out where the real estate value ends and the business value begins,” says Jones.

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Bowling alleys are a good example, because if nearly all of the bowling alleys in the area are sold as going concerns, i.e. the real estate and the business, how can an appraiser determine the value of the real estate only? “With these types of properties, it is the revenues from the business that pay the mortgage and maintain the property, and not rent. The sales comparison approach has similar challenges estate appraisal in the same report, and it is not only more reliable for the lender, but is also more cost-effective than ordering two separate appraisals. “For the most common property types (restaurants, gas stations, car washes, etc.), it completely makes sense for the lender to order one appraisal for both needs. And for real estate appraisers who have the skills to complete true going concern appraisals, they can earn fees of $750 to $1,750 higher than they currently might average per assignment,” Jones says.

In terms of how long these type of appraisals can take, Jones reports that the first few business appraisals can take a week. “Like most appraisers, I am rarely working on a single appraisal at one time and also rarely work on one appraisal from start to finish in the same stretch. After experience is gained, on average, business appraisals take a little less time than a typical commercial appraisal. Going concern appraisals, in contrast, take a little longer than a typical commercial appraisal, hence the higher fee,” says Jones.

Types of Clients
There are a wide variety of clients who need business appraisals, including lenders in real estate acquisitions and business acquisitions, developers, business partners, attorneys in divorce and estate cases, property owners, and so on. Jones says, “I had been around a long time in the commercial space, so I already had a fair number of contacts and a client base to build on, but what I’ve done over the last four years is slowly gotten rid of clients I didn’t enjoy working with, and sought out clients who are better to work with. Better clients are not as fee sensitive and also recognize the value of my work and how difficult the challenge is—to legitimately come up with values for each of the parts that we value in this type of work.”

A fair amount of Jones’ work involves hotel feasibility studies. “Typically it’s a developer or other interested party who is thinking about building a hotel and I’ll go in and analyze how much demand there is, what are the local demand drivers, what is bringing business in, and why are people traveling to the area—are they budget-minded or business travelers, and so on. Business travelers usually are traveling with an expense account and are much less price sensitive. And of course, there’s the cost side of things. I’ve developed a good size file of cost estimates done by contractors, conversations with builders, and I also use a national cost service,” Jones reports.

It helps to get to know other business owners and other business appraisers, according to Jones. “One of the big changes in my practice came when I started networking and talking with other business appraisers. The vast majority of those are CPAs. The good ones readily acknowledge they aren’t real estate appraisers and they don’t want to get involved in real estate. So in addition to learning a lot, that’s been another source of work for me. And in terms of gathering information, your contacts help a great deal. When you get to know hotel operators by doing interviews around the local markets, typically people who know and remember you will give you information more readily,” says Jones.

Becoming a Business Appraiser
Certified General appraisers do have an advantage in that they are already working on commercial assignments, i.e. business-related real properties where the business itself may also need to be appraised. However, residential
real estate appraisers can still get involved. “While Certified General appraisers have an advantage, residential real estate appraisers do not have a comparative disadvantage,” says Hyde. “Most business appraisers are not also real estate appraisers, and a real estate appraiser already knows the theory behind all three approaches to value, understands adjustments, and should be able to explain their thought process to a reader in a written report. Compared to dentists, business brokers or the average CPA who decides to get involved in the business valuation industry, any real estate appraiser has an advantage,” says Hyde.

The challenge for appraisers is to learn the financial side. “The only real weakness a real estate appraiser may have is financial statement analysis. Reading balance sheets, understanding comparative ratios, and finding the normalization adjustments are all examples of things that real estate appraisers do not typically do in the course of their real property assignments,” says Hyde.

Bruce Jones advises appraisers interested in getting into this line of work to really commit to expanding their knowledge base. “I’ve continued to take more and more courses, and what I keep doing each year is to slowly but surely do less and less work for the lowest tier clients, the ones who are difficult to work with, or are overly fee sensitive. I cull them out and seek to nurture relationships with the best clients. My advice to any appraiser is that you’ve got to keep growing, educating yourself and getting better. It’s very exciting to be on the cutting edge and doing the type of work that most appraisers don’t have the training to do,” says Jones.

About the Author

Isaac Peck is the Editor of Working RE magazine and the Vice President of Marketing and Operations at OREP.org, a leading provider of E&O insurance for appraisers, inspectors and other real estate professionals in 50 states. He received his master’s degree in accounting at San Diego State University. He can be contacted at isaac@orep.org or (888) 347-5273.

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