Valuation in the residential brokerage industry has some characteristics that are unique when compared to other industries and businesses.
First, the business of residential brokerage is highly dependent on the recruiting, retention and production of independent contractor sales agents. Brokerage firms are not producing goods on a factory line — there are no warehouses holding physical inventory, no retail distribution channels and really, no patentable intellectual property.
Instead, the primary asset of a brokerage firm is a person or a group of people. These folks are indeed valuable assets, but provocatively they are completely unconstrained. They are free to move their practice, along with their customers and customer lists, at any time, without notice and without financial risk.
Second, the residential housing market is highly seasonal, highly cyclical and as we are all keenly aware, highly volatile. As such, the business of operating a brokerage firm is considered highly risky.
Given these characteristics and others, brokerage valuations are subject to what I call a, “What have you done for me lately?” approach to value. Since the state of a firm’s agent roster and the state of the housing market can be radically different year over year, a huge emphasis is placed on recent performance.
As part of the analysis that goes into a valuation, we of course need to understand a multi-year history, but it all boils down to performance over the last 12 months. Of the 800+ transactions we’ve brokered and/or advised on over the last 35 years, nearly all were priced based on the trailing 12 months.
Like selling a home, comps are heavily considered. The same applies to M&A — comps are heavily considered when selling a company. Purchasers rarely use a multi-year average, and they rarely use pro forma projections when pricing deals. When it comes to the numbers, they focus on “What have you done for me lately?”
Interestingly there was a short period of time in recent history when deals, and thus valuations, were priced using a multi-year average. But this was not to boost value to account for a weaker trailing 12 months — rather, it was to abate what we called the Pandemic Pop, an obvious anomalous stretch from late 2020 to early 2022 that goosed this industry. This deviation from the norm has since worked its way through the system, and we’ve been back to the trailing 12 months basis for about the last year.
Unfortunately, the last 12 months for most brokerage firms have not been pretty. As such, valuations have indeed been suppressed. Fortunately, many firms have been savvy in how they’ve adapted to this market and have made the necessary moves to preserve, and in some cases enhance, value. Even though value is based on the last 12 months, the income approach to value, which is the most common approach, allows for normalization credits for recent operational changes. If these changes are geared toward cost reductions, then value can be enhanced.
The bottom line is the unique characteristics of the residential brokerage industry support the use of a trailing 12 month basis for valuation. As such, brokerage valuations can wildly swing from year to year depending on a firm’s ability to effectively recruit, retain and develop agents, all the while being beholden to the state of the housing market. Certain normalization measures can be taken to preserve value, but it ultimately comes down to, “What have you done for me lately?”
Scott Wright is a partner with RTC Consulting, a firm that specializes in real estate brokerage consulting, valuation and mergers and acquisitions.