How To Separate Real Estate From Business Value?

Hey guys, I have a pretty elementary business valuation question.

Imagine you are valuing a private digital marketing firm that owns its own office. How would you deal with the real estate value? Would you first value the business pretending it doesn’t own any office and therefore adding a rent expense to the future cash flows + add the real estate value to the business value? Or only value the business with no market rent expense?

I’ve been educated to go with the second option (because without the office the company wouldn’t be able to generate any cash flow), but I still think the first option brings more value… I have a hard time believing that discounting a rent in perpetuity reduces the value of the business by the same amount as the real estate value.

Any thoughts?


Most people will separate the business and real estate valuations because it will increase the total value due to the lower cap rates (higher multiples) for the real estate. For example, the business may sell at 4 or 5 times cash flow while the real estate may sell at a cap rate of 7 or 8 percent which is a 12-14x multiple.

To do this, you will need to add a pro forma market rent payment as an expense on the income statement. You will then use this pro forma rent to value your real estate, less any capital expenditures required under the proposed lease terms.

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Thanks Chad.

I see and understand your point in case I’ll go with a multiples valuation approach. It makes sense.

However, if I have a DCF valuation approach, I think I should not separate the real estate value from the business value. In your example, a 7% cap rate would pay the office in ~14 years (assuming no capex would be needed), therefore, in this case, adding a market rent expense to my cash flows in perpetuity would in fact reduce the value of my business perhaps by an amount higher than the market value of my office.

To illustrate, imagine my business with the real estate asset incorporated is valued at €10m through the DCF method. JLL values my office at €1m. Now, if I sell the office for €1m and then add a market rent payment to my IS and discount my cash flows in perpetuity, the value of my business should be valued at €9m (or even lower, that’s why selling the business with the real estate asset incorporated for €10m would be the better option).

Also, this makes me realize the overall value can be substantially different depending on the valuation approach.

Do you agree?


well youd sell together. because imagine you sell the business. and not the real estate. and the person who buys decides to move the business elsewhere. now ur stuck with a real estate property without a tenant. lol.
anyways you can put an imputed market rent to value the real estate and to affect the valuation of the business as well. but imo the imputed market rent is highly sus. a higher rent payment leads to a higher valuation of the real estate and an overall higehr valaution sicne real estate has a higher valuation than a private digital business. or vice versa depending on if your the buyer or seller of the bizness.

I respectfully disagree with the comments that others made in November 2020. This is an issue that I’ve dealt with many times in my 25+ years providing valuation and consulting services to non-public companies.

Unless the problem stipulates otherwise, the first thing to understand is that the “digital marketing business” doesn’t need to own the building its office is in to conduct its everyday business activities. That makes it a non-operating asset. Therefore, for valuation purposes, it must be taken off the balance sheet of the operating business and valued separately. In addition, all of the expenses associated with the real estate that are not operations-related must also be removed from the operating company’s historical financial statements; a reasonable rate of rent must then be included in the company’s operating expenses. In essence, two companies must be valued: an operating business that offers digital-marketing services and a non-operating business that owns a commercial office building.

The CFA candidate can value the operating business. That should be pretty straightforward. The real estate appraiser can value the real estate and also provide a fair-market-value rate of rent for the lessee’s P&L.

The other ringer that can trip people up arises when the operating business carries on its balance sheet interest-bearing debt that is unrelated to the real estate. That requires, not an equity-only estimate of the firm’s cost of capital, but a weighted-average cost of capital (a.k.a. WACC) that combines debt and equity. Here’s where things get complicated.

The value of the operating business must be derived iteratively because the equity has market value, but the debt has only book value. Therefore, the WACC must be adjusted iteratively (there’s an ‘Iterate’ function in Excel) so that the mix of debt (on an after-tax basis) and equity in the WACC approximate the mix of debt (at book value) and equity (at market value) on the company’s balance sheet. If the real estate has debt attached to it, it, too, its value must also be derived iteratively.

The value of the digital-marketing company and of the real estate is then the sum of the value of each the two separate businesses - operating and non-operating.

Hope this is helpful.

Thanks for your reply StrategyGuy.

In my opinion, I think separating the real estate asset from the company should not be necessary. At the end of the day, the value of the business (with the real estate included) should equal the value of the business (excluding the real estate) + the real estate value. The reason for this is that, when projected in perpetuity, the assumed rental expense should roughly be the same as the market value of the real estate asset. Therefore, valuing a company with its real estate asset included should give you the same value as separating the company from its real estate asset, assuming a market value rental expense and valuing the real estate value itself. Let me know if you agree.