January 18, 2023

As an avid watcher of “The Great British Baking Show,” I am keenly aware of the impact of meticulously measured ingredients. Take the scenario of baking my favorite cake - carrot cake, of course. Too much baking powder will make the batter bitter and will likely cause the cake to rise rapidly and then collapse. Too little baking powder will probably result in a carrot-flavored flan.  

When it comes to real estate succession planning, property valuation is a lot like accurately measuring baking powder. Too large a valuation creates an unattractive proposition for new partners due to unsustainable buyout notes. Too little, and the existing shareholders are subsidizing new partners to induce them into the investment.

In almost all cases the valuation methodology consists of a calculation of the equity through assets, less the liabilities. Beyond that, the options become varied and the tradeoffs become obscure. Here are a few of the most frequently witnessed methods and where they sit on the conservative to aggressive chart, also known as the “Cooking Show Host Aggression Scale":

“Fee-Simple Interest” - Appraisal used for a bank to value a building

  • Conservative
  • Completed by an independent appraiser
  • Based on market value, assuming the subject property is vacant and unencumbered.
  • A requirement of financing so generally, readily available
  • High exposure to changes in the market for commercial real estate valuations
  • Continued use of this valuation method can become costly

“Leased Fee Interest”

  • Moderately conservative
  • Completed by an independent appraiser
  • Assumes the lease is not arm’s length
  • Not a requirement of financing so requires additional investment
  • High exposure to changes in the market for commercial real estate valuations
  • Continued use of this valuation method can become costly

Valuation by Capitalization Rate

  • Moderately aggressive – valuation can be set at a comfortable point on the Cooking Show Host Aggression Scale
  • Utilizes leases and a capitalization rate
  • Contingent on leases being set at fair market value

Sale / Leaseback Market Valuation Methodology

  • Aggressive – akin to Gordon Ramsay on Hell’s Kitchen
  • Utilizes leases and a capitalization rate
  • Capitalization rate is typically aggressive and provided by a third-party based on the length and value of the lease

There is no one-size-fits-all when deciding on an appropriate valuation method. It is important, however, to balance the sustainability of the structure while fulfilling the objectives of as many of the stakeholders as possible. Very often, this becomes a worthy compromise that strengthens the glue of the practice.

To determine the sustainability and practicality of each of the aforementioned options, it is paramount to model the outcomes over a long-time horizon. CMAC has developed a model to assist practices in assessing the probability and severity of an unfavorable real estate succession plan outcome, based on each group’s unique structure. To learn more about the best valuation methodology for your practice, please reach out at solutions@cmacpartners.com.