From the archives: What firms are worth

If it’s location, location, location that sells property, then it’s reputation, reputation, reputation that sells brokerages themselves, particularly in the New York metro area.

The same market dynamics that will drive up a sought-after piece of property are at work in the real estate brokerage market, where successful smaller operations can fetch between three and 6.5 times their annual earnings in a merger or acquisition transaction, depending on the size of the business.

What a brokerage is worth begins with its EBITDA, or earnings before interest, taxes, depreciation and amortization, or more simply put, its annual cash flow.

“The whole process begins with what your EBITDA is,” says David Michonski, chief executive of Coldwell Banker Hunt Kennedy, which is itself a merger-created company that took its current shape in a 1995 deal.

But from there, the terms of a brokerage deal differ somewhat from say, a bank merger.

“In a service industry like ours, everything gets factored in – your reputation, your years in the business and especially [the seller’s] plans for their role in the company after the deal is completed,” Michonski says.

The tri-state area is the second largest in the country in terms of the value of its transactions, and major national firms are constantly consolidating market share with strategic acquisitions of smaller real estate companies as they jockey for advantage.

The purchase last month of D.J. Knight & Co by global relocation services powerhouse SIRVA (see story under “Residential” section on main page) and Halstead’s buy of Heron Residential are only the latest in a year marked by many acquisitions.

One of the year’s biggest deals, Corcoran’s purchase of Citi Habitats, was recently revealed to have taken place for $49.6 million, according to a person familiar with the contract.

Earlier, Sotheby’s International Realty joined the constantly expanding list of Cendant Corp. subsidiaries (of which Corcoran is also a member) in a deal worth $100 million. According to SEC filings from last November, Sotheby’s real estate division brought in $27.6 million in revenue for the first nine months of 2003. Projecting earnings of roughly $35 million by year-end, it means the firm, headquartered in New York with 15 offices nationwide, was purchased for around three times annual earnings.

There were also numerous smaller transactions throughout the year, including Brown Harris Stevens’ and Douglas Elliman’s first forays into Brooklyn and several purchases by Manhattan firms in the Hamptons.

Backed by the Biggest

Consolidation is the name of this game, and no company has moved more aggressively into Manhattan than Cendant, which, through its real estate subsidiary NRT, bought up Corcoran in 2001 and took over the Sunshine Group a year later, before picking up Citi Habitats and Sotheby’s this year.

Cendant shares have risen more than $2.40 in the last 12 months, partly on growth at its crop of Manhattan acquisitions, according to NRT chief executive Bob Becker.

Its main rival, the $12-billion Prudential Company, backs Douglas Elliman as its principal link to the city’s real estate market. Elliman, the city’s largest real estate company, expects to book $6 billion in sales this year.

“In one way every marketplace is totally different from other marketplaces, but in other ways they are totally similar,” Becker says. “What we looked for were the right opportunities, and first and foremost, we look for talent.”

The combination of talent and solid cash flow is set against a generally accepted range of multiples for a real estate company, says Michonski.

“The rule of thumb is that if a company is doing $2 million or less in gross commissions over 12 months, it’s generally worth its EBITDA,” he says. In other words, a multiple of one times earnings, rather than a higher multiple.

The bigger the company, the higher the price. “People want size and they’re willing to pay for that,” Michonski says.

When a company has $4 million in commissions, the purchase multiple can go to 2.5 times EBITDA, and can triple once the earnings hit $6 million, he says. “That’s what I call the magic number,” Michonski says.

The $9 million to $12 million range hits a multiple of four or better, and over that, prices will range from 5 times EBITDA to as much as a 6.5 multiple.

The Sotheby’s sale would work out to be less than Michonski’s estimates, but some observers speculated at the time that Sotheby’s may have actively sought to sell off the unit to offset losses following the U.S. Justice Department’s investigation of price fixing involving Sotheby’s and Christie’s, in which both companies agreed to pay $268 million each to settle civil claims.

Steven Murray, co-founder of Real Trends, a Littleton Colo. publisher and head of Murray Consulting, a group that represents sellers in mergers and acquisitions, says the 6.5 multiple is the top of the market, and something of a premium for major markets. Another factor taken into consideration is the relative desirability of the company on the market.

“The core of the valuation is the size of the firm and the location of the firm, and the potential synergies with other operations of the acquirer – and how many people are pursing the company,” says Murray, who estimates he’s worked on about 15 New York area transactions in the last 18 months. “That could mean they’re going to get a higher multiple than their size would dictate, but when the synergy for the purchaser is excellent they see it just fits very well with an existing company’s operations.”

The Right Fit

Making sure the office cultures will blend is something that can’t really be analyzed, but sellers, buyers and consultants agree it is perhaps the most critical aspect of any deal.

“It’s people who make an organization, particularly in a service business like this one,” says Becker. “It won’t work if there’s not a sharing of common values.”

Michonski says a true integration can take up to two years and can be very smooth, or very bumpy indeed.

After a rocky few months following last year’s acquisition of Charles H. Greenthal, Michonski says he had to address his new employees and say: “Look, we’re on a big bus, we’re growing at 40 percent a year and the driver knows where he’s going and knows the direction, and either you decide you want to be on it and take this ride with us or you’ve got to get off.”

“Within two months, about half the people had left,” he recalls. “That’s always a very painful experience, but a year later, everyone that stayed has doubled their income.”

A talented, organized management structure also adds value to a deal, say industry observers. Sometimes that’s not always obvious, as with the 2001 deal that moved Corcoran into the Cendant portfolio. The value of the NRT-led deal was estimated at $70 million, and closed just after the Sept. 11 attacks.

“To the whole outside world, that was a total personality-driven company, but [founder] Barbara Corcoran had great organization and great systems in place to run that company,” Murray says. “There was great depth to the team, and as carefree and entrepreneurial as Barbara seemed, there was a solid team. You can see that, [chief executive] Pam Liebman has tripled the size of that business in the last three years.”

He also says Barbara Corcoran’s decision to remain with the company in an advisory capacity after the sale closed boosted the purchase price.

“Very few people want to buy a business where the owner is going to retire the next day, not in our industry,” he says.

Other sources says it’s unclear how much involvement Corcoran has with the company now, however, and have heard that the “Queen of New York Real Estate” wishes she had waited longer to sell the firm in order to fetch a higher price.