Many restaurant owners have been shocked to learn that they are unable to market or lease their own restaurant property for an amount equal to its tax assessment value. The market value of a recently built restaurant is usually less than it's construction cost. When an owner attempts to arranged a sales price or lease rate, he is unable to recoup his costs. Excess property taxes derive from improper use of the price approach to market value.
The price approach is an excellent valuation methodology for some types of new properties. It works better for properties that can be utilized by a lot of users without alteration as opposed to special-use properties. Apartment complexes are a good example of properties where several users can use exactly the same property with couple of, if any, alterations. Restaurants are a category where extensive makeovers are typically required to transform a restaurant from make use of by one operator to use by another operator. This is particularly true where chain restaurants are involved. For example, how much would it cost to transform a restaurant built for McDonald's to be used by Pizzas Hut?
Randy Dishongh, of the Mason Container Restaurant Group, recently purchased a 8,Two hundred and fifty square foot restaurant that's been used by another owner and altered for use by his firm. It cost $400,Thousand ($48.48 per square foot0 to convert the restaurant. Phil Kensinger, of Kensinger & Company, lately purchased an 8,000 square foot cafe that cost $300,Thousand ($37.50 per square foot) to convert his tenant's requirements. Kensinger reports, "improvement in a cafe built-to-suit often has little if any value to a heir tenant."
Part of the business value produced by restaurants is dependent upon a unique architecture that is identifiable to restaurant patrons, who believe they are able to expect a reliable high quality of food and service for a set price at this establishment. It is important to restaurant operators that operating units possess this recognizable structures. It is the primary reason large restaurant operators such as McDonald's, Pizzas Hut, and Whataburger have distinctive restaurant design along with distinctive signage.
Signage is a good example of one of the high-cost conversion items. McDonald's golden arches tend to be distinctive and well serve the purpose of launching to its customers the presence of the McDonald's restaurant. However, they are not easily converted to be used by another restaurant, perhaps not even along with extensive conversion costs. The same is true for changing the elevation (outside appearance), interior layouts and redoing the inside finish.
The unique architecture of chain cafe facilities makes it difficult to convert a service built for one chain to use by an additional chain. It costs less to convert them through use by a major chain to a nearby nonchain operator. Examples of nationwide chains with special architecture include: McDonald's, Pizza Hut, Burger King, Wendy's, Long John Silvers, Pizza Inn, Jack within the Box and Whataburger.
Meanings Determine Methodology
The first steps in determining the correct valuation methodology includes, reviewing a series of meanings, determining how they apply to restaurants, and reviewing the laws which apply in your legal system. However, continual refinement is essential to the growth of the appraisal profession. A current economic definition of market value is stated as follows:
The most probable price, as of a particular date, in money, or in terms equivalent to cash, or in additional precisely revealed conditions for which the specified property rights should market after reasonable exposure in a competitive market under all conditions requisite to a reasonable sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is actually under undue duress. (The Appraisal associated with Real Estate, 20th erectile dysfunction., published in 92 by The Appraisal Institute)
The following definition continues to be agreed upon by agencies that regulate government financial institutions in the United States, such as the Resolution Trust Corporation (RTC):
The most probable cost which a property should bring in a competitive as well as open market below all conditions required to a fair sale, the buyer and vendor each acting prudently as well as knowledgeably, and assuming the cost in not affected by undue stimulus. Implied in this definition may be the consummation of a sale of a specified date and also the passing of name from seller to buyer under conditions whereby:
buyer and seller are typically motivated
both parties are well informed or well advised, as well as acting in what they consider their best pursuits
a reasonable time is allowed for exposure in the open market
payment is made in terms of cash in the United States or in terms of financial arrangements comparable thereto
the price represents the normal consideration for the home sold unaffected by special or innovative financing or sales concessions granted through anyone associated with the purchase. (USPAP, 1992 edition)One
Use Value. The value a specific property has for a specific use.2
Investment Value. The specific value of a good investment to a particular investor or class of investors based on individual expense requirements; distinguished from market value, which is cold and detached. See also market value.3
Liquidation Value. The most likely price which a particular interest in real property will probably bring under the following conditions:
Consummation of a purchase will occur within a severely limited long term marketing period specific by the client.
Real market conditions are individuals obtained currently for that property interest evaluated.
The buyer is acting prudently and knowledgeably.
The seller is under extreme coercion to sell.
The buyer is typically motivated.
The buyer is actually acting in what he or she considers his or her needs.
A limited marketing time and effort will be allowed for the completion of a sale.
Payment will be made in money in U.S. dollars or in terms of financial arrangements comparable thereto.
The cost represents the normal consideration for the property offered, unaffected by unique or creative funding or sales concessions granted by anyone associated with the sale.
This definition can be modified to provide for valuation with specified financing terms. (The above description, proposed by The Evaluation Institute Special Job Force on Value Definitions, was adopted by The Appraisal Institute Board of Directors, July 1993.) See additionally disposition value; stress sale; forced price; and market value.Four
How to Apply Market Value to Restaurants
The total amount of this article is focused on identifying and evaluating market price for a restaurant. Market price is the type of valuation performed in Texas. Value in use, or use in value, may be the value a property needs to a specific user instead of the value in the open market. Investment value may be the value an investment has for a specific class of investors. Within restaurant valuations, the investment value of a restaurant with a long-term guaranteed by a high credit tenant might be dramatically different from market value of the property with no long-term lease and guarantee. Liquidation value is distinguished from market value primarily by a brief advertising period. The valuation methodology discussed thus pertains to market value rather than value in use, investment value or liquidation value. The market value of the restaurant real estate ought to be distinguished from the purchase of a going-concern. When a good operating restaurant is sold it may involve the sale of property, FF&E (furniture, fixture, as well as equipment), business worth, and inventory. The following are definitions for real property, business value as well as going-concern value.
Real Estate. Physical land and appurtenances attached to the land, e.g., structures. An recognized parcel of system of land, such as improvements, if any. See also real estate.5
Business Value. A value enhancement that results from items of intangible individual property such as advertising and management skills, an assembled work force, working capital, trade names, franchises, patents, trademarks, contracts, leases, and operating agreements. See also heading concern value.6
Going-concern Value. The value created by a proven property procedure; considered as a separate organization to be valued with a specific business establishment; also called going worth. See also business value.7
When a restaurant is sold, the bulk price for these four classes associated with assets (real estate, FF&E, company value and inventory) will typically be negotiated. During the business negotiation, each celebration may give some thought to the different items but is typically focusing more about the net cash flow produced by the restaurant and also the market value of that income stream. When the attorneys and accountants become involved, it will be necessary to allocate the purchase price to real estate, FF&E, business value and inventory. Government income tax ramifications might affect the allocation in between these items. Many traders will attempt to maximize devaluation for federal taxes purposes. This will include maximizing the allocation to building values, FF&E, and inventory. Traders typically attempt to minimize the value allocated to property and business value.
When confirming equivalent sales, it is essential to pick which of these elements are participating. The final set of meanings to be reviewed is fee simple property and leased fee estate:
Fee easy estate. Absolute possession unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.8
Rented fee estate. An ownership interest kept by a landlord with the rights of use as well as occupancy conveyed by rent to others. The actual rights of the lessor (the leased fee proprietor) and the leased charge are specified by contract terms included within the lease.Nine
There are three main distinctions between fee simple estate and leased fee property for the purposes of our analysis: 1) agreement rent paid as opposed to market rent which could be achieved, 2) the word of the lease, as well as 3) the strength of the actual lease guarantor. A renter may agree to pay an above market rental rate in order to induce a property manager to invest capital to construct a restaurant that has a special architecture necessary to operate his business and maintain a brand image. Burger king could not maintain their own brand image when they simply leased restaurants built by others, which were not successful places for the first operator. A diverse set of restaurant elevations would calm the brand image produced by their advertising.
The primary reason that some of the cafe rental rates are in an above market level is the price of converting a restaurant through use by one operator to use by another restaurant owner. Many restaurant providers view the landlord's capital costs of tenant improvements as a loan being repaid over the lifetime of a lease. Based on Randy Dishongh, of the Mason Jar Restaurant Group, "landlords be prepared to receive tenant improvement costs returned within the leased term and also a 10% to 12% return on funds advanced.Inch Discussions with other restaurants, investors and providers indicate that the deliver on tenant improvements may range from 10% to 20%, depending on the level of costs, their uniqueness and also the financial strength from the lessee.
Although 10% to 20% may seem like a high rate of return for a real estate investor, an equity investor inside a restaurant business would expect a higher level of return for this funds. Therefore, it is prudent for that real estate operator in order to in effect borrow the actual tenant improvement costs from the landlord and repay them with a good above market rent as compared to raising extra equity.
Choosing the Proper Approach to Valuation
The final step in our analysis is to review the 3 traditional approaches to value: cost, sales comparison and income. The price approach involves adding the market value of the actual land to depreciated worth of the improvements. The subjective portion is determining depreciation of the improvements in a market price appraisal. Deducting the price to change the exterior elevation, interior layout, interior finish and signs is one approach to identifying depreciation resulting from the unique requirements of each restaurant operator. Other items, which can be considered, are the leasing commission paid to a third-party leasing agent and rent loss before property is leased.
These types of costs can be substantial. Another approach to identifying total depreciation in a restaurant is to evaluate recent sales and allocate the purchase price between property and improvements. If the replacement cost of the enhancements is estimated and physical depreciation is deducted, the balance from the depreciation may be a good indicator of the depreciation due to the cost of conversion.
None of the traditional forms of depreciation describe precisely depreciation due to conversion of a restaurant. Based on the Appraisal Real Estate, Eleventh ed., published by The Appraisal Institute, "Functional obsolescence is caused by a flaw within the structure, materials, or design that reduces the function, resources and value of the improvement." Curable functional obsolescence is defined as follows: "An component of accrued depreciation; a curable defect the result of a flaw in the structure, materials or design." A second strategy would be to treat the costs of conversion leasing and rent reduction in the same manner because deferred maintenance since it is a necessary expense to organize the restaurant for a new restaurant operator.
The sales assessment approach is a direct and easily understood valuation tool. With dining places, due to the number of aspects of value (real estate, business value, FF&E and inventory) involved in a sale, the sales comparison strategy requires more detailed research to prepare an accurate value. It is critical to perform detailed research to separate the value of the real estate, business worth, FF&E, and inventory when reviewing comparable product sales. Since the allocation of these items is often made by lawyers and an accounting firm to maximize federal tax depreciation, it may not be reasonable to use the actual allocation established by the buyer and vendor in preparing a genuine estate appraisal. Because adequate information may not be available to properly set aside value for the property when a going-concern restaurant is sold, it may be appropriate to make use of this information as a comparable sale. Further, the time involved to estimation the business value, inventory, real estate and furniture, fixture and equipment values may be a more in depth and complex analysis than the appraisal of the subject restaurant.
Selecting appropriate sales, which entail only real estate, is the most important step in preparing the sales comparison strategy. It is often practical to separate the other elements of a going-concern restaurant sale from the real estate value. Purchase of a restaurant creating where a restaurant is not being operated reflects the true value of real estate provided adequate time for you to market the property is available.
Improper application of the actual income approach can lead to an unreasonable value. The most common pitfall whenever valuing a restaurant for tax purposes within Texas is to think about the contract rent becoming paid as marketplace rent. This agreement rent in most cases entails compensation for renter improvements. This repayment of the cost of tenant improvements is often a significant portion of the contract lease.
The second major item, which sometimes distorts the actual valuation of the charge simple estate whenever a restaurant is rented, is the effect of the long-term lease to a creditworthy tenant. When valuing the fee simple property when a restaurant is leased is the impact of the long-term lease to some creditworthy tenant. When pricing the fee simple estate, the evaluator should use market rent, market openings, market expenses along with a market capitalization price. If local exercise involves valuing the actual fee simple estate, the income using capitalization rate for a creditworthy tenant.
Conclusion
The most important step in correctly valuing restaurants for taxes purposes is identifying which type of value should be utilized. There are significant differences between the market price, value in use and investment value for the similar property. There are frequently significant differences between your market value of the leased fee estate and the fee simple estate. Calculations of the appropriate value can then be performed using relevant information. However, controversy over proper valuation associated with restaurants will likely be an energetic topic of discussion well into the future.
The actual appraisal division associated with O'Connor & Associates is a national provider of commercial property appraisal services such as insurance valuation, real estate appraisal, cost segregation research, due diligence, feasibility studies, monetary modeling, gift tax valuations, highest and finest use analyses, injury loss valuations as well as HUD map market studies.
