We’re being told to wake up and smell the post-GFC property prices, but what if that property is a restaurant?
In October this year, Fairfax’s property editor Jonathan Chancellor published an article that called for Sydney home owners to face up to the fact that their slice of the market probably wasn’t worth what they thought it was.
“It is time for Sydney vendors to be realistic about what their houses are worth,” he wrote. “Prices are not necessarily going up and probably will not for some time.”
The same reality check was also playing out in major cities like Melbourne and Canberra, and, to a lesser extent, across regional areas around the nation.
And, according to a range of experts, running a business like a restaurant or catering company on that property involves similar assumptions about its true current value.
“Most business owners think their business is worth more than it is,” says NSW-based accountant Bruce Morton. “When that business is a restaurant or other similar food service operation, there’s the added emotional value that owners often put on their perception of its worth, because of the long hours they’ve poured into it, year after year,” he says.
But there are some simple rules about determining the value of a restaurant that remain more or less the same, regardless of what the property market or global economy is doing.
The first, according to Morton, is to separate the value of any real estate involved in the business.
“If restaurateurs own the premises or storage facilities used in running their business, they need to get an idea of the current value of that property, and I’d suggest using a property valuer for that job,” he says.
James Alexander is a valuer working on the NSW South Coast, and agrees many business operators overestimate the value of their property.
“The most common situation I see is where property owners — whether it’s a private home or commercial space—hang on to a value they have in their heads from when the market was particularly good,” he explains.
“They might have been offered a certain figure for their property five or 10 years earlier, or a real estate agent might have given them an indication of what their place would be worth in a certain market. But the only way to get a true value of property in a current market is to look at things like recent comparative sales in the area, rental yields, and any improvements that might have been made since the property was purchased,” he says.
Once an estimate of the value of your restaurant’s associated property has been established, Morton says two other factors come into play in determining the overall value of a business: assets and goodwill.
“By assets, I mean things like stock and equipment, and also wherewithal, which refers to your cashflow and the resources to steer the business through a sudden downturn or unforseen costs,” Morton explains.
So far, the process of forming an idea of the value of your business might seem obvious. But determining the goodwill of your restaurant is undoubtedly trickier.
In the middle of this year, a well-established café changed hands in a small, regional town on the Victorian east coast. The new owners, who don’t want to be identified, paid a sum for the business that included a “significant” portion for goodwill, which had been estimated according to the value of things like solid patronage and high levels of recognition in the local community.
“They might have been offered a certain figure for their property five or 10 years earlier, or an agent might have given them an indication of what their place would be worth.” James Alexander, valuer, NSW
But within a month of taking over, they realised the goodwill estimate had been misleading.
“One of the things that first attracted us to the place was its large rear courtyard, which included a garden and a small stage where the previous owners hosted live music,” the chef and co-owner says. “But we quickly realised that we’d inherited a free-for-all, where local people expected to be able to come and drink and hang out, without buying anything.”
The owners had a battle on their hands in changing the culture of the café’s patronage, and clawing back the business’s profitability with a more workable economic model. And it’s a battle they say should have been taken into account in the estimate of goodwill they sought before buying into the business.
“We felt like we’d been cheated, because on the surface, it was true that the café had been recognisable in the community and busy for most of the time, but in reality, those two things were actually the source of major problems in the business. And we felt like we’d paid extra for it.”
Morton warns potential buyers of restaurant or catering businesses that it is their responsibility to make sure due diligence is completed, and suggests these particular owners might not have done so if their consideration of the sale didn’t turn up clues to this apparent disconnect.
But it certainly highlights the minefield that can be determining the value of goodwill.
“It is a hard one to examine,” he admits. “But even though it’s complicated, there is a certain logic to it, and a theory, so you should be able to trust in the figure that comes back if it’s been done properly.”
He also says the restaurateur’s behaviour and attitude to his business can play a part.
“From a purely accounting perspective, restaurateurs usually overestimate the value of goodwill because there’s a huge emotional element for them,” Morton explains.
“Gut feeling does come into it, but you’ve got to look at the whole picture.”
For instance, restaurants are often only owned and operated for about five years because of the toll of long hours and constant work, he says. “Food service businesses are hard, but you’ve then got to weigh that up against things like being your own boss and managerial independence.”
“Of course you look at the economy of it, so you’d consider the number of hours the owners work in the business and the amount they take home in the equivalent of a wage… but if it turns out that once you look at those figures and realise they’ve been working for the equivalent of ten dollars an hour, you have to consider what else they’re getting out of it to make it worthwhile.”
In terms of improving the value of your restaurant or catering outfit, Alexander says many of the same rules apply as residential real estate.
“Restaurateurs need to remember that you don’t always get back what you’ve put in when it comes to improvements, so be careful not to overcapitalise,” he says.
That means, while building a new deck might add value to the business because the kitchen can turn out more covers and more latte-sippers can be served, it doesn’t necessarily equate to an extra hundred grand in the value of the actual property.
“The best thing you can do is keep the place looking good, and as functional as possible. Keep it painted inside and out, keep the kitchen up-to-date, maybe give the bathrooms a bit of a makeover every few years,” Alexander explains.
For every aspect of the property that doesn’t work or is seriously outdated, you should expect a potential buyer to factor in the cost of fixing it into their perceived value of the whole place. So, if you do end up putting in a new deck, keep it oiled.
And whatever you do, see your financial advisor and other professionals before embarking on any valuation exercise with your restaurant. They’ll be able to give you Jonathan Chancellor’s idea of a ‘realistic’ vendor value.