How to Value a Business with Real Estate

For many Canadian entrepreneurs, owning the property their business operates from feels like the ultimate milestone. It’s a tangible asset, a sense of permanence, and often a symbol of success.

But when it’s time to sell the business, hand it down, or plan their exit, a question inevitably comes up:

Does owning the real estate make the valuation easier, or more complicated?

In almost all cases, it makes things more complex, and if handled incorrectly, that complexity can result in inflated values, failed deals, unexpected tax bills, or disputes between shareholders.

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Business Valuation vs. Real Estate Appraisal

To accurately value a business that owns real estate, one must first understand that this task sits at the intersection of two distinct professional disciplines: business valuation and real estate appraisal. Each has its own set of internationally accepted methodologies, driven by different risk factors and cash flow streams. A successful valuation requires a nuanced understanding of both toolkits.

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Business Valuation Approaches

A CBV in Canada will typically rely on one or more of these core methods to determine fair market value:

Income Approach: Based on the business’s ability to generate future economic benefits.

• Discounted Cash Flow (DCF) Method: Forecasts future cash flows and discounts them to present value (to learn more, click here).
• Capitalization of Earnings Method: Uses a representative year’s earnings and applies a capitalization rate.

Market Approach: Looks at real-world sales of similar companies.

• Precedent Transactions: Uses multiples from comparable business sales.

Asset-Based Approach: Calculates value as assets minus liabilities. Often used for asset-heavy or unprofitable companies.

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Real Estate Appraisal Approaches

Designated appraisers use different tools to value property:

Sales Comparison Approach: Compares the property to recent similar sales, adjusting for differences.

Cost Approach: Calculates the cost to replace the building (minus depreciation) plus land value.

Income Approach: For income-producing property, divides Net Operating Income (NOI) by a market-derived capitalization rate.

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The core challenge in valuing a business with real estate arises from the fundamental incompatibility of the primary inputs used by these two disciplines. A business valuation often starts with EBITDA. A business that owns its property has no rent expense, which artificially inflates its EBITDA compared to an identical business that leases its premises. In contrast, a real estate appraisal's Income Approach is driven by NOI, which is calculated after property-specific operating expenses (like property taxes and maintenance) but before the business's financing costs and income taxes.

This mathematical disconnect is the primary source of the "double-counting" error. Simply valuing a business based on its inflated EBITDA and then adding the separately appraised value of the real estate results in counting the economic benefit of the property twice. Understanding this distinction is the first step toward a credible valuation.

The following table provides a clear, side-by-side summary of these distinct valuation frameworks.

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Is Your Real Estate Operational or Non-Operational?

Before any calculations can begin, the valuator must make a critical strategic determination that dictates the entire valuation methodology: is the real estate operational or non-operational?

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Defining Non-Operational (Redundant) Real Estate

Non-operational real estate consists of assets that are incidental to the core profit-generating activities of the business. They are often described as "passive" or "redundant" assets. To put it simply, if the business could operate identically in a similar rented space without hurting profitability, the property is considered non-operational.

Examples: A software development company that owns its office building; a manufacturer that owns a standard warehouse for storage; surplus land held for future development or investment; a residential condo owned by the operating company for an executive's use.

Valuation Treatment: These assets are valued separately from the core business using a "sum-of-the-parts" approach.

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Defining Operational Real Estate (OpRE)

Operational Real Estate (OpRE) is property that is inextricably linked to the business's ability to generate revenue and profit. In these cases, the property is not just a place of business; it is an active and essential component of the revenue-generating process. The property's specific location, physical attributes, specialized improvements, or general uniqueness are core drivers of its value.

Examples: Hotels, resorts, golf courses, marinas, farms, wineries, self-storage facilities, private hospitals or care homes, purpose-built accommodation, etc.

Valuation Treatment: Value the entire business and property as one integrated enterprise, because separating them would destroy the very value you’re trying to measure.

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On paper, the distinction seems straightforward. In reality, there’s often a big grey area where professional judgment comes into play. Take a manufacturing business that’s operating out of a facility it designed and built from the ground up, complete with specialized equipment, structural modifications, and a layout tailored exactly to its production process. Even though it’s not a hotel, relocating would be extremely costly and disruptive, and a standard warehouse just wouldn’t work. In cases like this, the property itself is tied closely to how the business operates. The valuator has to dig in to figure out how much those unique features are driving earnings compared to what the business could achieve in a typical rented space.

The table below serves as a diagnostic tool to help distinguish between these two critical categories.

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Valuing Non-Operational Real Estate

When real estate is classified as non-operational, the standard and correct methodology is the "sum-of-the-parts" approach. The guiding principle is to treat the operating business and the real estate as two separate and distinct investments, value each independently, and then add their values together to arrive at the total value of the enterprise.

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Step 1: Isolate and Value the Core Business via Normalization

The first step is to determine the value of the business as if it did not own the real estate. This is achieved by "normalizing" the company's financial statements to reflect its true, sustainable earning power under the assumption that it is a tenant.

If the company owns the property: It pays no rent, which, as discussed, inflates its reported earnings (EBITDA). To create a valid basis for comparison against other companies in the industry that lease their space, a hypothetical Fair Market Rent (FMR) expense must be deducted from the company's earnings.

If the company rents from a related party: Business owners who own the property in a separate holding company often set the rent at a level that is advantageous for tax purposes, which may be above or below the true market rate. In this case, the rent expense must be adjusted to what an arm's-length party would pay.

The valuator determines the FMR either by engaging a real estate appraiser to provide a market rent analysis or by calculating it based on the property's appraised value and a market capitalization rate. Once all normalization adjustments are made, the valuator applies standard business valuation methods (typically the Income or Market Approach) to the adjusted, normalized earnings to determine the value of the operating business only.

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Step 2: Value the Real Estate Separately

Concurrently, a qualified, independent real estate appraiser should be engaged to determine the Fair Market Value (FMV) of the property, using the principles and methods described earlier.

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Step 3: The Final Calculation

The final step is to combine the two separately determined values. The real estate is treated as a "redundant" or "non-operating" asset that is added to the value of the core operations. Any mortgage or debt specifically tied to the real estate must be accounted for correctly within the company's total liabilities to arrive at the final equity value.

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Valuing Businesses with Operational Real Estate

For an operational asset like a hotel, it is nonsensical to deduct a "market rent" because there is no comparable market for leasing a fully equipped, branded, and operating hotel. The income is generated by the entire enterprise, a seamless blend of the tangible asset (the building), operational expertise (management), and intangible assets (brand reputation, booking systems, goodwill). Separating them destroys the very value one is trying to measure.

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The Correct Methodology

The entire entity must be valued as a single going concern. This is typically accomplished using an Income Approach, specifically a Discounted Cash Flow (DCF) analysis, applied to the total projected cash flows of the integrated enterprise. A Market Approach can also be used, but it requires finding transaction multiples from the sales of other, similarly integrated businesses (e.g., the sale price of another hotel as a multiple of its EBITDA), not just the sale of hotel real estate.

This type of valuation demands a sophisticated, hybrid expertise. The valuator must understand not only corporate finance and business cash flows but also the specific operational metrics and risk factors of the underlying real estate sector, such as Revenue Per Available Room (RevPAR) for hotels, occupancy rates for senior care facilities, or assets under management for self-storage. This complexity often necessitates a close collaboration between a CBV and a real estate appraiser with deep specialization in that specific property type.

Consequently, the due diligence process for OpRE shifts from a traditional real estate focus (title, zoning, physical condition) to one that resembles a corporate merger and acquisition analysis. It involves a deep dive into the operator's business plan, brand strength, marketing strategy, and operational efficiency. A buyer is not just acquiring a building; they are acquiring an operating system. The value is contingent on that system remaining in place or being replaceable with one of equal or greater quality. This illustrates that the value in OpRE resides in the operation, not just the location, and requires a valuator who can function as a business strategist to dissect these operational drivers.

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Conclusion

The valuation of a business with significant real estate holdings is a complex undertaking that requires a sophisticated, multi-disciplinary approach. As this article has demonstrated, the path to a credible conclusion is fraught with potential missteps that can have serious financial and strategic consequences.

Flux Valuations focuses on valuing businesses, but in certain situations, we’ve also helped owners value the real estate tied to their operations. If you’re planning a sale, succession, or just want a clear picture of what your business and property are worth, reach out to see how we can help.