How do you find the new cost of your business after renovating

article

Renovating your venue is usually undertaken for one of three reasons:

To attract new customers,
To improve the value of your business, or
It really, really needs it.

Whatever the reason, giving your restaurant, cafe, or bar a good once-over will invariably bump up it's value for sale. And whilst it might feel like you've given the building a new lease on life, it's actually a very specific art to quantify the new cost. Here's how:

Will it be higher or lower?

Strange as it may sound, the improvements or renovations you make on your venue might not always result in a higher sale price.

Restaurant improvements are typically designed to accommodate a specific concept or type of restaurant, and may require extensive remodelling. Why? To suit the new needs of a different owner or tenant. For example, a Turkish restaurant will require a totally different layout for floor seating, as opposed to an American diner that previously had in-built booths.

The value of the improved site and restaurant building components may be higher or lower than the original cost to purchase and prepare the site and build a restaurant, depending on the age of the improvements and whether the building is occupied by an operating restaurant business.

There are three ways to find this new value

Appraisers (valuers) of restaurant real estate normally consider three approaches to value:

The cost approach,
The sales comparison approach, and
The income approach

The Cost Approach

One reason for renovating a venue is to customise it to a particular brand or franchise.

These properties are generally owned by investors who have bought the building with the awareness that it would need to be specially modified to suit a franchise store. Why? They love franchises because they're a safe option, low risk, and have proven success rates.

But what this means is that the price of the building isn't found by the market value (as it normally would) but by the 'investment value' - specific price based on the lease payments for the franchise.

But because this new restaurant building is designed with a specific concept in mind - i.e. won't work for any old tenant - it is considered a 'going concern' by valuers. The appraiser of restaurant real estate most often will provide the client with an opinion of the' value in use' (the value of the property when it's that specific franchise it's been created for), as well as a 'sale value' when it's not apart of that franchise.

Sometimes, that value can be lower, so it's 'value in use' price will therefore be it's highest value.

This is called the cost approach. It's only really valid until the point that your restaurant is stable in its revenue stream - usually around the four year mark. It's kind of like finding the' full value' of the land and building, whilst it's new, and operating in the franchise brand it was built for.

The Sales Comparison Approach

The sales comparison approach, or market approach, attempts to value the subject restaurant real estate based on the selling prices of similar properties. Simple, yes. But this approach is the least reliable of the three valuation approaches when applied to restaurant real estate.

Why? Because it is almost impossible to find a sale of a restaurant property that is truly comparable to a subject property. This is true even if it was a chain franchise, in the same area, with the same furniture and same size. It just doesn't work that way.

In fact, there are a number of adjustments that need to be made to the sale prices of similar restaurants even to get an indication of value for your property. You need to consider differences in conditions of sale, location, access, visibility, and volume of business generated by the restaurant.

But the most difficult (if not impossible!) factor in comparing the two is for the appraiser to truly identify what was going on in the minds of the buyer and seller when they were making their purchase and sale decisions. This is the greatest weakness of the sales comparison approach.

The Income Approach

In this approach, the appraiser assumes that the property is rented to the restaurant operator at a market rent, even if the property is owned by the operator and no rent is paid.

This assumption is made in order to isolate these two things:

The income to the land and building
Income that is based purely on the investment in furniture, fixtures and equipment (personal property), and the return to the restaurant operator for taking the risk of running a business (business value).

Valuing the land and building in use as a restaurant requires knowledge of market rent for similar type properties in the restaurant's neighbourhood.

If there is no lease encumbering the property, the appraiser assumes that the restaurant is leased at market rent. However, if the property is encumbered by a long-term-lease at below market rent (with no additional costs) the value of the land and building may be negatively impacted.

If the operating restaurant is paying rent based on a minimum rent plus a percentage of gross sales, the income approach to value may indicate a value for the 'subject real estate' - which is higher than the cost to buy the land, and build a restaurant on it.

On the other hand, if the restaurant has ceased operation and is no longer an ongoing concern, the 'going dark' value of the vacant restaurant building may be far lower than the 'value in use' when the restaurant was in operation.

And if the restaurant is still in use? Then the combined 'value in use' of the land and restaurant building can be approximated by capitalizing the net income stream that would flow to a hypothetical landlord.

Whilst you may not be looking to literally apply any of these methods to discern the value of your renovations, it may still give you some insight into the complexity behind reaching that figure.

More than often, it will bolster the value of your business. But, as you can see above, it may also hinder. A great reason to check in with your real estate appraiser for kicking off that makeover!