Multiplying the multiplier

Published: 22 July 2008.

Contributed by Ian Brooks of Platinum Resort Brokerage

Recently one of our leading accounting firms hosted a tax planning and management rights industry seminar and they asked if I could include a presentation to their clients on current market sales. Not surprisingly they singled out the old ‘what is the multiplier doing’. Wow if got a $100 every time I have been asked this over the years I could give up my day job and retire to the Bahamas.

So why is it impossible to answer in less than five hundred words this seemingly simple question? Surely at any point in time all buildings in similar locations must be selling at a comparable multiplier? Well unfortunately not. In fact there can be huge differences in multipliers even between buildings located next door to each other. Residential property markets produce similar disparity - pick virtually any street in any suburb, are all the houses in that street the same price? No, we find that substantial price variations occur as they do with cars, boats and holidays, its not apples with apples and there are a vast number of variables to consider with each purchase the same applies to management rights.

Over the last decade we have experienced an unprecedented period of economic stability and growth. This, coupled with historically low interest rates and the public listed tourism companies scrambling for market share, created a fertile market for management rights. The dynamic started to change when interest rates began to rise and that was quickly followed by the sub prime mortgage fiasco and general stock market correction late last year.

The old saying no one ever rings a bell at the top or at the bottom also applies to the real estate and management rights market. It is only with the benefit of hindsight that we can look at a graph or line chart to see where the high and low points of the economic cycle occurred.

There are two things above all else that determine the sales multiplier of management rights: The first determines the price of virtually everything we consume and that is supply and demand! More buyers, less stock equals higher prices and a seller’s market. Fewer buyers, more stock equals lower prices and a buyer’s market. The second major factor is interest rates! When interest rates increase more of the business profit is eroded to service debt this has a dampening affect on the buyer’s ability to borrow funds and in turn places downward pressure on the multiplier.

So, what can managers do about the multiplier and is it the be all and end all? My personal view is that far too much importance is placed on the multiplier by buyers and sellers alike. We have already established that supply, demand, interest rates and general market sentiment will ultimately determine what the multiplier and sale price is for any given property at any point of the economical cycle, so as a buyer or seller all we can do is decide when we wish to enter or exit the market.

Unfortunately some times issues such as health or stress place sellers in the market at a time when few buyers are active this creates opportunity for some to grab that elusive bargain (such is life). There will always be willing sellers and willing buyers at price acceptable to both parties. Conversely there will always be unrealistic sellers and buyers who wish they had heard that imaginary bell ring. What managers and prospective buyers should be focused on is growing the business. Let’s look at the following example but remember we have no control over the multiplier and we don’t have a crystal ball that shows us a graph with the peaks and troughs before the event but we can improve our net profit by growing our business

Assume you buy a building that was netting $150k at a 5x multiplier, you keep it for five years, you are a good operator and you manage to increase your net profit by 10% p/a $15k per year – an extra $75k over five years x 5 – that’s $375k capital gain with zero change to the multiplier. Use the same formula on a business that nets $300k and the gain is three quarters of a million dollars (not too shabby indeed).

Management rights are a unique business in that they can’t be sold independently to the manager’s apartment and ancillary real estate. Likewise the manager’s apartment can’t be sold without the business. This creates one of the major problems in determining the sale price of the business and in particular the multiplier. While, in theory, you can borrow up to 75% of the total purchase price for management rights, in practice there are very few buildings that will have enough profit to service that level of debt due to high real estate values.

A good rule of thumb is that most buyers and bankers will be looking for a business where the real estate value is no more than 30% of the total purchase price (25% or less is ideal). This is one of the main reasons why buildings with net profits over $500k P/A are able to consistently achieve 6x plus multipliers; low ratio real estate value enables higher gearing levels. We have sold properties where the manager’s apartment has been 50% or more of the total purchase price but buyers for these types of buildings are rare and the multipliers for these types of properties have been comparatively low.