Going Concern Valuations: Get the report at the start

As of March 2013, business interest rates have come down to a level not seen for a long time (3yr BBSW levels). As a result, there are a lot of business opportunities where the possibilities of purchasing businesses and buildings have suddenly become attractive and profitable.

Examples include childcare, boarding houses, hostels, pharmacies etc.

However, for people moving away from the residential properties investments into something a bit more lucrative, different rules applies.

Firstly, what is going concern valuations?

Going concern valuations are basically assets (or businesses) where there is value in the actual asset that could operate with any changes in management (I’m sure there are more technical definitions out there – but lets keep it simple). A convenient way to explain what a going concern means is that in the event that owner of the asset fails to meet their loan repayments, an administrator can come in and continue running the business.

Think pubs – if one fails, the pub will still be there. Just new owners/managers running the place.

For property investors, what does this mean if you were to look at dabbling into the world of boarding houses/hostels, where the gross rental returns are usually quite high? (here is an example of one)

Well it means that the bank does not necessarily lend at 80% (or whatever the standard loan value ratio (LVR) for home loans). Instead, for security, it will actually be dependent on how strong the income is generated from this asset. Think of it more of a business than a residential property – there will be a requirements for profit and loss financials for the boarding property you are looking to buy. This will help confirm whether this investment will be a good buy and also, help a going concern valuer determine the “intrinsic” value of the business.

From the strength of the income from the boarding house, plus any income you generate (i.e. whether from your salary or business income), it will ultimately determine the LVR against the value of the property. The debt service coverage ratio will usually determine the LVR and that’s why its important to speak to a business banker who is quite savvy with these type of transactions. Hence, it’s not a simple walk in the park + 3-4 weeks settlement. Your banker (usually a business banker) will require time to analyse and put a proposal together to help you purchase this asset.

There are generally 3 types of going concern valuations –

  1. Freehold basis – you are buying the “business” plus the land
  2. Leasehold basis – you are buying the “business” only with the view to run the business
  3. Lessor’s interest – you are buying the “business” only with the view of having someone else run the business

There are stark differences and its essential that the right valuation is ordered – otherwise, expect to be hit with another 4 digit tax invoice (yes, you are expected to pay for these commercial reports unlike a home loan valuations which are usually absorbed by the banks).

So, why should you pay for this report upfront?

Its simple  – there are so many variables especially with the projected income that the asset is expected to generate. So, if the accountant was to provide a guesstimate of the future income and expenses and the bank relied upon to these guesstimate to give you a conditional approval – only for the valuation to return a lower figure, its back to the drawing board in analysing the data again. Ultimately, it’s the time it takes and this could mean losing your 5-10% deposit or losing the lease to a rival.

 

 

 

 

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