Profits Method

Question 1

When would you use the profits method?

Answer 1

Used when there is no capital value, rental evidence, or comparable data available. Typically applies to properties with a monopoly element, whether legal or factual. Suitable when the property changes hands based on its potential to generate profit. Indicates value by converting future cash flows into a single current capital value. Commonly used for specialist properties such as hotels, golf courses, petrol stations, restaurants, and care homes.

Question 2

What are the alternative names for the profits method?

Answer 2

Accounts method; Receipts and expenditure method

Question 3

What are some considerations when using the profits method?

Answer 3

Review several years of trading accounts to assess consistency and reliability. Check for licensing, planning, and zoning constraints that may affect trading potential. Consider the impact of market conditions, competition, and operational efficiency.

Question 4

What are the drawbacks of the profits method?

Answer 4

Assumes trading is solely from the property being valued, which may be flawed if part of a wider business. Trading accounts can be challenging to analyse. Years’ Purchase (YP) can be difficult to establish. Requires specialist knowledge; relevant databases are not publicly available. Relies on the concept of a Reasonably Efficient Operator (REO), which may under- or over-estimate trading potential. Legal issues such as licensing, planning, and broadcasting may affect viability.

Question 5

How is a Profits Method capital valuation carried out?

Answer 5

&E Valuation (Capital) – Short Version

1. Assume a Reasonably Efficient Operator (REO) running the business in its current form.
2. Estimate Fair Maintainable Turnover (FMT) based on trading history and market conditions.
3. Deduct operating costs to calculate Fair Maintainable Operating Profit (FMOP).
4. Apply a Years’ Purchase (YP) multiplier to FMOP to derive a capital value.
5. Adjust for legal, planning, licensing, and business-specific factors to reflect market reality.

Question 6

What is a Reasonably Efficient Operator (REO)?

Answer 6

A hypothetical operator assumed to run the business efficiently. Used to standardise profit expectations in valuation. Avoids reliance on actual operator performance.

Question 7

What is Fair Maintainable Turnover (FMT)?

Answer 7

The expected annual turnover achievable by a REO. Based on trading history, market conditions, and property characteristics.

Question 8

R&E Valuation (Rating)?

Answer 8

R&E Valuation (Rating) – Short Version

1. Assume a Reasonably Efficient Operator (REO) running the property in its existing state.
2. Estimate Fair Maintainable Trade (FMT)—sustainable turnover based on trading history and market norms.
3. Deduct operating costs to get Fair Maintainable Operating Profit (FMOP).
4. Deduct tenant’s capital, labour and risk margin to find the divisible balance.
5. The divisible balance = Net Annual Value (NAV)—the rent a hypothetical tenant would pay.