SELLING A BUSINESS

Mar 29, 2023

How to Value a Property Management Company: A Quick Guide to Valuing Property Management Companies

What Classifies as a Property Management Company?

A property management company is a business that specializes in the management and maintenance of rental properties. They are responsible for the day-to-day operations of the property, including taking care of tenants, collecting rent, and handling any maintenance or repairs. Property management companies may also specialize in certain types of properties, such as single-family homes, condos, or large office buildings.

Property management companies often use Proptech software like Appfolio, Yardi or Buildium to help with the day-to-day operations of the property, such as tracking rent payments, managing maintenance requests, and scheduling repairs. In addition, they must possess an understanding of the local rental market, rental laws, and landlord-tenant relationships in order to succeed.

The value of a property management company comes from their ability to provide a great tenant experience (consistency), manage contractors and the operations budget (profitability), and help create a sustainable and profitable rental income (churn).

What Is Included In a Business Valuation?

A business valuation typically takes into account a company's assets, such as its buildings and equipment, liabilities (e.g., an SBA loan or lines of credit), profitability, transferability (e.g., how easy is it for a new owner to take over?) and growth prospects. This helps to provide a clear and accurate picture of the business’s worth.

As a business brokerage that specializes in “main street” businesses, we work with dozens of property management company owners each quarter to craft valuations from the ground up. These valuations can be used to think about exit planning or to set the asking price when selling a property management company.

In this post, we’ll break down the basic process for valuing a property management business based on seller's discretionary earnings. That being said, if you want to get a detailed valuation of your own business, please reach out.

How Do I Value a Property Management Company?

To calculate the value of a property management company, start by analyzing the past three years of your tax returns. Once you’ve pulled these financial documents from your records or your CPA, the next step is to calculate Seller’s Discretionary Earnings for each year. Seller’s discretionary earnings (SDE) is a proxy for how much future earnings an owner-operator would receive from owning the business. 

To get to SDE, we add up the following:

• Net Income (reported to the IRS on the tax return)

• Interest

• Depreciation

• Amortization

• Owner Compensation (e.g., salary of the owner, healthcare and retirement benefits)

• Discretionary Expenses (e.g., kids on the payroll who aren’t actively working in the business)

We then need to adjust the initial SDE number for common “edge” cases in a small business:

• If you own a small shop for storing equipment, are you under- or overpaying rent?

   Adjust the rent expenses to account for what you would charge the buyer of your business on an ongoing basis.

• Did you make a purchase of a personal vehicle through your company?

   Make sure to add back the cost of the vehicle (and subtract any depreciation), as the buyer would not be forced to make such a purpose.

• Do you employ family members working as bookkeepers or on crews?

   Adjust the payroll to remove family members who do not work and pay market prices to family members who would need to be replaced.

• Did you book PPP or EIDL as income?

   Make sure you remove any COVID-related loans from the income statement.

Now that we have a number for SDE and we’ve adjusted it for a new buyer, we need to come up with an average that represents future earnings. For instance, if you specialize in commercial properties and lost management contracts during COVID, you probably saw recovery in 2021 as people came back into the office.

There are a number of ways to calculate a fair average of SDE across the years. At Beacon, we use a somewhat complicated formula. If you’re doing a valuation at home, we recommend that you weight the most recent year 50%, the second most recent year 37.5% and the third most recent year 12.5%.

For instance, if you had SDE of $420K, $390K, and $325K in 2022, 2021, and 2020, you would do the following: $420K x 50% ($210K) + $390K x 37.5% ($146.25K) + $325K x 12.5% ($40.6K). Adding those up would yield $356.2K. This would be your weighted average SDE.

Once you’ve calculated your weighted average SDE, you’ll need to apply a multiple to your earnings to determine the value of your business when ignoring cash on the balance sheet.

What Affects The Valuation of My Property Management Company?

There are a number of factors that can impact that value of your property management company:

• Customer Concentration: How many of your properties under management are tied to one landlord or real estate owner?

• Profitability: Property management is a hard business and margins can be tight. The higher the profit margin (i.e., > 10%), the better the multiple for a new buyer.

• Churn: How long is your average contract? What's the % of contracts that churn on an annual basis?

• Consistency: How durable is your team? Is there constant turnover in your crews and back office staff? Or have your employees been around a while?

• Transferability: How easy is it for a new owner to come in? Do you have documented SOPs? Are your contracts transferrable to a successor entity? How much is left on your average management contract? Do you have a number two who can help train the new owner up?

• Specialization: What types of property do you manage? For most buyers of residential property managers, the management of large (100+ unit) apartment buildings is the most sought after, followed by the management of medium-sized (20–100 unit) apartments, followed by the management of single-family homes.

• Contract Terms: Do your contracts have automatic renewals? What is the length of the contract?

These factors will impact the multiple applied to your SDE. As a general rule of thumb, we recommend using your revenue to guide your multiple. That being said, it is pretty imprecise. Some management companies may have high revenue but very low profitability with high churn. For a more exact valuation, please reach out to a member of our team.

For those performing a quick valuation at home, we recommend the following approach:

• For property management companies with less than $500K in gross revenue

  • Use a multiple of 1.5 - 2.25x

• For property management companies with $500K to $1M in gross revenue

  • Use a multiple of 2.25 - 2.75x

• For property management companies with $1M to $5M in gross revenue

  • Use a multiple of 2.75 - 3.5x

• For property management companies with more than $5M in gross revenue

  • Use a multiple of 3.5 - 5x

Using our example from previously, if the property management company earning $356K in SDE was grossing around $2M in revenue, then their valuation would be between $979K and $1.246M.

FAQ

How do market rent, rental income and rental property value affect the value of a property management company?

The value of a property management company is definitely affected by market rent, rental income, and rental property value. When rent prices in the market are high, rental income for the company will increase, which can lead to increased value for any property management companies in the area. Conversely, when rent prices and rental property values are low -- as is starting to happen in the country as of the writing of this post, the value of the company will decrease as the company’s profits decline.

What other methods are used to value a property management company?

In addition to the SDE approach, some buyers prefer to use a per-unit method of valuing a property management company. This involves setting the asking price or bid price of the company based on how many units are under management contracts. For example, some buyers may bid at $1,050 per unit. A property manager with 375 units under contract would be valued at $393,750.

What does it take to be a successful owner of a property management business?

First and foremost, a new owner needs savvy marketing and technology skills, ability to multitask, prioritize and be organized. Property management is the art of multitasking, as any company could have well over 100 units under contract.

Aside from the organization skills, customer centricity is important as well. Property managers are often the first call when something goes wrong. Being able to disarm and work with difficult tenants is crucial to maintaining contracts for the long run.

Katie Lamar

Business Development

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.