There are three valuation methods commonly used to value pubs and hotels in Australia today.
Going Concern Hotels
Capitalisation of Net Operating Profit is the primary method of valuation and is performed by assessing a net operating profit (based on the pub or hotel’s historical trading performance) and capitalising that into perpetuity at an appropriate capitalisation rate (yield). The capitalisation rate is derived by analysing recent hotel sales that are considered comparable.
For example, if the Valuer adopts an achievable net income of $400,000 per annum and a capitalisation rate of 16%, the adopted value would be calculated by dividing the net income by the capitalisation rate. The achievable net operating profit is assessed by analysing the hotels trading performance through the profit and loss statements and turnover reports.
Particular consideration is given to each of the following items:
Turnover – Analysed on a dollar per week or dollar per annum basis. Historical turnover levels for each department will need to be provided (ie. bars, retail, food, accommodation etc.). The Valuer will determine appropriate turnover levels in comparison to historical performance.
Gross Profit Margins – Analysed as a percentage of turnover. The Valuer will compare the achieved gross profit margins with industry averages for each department. The Valuer will adopt gross profit margins based on historical performance, as long as achieved gross profit margins are not out of line with industry parameters.
Expenses – Analysed as a percentage of turnover or on quantum dollar basis. The Valuer will compare expenses to industry levels and may require invoices to reconcile major expense items. Assuming that expenses are not out of line with industry parameters, expense levels will be based on historical performance.
Wages are of particular interest and depending on the size of the pub or hotel may either be included or excluded in determining the net operating profit. Typically, smaller hotels suitable for owner management will have owner’s wages excluded, however larger hotels will have all operational owner/management wages included in the expense assessment. The inclusion or exclusion of manager’s wages will be dependent on the manner in which the Valuer analyses their sales.
Gaming – Gaming income is commonly analysed based on metered win per machine per day. Gaming income is compared to local area averages. Net Operating Profit – The resultant net operating profit is often adjusted for a gaming machine replacement allowance, which is a sinking fund that allows for the continual upgrade of gaming machines. The adjustment for the gaming machine replacement allowance will depend on the Valuer and their valuation method.
Yields for Going Concern interest hotels may vary dependent on, but not limited to, the following:
- Asset quality
- Cash flow profile (which considers the nature of trade, and opportunities and risks to the cash flow)
- Market demand
2. Summation (Lessee’s + Lessor’s Interests)
The value of a Going Concern hotel is made up of land, improvements and goodwill. The first two components make up the real estate value and comprise a hypothetical Lessor’s Interest. The third component (goodwill) is the value of the business comprising the hypothetical Lessee’s Interest.
The Summation approach reflects the Lessor’s Interest (real estate value) plus the Lessee’s Interest (business value). In undertaking the Summation approach, the Valuer will determine a notional rent for the pub or hotel, which typically lies within the range of 40% to 45% of net operating profit. The value of the Lessee’s Interest (business) is determined by capitalising the net operating profit after rent at a capitalisation rate (yield) obtained from recent business interest sales. The value of the Lessor’s Interest (freehold value) is determined by capitalising the net rental income at a capitalisation rate (yield) obtained from recent freehold interest sales. The value of the Lessee’s Interest and Lessor’s Interest are combined in order to provide an indicative value for the Going Concern Interest.
3. Direct Comparison
The Direct Comparison method of valuation for pubs and hotels compares sales on a total quantum dollar basis. This method is generally performed as a check method to ensure the value derived from the Capitalisation approach reflects a total quantum value that is within the range of the sales evidence.
Lessor’s Interest Hotels
There are two valuation methods commonly used for Lessor’s Interest hotels, being the Capitalisation and Direct Comparison approaches. In both instances, the methods of valuation are undertaken in a similar manner as described above, however the Capitalisation approach instead capitalises the net market rental income that is derived from the hotel. The passing rental will be compared to recent leasing evidence to determine if the rental is at market levels. Hotel rents are tied to affordability and often the Lessee’s trading figures will be required to determine if the passing rent lies within normal affordability levels, which is typically 40% to 45% of net operating profit.
The market rent is adjusted for any outgoings that are not recoverable under the conditions of the lease (such as Land Tax) and the adjusted net rental income is then capitalised into perpetuity.
Lessee’s Interest Hotels
There are two valuation methods commonly used for Lessee’s Interest hotels, being the Capitalisation and Direct Comparison approaches. In both instances, the methods of valuation are undertaken in a similar manner as described above, however the Capitalisation approach instead capitalises the net operating profit after rent.
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