How do I determine a purchase price?

From “Ask Kit!”:

Q: We are looking at several properties and trying to decide after looking at gross income (some records only show net income) how you decide what to offer?

A: To be on the same page, let me define *my* use of gross income and net income. When I talk about gross income it’s the amount of income guestrooms generated, not including tax, special events, gift shop, or rentals (or for that matter, anything outside of guestrooms).

Net income, in my usage, is gross room-income minus extra-ordinary expenses and management fees/wages. Again, sales tax shouldn’t be part of the formula at all.

That said, I’m guessing you are getting gross income because I don’t think the typical innkeeper thinks in net income terms. How far off am I with that guess?

Ok, now to your question. There are several rules-of-thumb to help guide you in making an offer. They have to be used carefully though because a rule-of-thumb is a guideline, not “gospel”. The national average for the GRM (gross room income multiplier) pricing method is 5.5 — take the stated gross room income and multiply it by 5.5 to get a “today” selling price. The multiplier will go up and down based on the condition of owner’s quarters, the property and business and what level of amenities are offered. And after you determine that price target, figure you need at least 30% of that for a down payment on your bank loan; you’ll need additional funds as well for other things, but start with at least 30% to help you understand if you can afford the property.

2 thoughts on “How do I determine a purchase price?”

  1. From “Ask Kit!”:
    Q: Let me create an example so I can see if I am understanding your formulas. If their gross income is $50,000, then by your formula the sale price should be $275,000, not the$550,000 they are asking? Am I missing something here?
    A: The problem with the formulas is that they don’t take into account part-time businesses, small properties, or larger properties with lots of land. They don’t take into account how much renovation has gone into the property, renovation you won’t have to do. Turn the tables on the formula approach and figure out if your debt service would be covered by the present level of income. How much money is left after that for running the inn and such?
    When you are looking at a B&B in that price range ($550,000 and less) the formulas are *almost* irrelevant. You couldn’t build and furnish those houses for that kind of money (probably, anyway). If you tried buying a house, renovating it, and then opening it for business, you’d spend a lot of money, and time with zoning issues.
    I kinda figure that if the B&B is in the $550,000 and under price range, the best way to price it is to figure out if it works for you financially with the plans you have for the property and for your situation. Your situation would include additional sources of income to cover the possible negative cash flow, marketing, and your personal expenses.
    I know you are looking at other inns. How do you like the inn that makes more financial sense compared to the other two? Can you figure out why their income is low? Could they be higher than they are now? What would it take to make them higher? Can you do what it takes to improve either of the other two businesses to make them what you want/need? Will one of the properties take less work to make it what you want than the others?
    Don’t overlook the other issues you need to consider when buying an inn besides income. Look at the big picture and analyze all the parts together.

  2. I just wanted to add that the business and the real estate that houses a business are two separate things. If a person buys a gift store, she pays for the business and the real estate may or may not be owned. I think that there is some confusion about real estate ownership and the value of a business. Most businesses need a shop, warehouse, etc and that is part of the expense. You need to look at what percentage of the house will be for business purposes – i.e. bed and breakfast. The real estate is an investment and can be sold and typically appreciates the same way other real estate appreciates. It’s much easier to sell a house than an inn, if things don’t work out.

Comments are closed.