How are Multiples Determined?
We answer one of the most commonly asked questions about valuing a brokerage.
By Steve Murray, publisher
Among one of the most commonly asked questions we received when providing valuation assistance to our clients is, “How are multiples determined?”
It would be easy to say what the multiple is when we believe that either HomeServices of America or NRT are likely bidders because they have a systemized way of approaching how they value residential brokerage firms. NRT uses a straight EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) Approach while HomeServices uses a Discounted Cash Flow Approach.
With a general understanding of how they approach valuation and some substantial evidence of what they are paid in the past (the real numbers not the ones brokers talk about), valuation is not that difficult.
But, for the majority of valuations we perform, these two firms are not present or not likely to be present. In these cases, we defer to a Market Approach, which is based on the net operating income (NOI) of a brokerage firm and comparable sales that REAL Trends has been involved in over the past 12 to 24 months.
Valuations are affected by a number of factors when looking at value from a market view. They are:
- Terms of a potential sale – how much cash, what are the terms of the earn-out, for how long;
- Does the firm have a franchise agreement, for how long, in what market(s);
- What is the depth of the market for the acquisition, how many other firms are in the market, or want to be in the market, what capabilities do they have in terms of capital and management to take on a deal;
- Is this an inside sale to others who are already owners of the firm or senior employees of the firm or is this an outside sale to others not involved currently in the company;
- Is the market going up, sideways or down at the time of the valuation;
- How has the firm operated over the past 3-4 years?
While most valuations are performed based on the most current 12 months, we and others involved in valuations, mergers and acquisitions always look at how the firm has performed in prior years. Is the firm growing, and what is happening to its gross and net margins and cost ratios?
While none of these is more important than others, one question that is most often overlooked is, “What does the pool of interested and capable buyers for a firm look like?” We’ve done valuations of firms in a wide variety of markets, and have seen many cases where two firms or equal size and performance have distinctly different valuation multiples. One firm in a market of 2 million people will generally have a higher multiple than the same size firm in a market of 400,000 or fewer people. The pool of potential buyers in that market is smaller and less capable of acquiring other firms.
While the valuation of residential brokerage firms and related businesses such as mortgage, title, escrow and property management, are as much art as science, in our practice we look at market comparable much as an agent would do in pricing a home.
The factors that can drive a price up are much more likely to be driven by other factors such as strategic value and the potential value of the leadership of a firm being sought. Yes, the numbers and other factors such as those listed above serve as the basis for all acquisitions, but there are intangible factors that often come into play as well.^
This article originally appeared in the June 2016 issue of the REAL Trends Newsletter is reprinted with permission of REAL Trends, Inc. Copyright 2016.
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