Untangling real estate value from business value

Vice President , The Regional Group of Companies Inc
  • Jun. 5, 2014

John ClarkVictoria’s landmark Fairmont Empress Hotel is for sale – interested?

The asking price isn’t being disclosed. The Vancouver Sun reported the property’s assessed value is $89.9 million.

But assessed value is a measure of the value of the real estate on which the building rests, as well as the building itself. This does not take into account the value of the business operating on the premises.

These are unrelated – at least in theory. In practice, they often become quite tangled, and not just in the tourism and hospitality sector. This entanglement is often accidental. Sometimes it’s deliberate – a subtle exercise in turning a blind eye some owners may believe will serve their tax planning objectives. Trying to shave dollars from one tax bill, however, may just end up costing you more down the road and leave you painted into a corner.  

But even with the best of intentions, distinguishing real estate from business value can be a challenging valuation scenario.

When a hotel isn’t just a hotel

Take a hotel. A sale will typically include all the chattels – furniture, fixtures and equipment – plus the expectation on the part of the buyer that they have acquired an existing and experienced workforce. These would all generally be considered part of the hotel’s business value, as they are necessary to the operation of the business.

But then there is the building itself, which could conceivably have other potential uses, be it a private school, retirement residence and so forth – what value does this structure have separately from the business value and the chattels necessary for it to operate as a hotel?

And what about the land? Depending on market conditions in the tourism industry, the state of the building’s repair, and other prevailing factors, the greatest value may be found just in the land. Maybe the most interested buyers are itching to simply bulldoze the existing structure in favour of a new mixed-use office/retail/condo tower.

When considering all of these variables, it’s easy to see how easily real estate and business value can become entangled, especially when the business and the building/property are being sold together as a single unit.

Muddying the waters

The problem often begins with the affidavit for land transfer tax. This is a provincial tax levied on the purchase of real property, exclusive of chattels. When you purchase a property, your lawyer will complete a land transfer tax affidavit on your behalf. People will often muddy the waters by listing the purchase/sale price as the real estate value, but this amount sometimes includes both business and property value.

That means they have just overstated the real estate value. Local assessment authorities may take this at face value as being the declared value of the real estate and use this information as part of the basis for a future assessment. This can bump up the property’s taxes, which in effect could erroneously include a property tax on a business component.

Now, there can be an advantage to this, from a long-term capital gains perspective when you sell the property. But do the math, and compare your potential capital gains against years of overpaying on your property taxes before deeming this advantageous. It also may simply cause grief down the road if the income tax people reject the cost base for capital gains. You could shoot yourself in both feet by paying too much property tax in the short term and having to pay higher capital gains tax in the long term.

And don’t blame assessors for getting it wrong if they are going by legal documents that bear your signature. Always manage your affairs in an honest and rational manner. Otherwise, it may be hard to refute the paper trail used as evidence against you if a property assessment dispute goes to the courts.

Owning vs. leasing

It also bears noting that it often pays to own the property in which your business operates. With the Fairmont Empress (and several other comparable landmarks across Canada) owner Ivanhoe Cambridge, a subsidiary of Quebec’s Caisse de depot pension fund manager, is getting out of a volatile business and a portfolio of properties that, due to their age and heritage value, may be costly to maintain. Trying to run a profitable business, on the other hand, will still rest with Fairmont Hotels and Resorts, which is under a long-term management agreement to operate the Empress, regardless of who owns it.

Having ownership of the property, rather than being a tenant under lease to landlord, can be particularly advantageous to smaller, family-run businesses, or personal service consultancies such as mine. In my case, I am the business – there isn’t much else to assign a business value to and sell.

More options for a lucrative exit

Sticking with tourism and hospitality, consider the family restaurant. These businesses typically operate on razor-thin margins. Furnishings and décor are often allowed to grow dated. Leases coming up for final renewal are a red flag for informed buyers – they know the landlord is the wildcard, who may decide they no longer want a restaurant at the location. Labour costs are often artificially depressed by the long hours family are willing to put into the business versus paid staff. Given all of these factors, there may in fact be very little value to the business itself.

If the family owns the property, on the other hand, and it lies at a decent location, perhaps, in the best case, adjacent to urban renewal and revitalization projects, the odds of a strong return are much better, regardless of whether another restaurant business has any future on the site.

As a business owner who also owns your property, you always have the advantage of more options when it comes to exiting your business in the most advantageous way.

To discuss this or any other valuation topic in the context of your property, please contact me at jclark@regionalgroup.com. I am also interested in your feedback and suggestions for future articles.

 

 

 


John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

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John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

Read more





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