Valuing a real estate agent’s business

Determining the value of a real estate agent's book of business can be complicated.

How many agents and teams retire and either give away their book of business/database or want to sell but don’t have anything of value to sell? Answer: Too many. That’s because they didn’t structure their businesses to have value. According to Steve Murray, senior advisor to RealTrends, the value of an agent or team’s business is based on the agent’s or team leaders’s ability to track business and clean financials, among other things. That’s where brokerage coaching comes into the picture.

But, let’s say an agent or team leader has structured the business correctly. How do you determine value? First, says Richard Fino, who heads up Long & Foster Real Estate’s Agent Succession Program, “You have to determine whether you have a clear path to a sale. Is the selling agent excited about their next move? The ones who aren’t have a hard time transitioning.” Once you determine they’re ready, it’s time to set a value.

“Virtually always, the purchaser will purchase the assets of the selling real estate professional and not purchase stock in the selling agent’s business,” says Murray. “Second, there is always a modest amount of cash paid at close, between 10% to 20% of the estimated value, while the rest is paid out over three to five years based on actual sales from the selling agent’s database.”

Depending on whether the purchasing real estate professional, “desires to continue to use the trade name of the selling real estate agent, there may also be a royalty paid for the use of the trade name and expressed as a percentage of gross revenues,” says Murray.

Valuing the business

Fino says that they look at the selling agent’s last three years of net earnings and determine what percentage of those earnings came from past clients. “Then, we make some adjustments based on their database being in a solid customer relationship manager (CRM), whether the business is spread out over three counties or that person is No. 1 in a certain development. All of those things will impact the perception of value,” says Fino. He notes that the rules of the valuation are similar to any other business valuation. “Just like in the insurance or legal industry, over a period, what kind of return should the buyer expect when buying the business?”

Chuck Boles, a certified mediator, business coach and founder of The Chuck & Buddy College of Business Knowledge, looks at valuation differently. “Recently, I spoke to an agent in Hawaii who told me he had a successful year of $27 million (in sales volume) and had 40 transactions (sides). I replied ‘That’s great, but that’s just ego. Tell me, how are you going to deposit volume and sides in the bank? Not possible because the industry uses “ego measurements” to falsely inflate an agent’s sense of success rather than measuring the monetary success necessary to sustain a licensee’s career.”

Boles consults with brokers to develop a three-year “career transition strategy” for agents who intend to transition out of the real estate business. Boles used his strategy to sell his real estate practice three months before the market crashed in 2008. “To this day, the person who purchased my business says he would have not have made it through the Great Recession without doing it. In fact, to date, my business has generated over $1.5 million in income for him,” says Boles.

While most brokers look only at an agent’s book of business, Boles’ valuation formula calculates the value of the agent’s entire business practice. His valuation formula (Estimated Business Practice Value = Anticipated Income + Intangible Assets + Tangible Assets) helps brokers determine if an agent has a salable business practice. Brokers also use the valuation formula to help aspiring agents build business value over the course of their career.

“It’s important to recognize that I’m calculating the value of an agent’s entire business practice, just not their book of business.” In addition to projecting anticipated income (based upon an agent’s most recent three-year average net income) plus the value of tangible assets (based upon IRS tax values for equipment), his formula also calculates the “loyalty value” of an agent’s client base.

“The depth of client relationships are measured by loyalty which, in turn, gives birth to repeat and referral business; the life blood of a successful real estate business practice. Even though client loyalty levels are intangible assets, they are core to the sustained success of any business and deserve financial recognition for their potential value,” says Boles.

“For sake of an example, let’s say we divided client loyalty into three categories based upon their repeat and/or referral settlement history with the agent. Let’s say Category A clients (those who completed three or more transactions with the agent) receive a “loyalty value” of $1,000 each; Category B (two transactions) receive a “loyal value” of $500 each; and finally, Category C (one transaction) receive a “loyalty value” of $100. In this example, an agent with 15 A’s, 10 B’s and 30 C’s would have a client data base worth an estimated $23,000. Currently, the industry seems to ignore client relationship and loyal in determining the value of an agent’s business practice.”

There’s a reason for that, says Murray. “In our valuation work, we’ve found that the transfer of personal relationships from an agent selling their practice to another agent is not a given and is almost entirely based on the selling agent working diligently to introduce the new agent to their customers.  It has little to do, in our opinion, with how many deals have been done in the past.”

Build a confidential foundation

Boles says that creating a confidential foundation for the “career transition strategy” is critical to a broker’s helping an agent sell their business practice. He also notes that “confidentiality throughout the entire process is critical.” That’s because, “a broker with an agent candidate, over the next three to five years, can help the agent build a track record of increased value to achieve highest and greatest market price while, at the same time, identify potential buyers for the business. By being involved in the sale, the broker can develop a long-term business growth strategy to insure business and agent continuity plus growing market share.”

Arranging the sale

He recommends a “buy-sell” arrangement where a purchase price is defined with the buying agent putting down a deposit and the selling agent carrying a note for the remaining value. “Additionally, once the “buy-sell” agreement is signed, I recommend creating a 12-month written transition plan during which the agents work together to insure a smooth “business merger” with the broker acting as the transition period accountability partner to insure the parties are living up to their commitments during the 12-month transition.”

There are a number of ways in which financing strategies can be applied to the “buy-sell” arrangement. For example, during the one-year transition period, the agents could arrange a referral fee arrangement (payments applied toward the note) followed by a five-year payoff of quarterly payments at prime plus 1% (or a flat interest rate) with no pre-payment penalty. The big advantage of the “buy-sell” note approach is that it releases the selling agent from the requirement of remaining licensed in order to receive payments.

For Fino at Long & Foster, also believes in confidentiality, but says that cash up front isn’t the norm. “Usually there’s an integration period where both sides will work together. At that point, we haven’t announced that one side is retiring,” says Fino. “The longer the integration period; the better.” He says that he serves as the intermediary to match a buyer and seller and gives them interview guides. “If you haven’t sold your business before, you don’t know what you don’t know, so we help them with the interview process, as well as integration deals and the contract.

“We announce that the two are working together, but not that one side is retiring. That agreement is about a year,” says Fino.

In the Long & Foster program, the retiring agent still does their lead generation. “For the first few months, they might be even be taking the lead on servicing, but the acquiring agent is a part of every consultation. And then as they move on, the retiring agent ends up just generating the leads and maybe converting them, but the servicing transfers over to the acquiring agent. And we know that the biggest trust transfer happens when they have an opportunity to service the client,” says Fino.

Then, he says, they get into “what we call a cooperation phase or phase out.” After that year and the retiring agent’s ready to go ahead and move on to something else, the agent will announce their retirement. They may still have some marketing accountability or responsibilities in terms of their database. But at that point, it does end up being typically a referral fee over anywhere from a three- to five-year period, and it’s usually cascading,” Fino says.

One thing is sure, tracking business and have a CRM with detailed client information is vital to securing a solid valuation. The next key is finding the right person to take over the business and handling the transition in a way that sets up the buyer for success.

In Part Three, we’ll talk about lessons learned, contracts, NDAs and give more detail about the transition plans.