What Determines the Multiple?

The Mortgage Bankers Association changes course on its support of the mortgage interest deduction.

By Steve Murray, publisher

Many in the industry talk about what the multiples are for real estate brokerage firms. It comes up consistently, of course, in our own consulting with clients on the valuation of their firms.

Brokers want to know why firms, such as Realogy and RE/MAX, two pure real estate brokerage players, trade at price and earnings multiples far higher than the EBITDA (earnings before interest, taxes, depreciation and amortization) multiples of other brokerage firms. Further, some ask, ‘When a multiple of four times EBITDA is considered a fairly good one, and the inverse of that represents a cap rate of 25 percent, why is this a good thing for a seller when cap rates are so much lower for other kinds of investments?”

The answer is risk. Realogy and RE/MAX have much larger footprints than any individual brokerage firm and gain most, if not all, of their revenues and earnings from franchising fees and royalties. They have thousands of brokerage firms and tens of thousands of sales associates in their systems. For the most part, neither firm has the burden of the fixed business liabilities of a brokerage firm, such as office and equipment leases, and the employees it takes to manage a realty firm.

The risk of agent departures is the single biggest risk of owning a brokerage firm. As someone once said, your main assets go home at night, and there is no legal requirement that they show up the next day. Since the early 1980s, we’ve seen three new forms of brokerage show up; each has caused a material shift in where agents are located. The 100 percent commission concept, the capped company revenue concept and the flat-fee brokerage have each shifted agents from traditional graduated commission-based brokerage firms. The risk of agent movement has been highlighted once again by Compass and its acquisition of top producing agents in several of the nation’s largest and most expensive markets.

So, whether you refer to the multiple or the cap rate, both reflect the same thing. It shows the risk of an investment in a business that generally owns few defensible assets—no trademarks, no patents, few sustainable competitive advantages.

But brokerage firms do have some assets that make them worth more than they used to be. With size comes the advantage of offering multiple services, such as mortgage, title insurance, escrow services, property management, property casualty insurance, and others related to homeownership. The CFPB killed off the easy money in this area, but they didn’t kill it off entirely.

Getting back to RE/MAX and Realogy, they will almost always trade at higher multiples and cap rates because they are less risky to own than brokerage firms.

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