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Appraising Real Estate Centered Business Enterprises

A Conceptual Framework to Consider

Real Estate Centered Business Enterprises (RECEs) commonly sell as real property going concerns with elements of real estate, personal property and a business enterprise component. Business appraisers face several challenges with these assignments due to the interdependence of the business with the other assets. Another key challenge for business appraisers with these types of assignments is relying on separately completed real estate appraisals that are frequently incorrectly developed based on an inappropriate premise of value. This article provides readers a conceptual framework to valuing these types of businesses.

Appraising Real Estate Centered Business Enterprises: A Conceptual Framework to Consider

Real Estate Centered Business Enterprises (RECEs) commonly sell as real property going concerns with elements of real estate, personal property, and a business enterprise component. Business appraisers face several challenges with these assignments due to the interdependence of the business with the other assets. Another key challenge for business appraisers with these types of assignments is relying on separately completed real estate appraisals that are frequently incorrectly developed based on an inappropriate premise of value.

After completing a search for funeral home business transactions within the DealStats database, a review of the transaction data revealed that, with few exceptions, the transactions involved not only the sales of the business enterprises, but also involved sales of the real estate.

In most cases it was indicated that the real estate was sold separately and was excluded from the sale price of the business. In other cases, it seemed apparent that the sale price most likely included the real estate but there were no notations anywhere addressing this question directly.

Funeral home businesses are just one example of enterprise types that perform their services within operational real estate. In other words, real estate that is specially designed and purpose-built to operate within a specific type of business. There are several terms that have emerged over the years to describe these types of businesses, including: RECEs, Real Estate Centric Businesses, Real Property Going Concerns, Real Estate Dependent Businesses, Location Dependent Businesses, and others.

Despite the seemingly handy allocations of business value within the database, the fact that most of the funeral home transactions involved sales of both business and real estate raises important questions for valuers.

Most importantly—Is it reasonable to rely on the allocations reported transactions? Who performed these allocations? Were the results of the allocation truly based on an earnest attempt at accuracy?

Most experienced appraisers recognize that allocations, which are actually part of the negotiation between the buyer and the seller, are influenced by such factors as tax implications and sometimes the relative bargaining position of the respective parties. In short, they should be treated with skepticism.

Special Purpose Properties

Special purpose properties are defined as: “A property with a unique physical design, special construction materials, or a layout that particularly adapts its utility to the use for which it was built”.[1] They are different from what are described by some as commodity type properties, such as general office, retail, and industrial buildings.

Characteristic of special purpose properties are generally high costs to convert to alternate uses if it is possible at all. Even when they can be converted to an alternate use, the result is frequently a building with significant functional obsolescence.

Examples of other types of businesses that operate out of special purpose properties are restaurants, car washes, bowling centers, movie theaters, special purpose manufacturing facilities, and golf courses.

Value in Use

“In economics, a distinction is drawn between value in use and value in exchange, with the former being the value derived from utilization of an asset and the latter being what the asset could be exchanged for.”[2]

In many real estate appraisal texts and courses, market value has effectively become synonymous with exchange value. Additionally, there are misconceptions and misunderstandings about value in use.

These misconceptions frequently confuse value in use with use value. Use value is a type of value, as are disposition value, investment value, and insurable value. In contrast, value in use is a valuation premise. Value in use is defined by the Dictionary of Real Estate Appraisal, 6th Edition, as: “The value the real estate contributes to the enterprise of which it is a part.” Said another way, it is the value an enterprise derives from use of the asset.

Neither the building nor the machinery or equipment have intrinsic value, which is why simply adding together the individually appraised parts to derive the total value is not a reliable methodology. Their value is derived in the minds of market participants based on utility of these components.

Highest and Best Use

Highest and best use is a central premise in real estate appraisal. The concept is to value the property in the manner which would generate the greatest return to the owner. And because real estate commonly represents the single largest asset associated with these types of business, it is crucial to their valuation. This is notwithstanding the common practice of business owners who hold the business real estate in a separate entity for tax and liability management issues.

The highest and best use analysis addresses four criteria:

  • Physically possible
  • Legally permissible
  • Financially feasible
  • Maximally productive

If after completing a thorough analysis of the above considerations, it is determined that the highest and best use of the property is as an integral part of an operating business, including real property, personal property, financial assets, and the intangible assets of the business, then value in use is the appropriate premise of value.

This is an important distinction because this effectively results in the interdependence of the real estate value with the business enterprise. This interdependence extends to the related equipment. Consider the difference in value between factory equipment purchased in place for continued use within the plant, versus the same equipment in a factory that has ceased operations and any equipment would be sold off for removal and transport to another facility.

Because of this interdependence, the most reliable method of valuation is allocation. It is not to appraise each asset separately and to add them together. In fact, USPAP explicitly warns against relying on such an approach, noting “… an appraiser must refrain from valuing the whole solely by adding together the individual values of the … component parts”.

It is worthy of note at this point, that the highest and best use analysis of these special purpose properties are typically more complex than of other property types, because general business elements must be considered in addition to the real estate. Consideration must include the business in general—including the nature of the business and its prospects. The economic outlook in general and the outlook of the industry in which it operates. The strengths and weaknesses of the primary geographic trade area in which the business depends for deriving most of its customers. This includes careful consideration of the competitive landscape—especially recent or proposed properties that will directly compete with the subject in the future.   

Hierarchy of Values

Total cash-flows effectively represent the aggregate of multiple cashflows attributable to each component, or factor of production. In fact, each component can be valued by capitalizing the earnings that can be attributed to that asset.

However, cash flow to the business enterprise component can only begin after the cashflow requirements of the land, building improvements, and personal property have been satisfied. Therefore, before a positive business value is created, the business must satisfy the requirement for an adequate return of and return on investment for the investment in land, the building improvements, and the personal property investment.

Therefore, when valuing the business, it is useful to consider the conceptual premise that the cashflows should be allocated in a hierarchal fashion: all cashflows must first be allocated to supporting a return of investment in the real estate. Only after the real estate value is supported by available cashflows, can the remaining cashflows be allocated to begin providing a return of and return on investment in the building improvements.

Many will recognize this as the conceptual underpinning of the excess earnings method. A concept that is valid, despite the wide historical misuse and misapplication of the method by early business valuation practitioners.

Over the past 20 years, recognition of the usefulness in solving the particular challenges associated with appraising special purpose properties has gained wide acceptance. That acceptance accelerated significantly in the past 10 to 15 years in the wake of several authoritative books being published on the valuation of properties like senior care facilities, gas stations and convenience stores, golf courses and country clubs, funeral homes, and restaurants. All of which incorporated the fundamental concepts in their approach to solving the valuation problem.

Example Case Study

A high visibility 1 1/2-acre parcel of land is improved with a restaurant. Assuming a land value as though vacant of approximately $1,000,000 would require a minimum revenue to support the underlying land value of $60,000, further assuming a land capitalization rate of 6.0%.

If the restaurant is generating overall revenues of $750,000, and there is no evidence that those revenues can be dramatically increased, then the business likely cannot support a rental rate much more than $60,000, which equates to 8.0% of revenues.

In such a scenario, there is no business value. Similarly, there is likely little or no value associated with the furniture, fixtures, and equipment (FF&E) since the premise of value would not be as part of a going concern but a liquidation value scenario. Finally, the highest and best use of the property is likely no longer going to be for restaurant use. Even if the restaurant building shell lends itself to conversion to an alternate use, the building improvements frequently do not contribute much more than nominally to overall value. Moreover, if the building shell cannot be salvaged, the cost to demolish would actually negatively impact the underlying land value.

For business appraisers, attempting to value the business without knowing the underlying land value could result in misleading results in these types of situations.

For real estate appraisers that do not fully comprehend value in use and who do not have adequate knowledge about the business that supports the real estate, the FF&E, any licenses and any existing intangible values, the results of those real estate appraisals can be similarly misleading.

Common Real Estate Appraisal Issues

Business appraisers frequently rely on real estate appraisals as inputs into their own analysis. These inputs may include a market rental rate, or the value of the improved property. However, there are common problems that are encountered.

As previously discussed, many real estate appraisers hold misconceptions or misunderstandings of value in use, which can result in faulty valuations, which can have a domino effect on the business valuations that rely on those inputs.

Specific issues to watch for when deciding how much to rely on a real estate appraisal, include whether the appraiser’s analysis appears to logically make sense.

For example, it is not uncommon to see a sales comparison approach presented in which several real estate sales are presented, whether they be funeral homes, restaurants, or gas stations. If the sales were of operating properties, then the transactions were not likely of the real estate only but included the businesses as part of the negotiation. Even if separate agreements of sale were drafted for the real estate and the business, the buyer was clearly not just buying real estate only. In other words, the values being reported are likely either allocated values for the real estate, or may even include business values and/or FF&E. Unless the appraiser had intimate details of every sale transaction and a sound basis for the allocation, the reported values may be unreliable.

Alternatively, if the sales presented were of former funeral homes, restaurants, or gas stations, that were potentially being sold for an alternate use or for redevelopment, then they likely do not share the same highest and best use and are not appropriate sale comparables.

Similarly, because these property types are rarely leased, it is not uncommon to see some real estate appraisers estimate a market rental rate based on comparisons with office rentals within the local market area; however, the assumption that a funeral home would rent for the same rental rate as an office building is unlikely to be reliable.

These common issues associated with real estate appraisals stem from the misapplication of general real estate appraisal techniques to special purpose properties which are bought and sold primarily based on the economics of the business associated with the property, and secondarily on the physical attributes of the property.


By recognizing the important concepts, as well as some of these common problems, it is possible to incorporate the concepts and to avoid the problems. If you are considering incorporating the valuation conclusions of a real estate appraisal that has been provided to you, and your reliance on those conclusions could materially impact the results of your valuation, first read through the report to see whether it appears to contain some of the potential flaws discussed above.

Alternatively, if you are completing a business valuation while a separate real estate appraisal is being developed concurrently, it would be a good idea to compare notes with the real estate appraiser and to collaborate to the extent possible. For starters, request that they include a cost approach in the appraisal. Starting with a solid land value estimate can be an important first step, especially since an exceptionally high real estate value will provide you with critical clues as to highest and best use.

Similarly, while depreciation estimates for the building are necessarily subjective, some understanding of replacement cost and economic life of building improvements will provide important clues as to what cash flows are required to support that component of the business.

Also recognize that the appropriate income approach methodology for real estate appraisals, commonly termed a “Going Concern Analysis”, largely mirrors the income analysis in business valuations. Therefore, the expertise of the business appraiser in considering the fundamentals of Revenue Ruling 59-60 can provide an important contribution to the real estate appraisers analysis. Therefore, collaboration between the two appraisal disciplines will yield the most reliable results.

[1] The Dictionary of Real Estate Appraisal, 6th ed. Chicago: Appraisal Institute, 2015. Pg 217.

[2] Kerry M. Jorgensen, MAI, “Market Value in Use is Not an Oxymoron”, Counselors of Real Estate, Volume 42, Number 7.

Bruce E. Jones, MAI, ASA-GC, BCA, CMEA, focuses his practice on the valuation of special purpose properties, with an emphasis on restaurants and funeral homes. In addition to being a designated member of the Appraisal Institute, he holds the specialty designation in Going Concern Valuations from the American Society of Appraisers. He is also a business appraiser and machinery/equipment appraiser.

Mr. Jones may be contacted at (732) 374-9064 or by e-mail to

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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