S.E.C. Real Estate Observer

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Editor’s Note: This article was previously published in the New York Real Estate Journal January 31, 2000.

What I am referring to is the value to the client that a qualified and well-trained business/ investment broker can create. This value is normally measured in terms of increased dollars, and may go beyond accurate pricing and market knowledge to include other tangibles such as creatively structuring a transaction, being diligent or designing a beneficial tax deferred exchange. Following is an example of creating value by discovering and quantifying information in order to enhance and give an accurate representation of the true value of an offering.

This issue reports a sale I recently transacted of a gas station/convenience store, the Mendon Mini-Mart, on behalf of an estate. The sale included the real estate and the business. The underground storage tanks and pumps had recently been replaced; it was competitively situated and nicely located on a corner of a busy intersection. It was, in short, very salable. However, since there were three successive “rights of first refusal,” it was also going to be challenging.

When I received the assignment, I analyzed the tax returns for the past three years. I started with the financials because the value of this type of offering is based not so much on the value of the real estate but on the value of the business. After making the appropriate adjustments to the expenses, deriving the net profit available to a new owner and applying the business pricing formula, I concluded the value to be $475,000. However, that value troubled me! It seemed too low. I was marketing another nearby gas station/convenience store at the same time which was in similar condition, not as well located, and whose sales and production figures (gallons sold) were substantially lower than the subject. In spite of that, the value I derived for the nearby facility using the exact same formula and approach was about the same as the subject. How could that be?

I could have put the subject offering on the market at the $475,000 value, had a quick sale and gone onto the next project. However, I was not satisfied with my valuation results and decided to dig deeper. There had to be a logical and quantifiable reason for the discrepancy and I started looking beyond the income tax returns. I compared the profit margin per gallon of gasoline sold the subject to the nearby station. There was a marked difference! The nearby station sold about one-half as much fuel as the subject, but the profit margin per gallon sold was almost twice that of the subject. A careful comparison of the expense line items did not yield a solution. A careful study of the agreement with the supplier did! The supplier had recently replaced the tanks and pumps in return for a 10-year supply agreement that called for monthly payments and a portion of the proceeds from the sale of the gasoline. The agreement was structured so that only the net sales proceeds from gasoline sales showed on the mini-mart’s income line. Although this kind of agreement was not uncommon, it put a huge hole in the profits and affected the current value of the business.

I then researched the industry-operators, CPAs, publications and business pricing models – to determine what profit margin could be reasonably expected if there were no supplier agreement. All of my research yielded the same answer. Feeling confident that I was on the right track, I then did a 10-year projection based on current sales of how much the profits would increase as the requirements of the supply agreement started to drop off. Why did I do that? In order to place a today’s value on the future upside profit potential. Another way of stating it, I wanted to derive the present value of the future anticipated increased cash flows. The projection ranged from $0 over the first three years to $14,000/year for years four, five and six, and then to $66,000/year in years seven to ten.

What is the present value of the above future anticipated increase in cash flow using a market rate of return? Or, stated another way, how much money would I have to invest today to yield the above annual return? The answer calculated to be $150,000. I could now place a value on the offering that took into account the present and the future potential. The value was the summation of the present, $475,000 and the present value of the future, $150,000, or $625,000. I carefully explained my valuation approach to all prospective buyers using a chart to demonstrate the present value calculation. How did it work out? It was very well received and when the dust finally settled, I was able to deliver a sales contract to the estate at a premium price, slightly higher than the $625,000 offering price. The project took a considerable amount of time and effort but, when the transaction was complete, I felt rewarded professionally knowing that I had earned my fee by adding value to the transaction for my client.