Trends in Price to Earnings Ratios for Public and Private Companies

by Cody Lindman

he price to earnings ratio (P/E) is one of the most widely used metrics in the valuation of companies. As the name suggests, the P/E ratio is calculated by dividing the price of one share of a company’s stock by the company’s earnings per share. Although commonly used as a relative measure of valuation between companies in the same industry, it can also be beneficial to compare P/E ratios for a specific company or index over time.
In particular, the Standard and Poor’s 500 (S&P 500) P/E ratio is closely followed by investors and analysts because it is believed to provide a reading on the temperature of the overall stock market. As of December 31, 2021, the P/E ratio of the S&P 500 was 30.0, a level significantly above the long-term average of 16.0 since 1871, yet below the levels experienced during the dot-com bubble and the 2007-2008 financial crisis. Additionally, the S&P 500’s P/E ratio of 30.0 as of December 31, 2021 was above the five-year historical average of 26.7, yet below the 2021 average of 32.2. Due to lower interest rates in response to the COVID-19 global pandemic, P/E ratios have increased significantly since December 2019. In the near term, we expect P/E ratios to decrease as a result of both higher interest rates and inflation. However, the decrease may be muted as a projected increase in interest rates and inflation is likely already priced into the market.

Unfortunately, one is not able to readily calculate the P/E ratio of a privately held company. Instead, investors and analysts look at transactions involving privately held companies and then calculate a variant of the P/E ratio called the selling price to earnings before interest and taxes ratio (Price/EBITDA). The Price/EBITDA ratio is calculated by dividing the selling price of a business by its EBITDA. Although the formula is slightly different, the P/E ratio and the Price/EBITDA ratio should follow the same trends, although they are not directly comparable. One of the best resources for data on Price/EBITDA ratios for privately held companies is the DealStats Value Index, which is published by Business Valuation Resources. According to the fourth quarter DealStats Value Index, the Q3 2021 median Price/EBITDA multiple for private company transactions was 4.0, a level slightly above the three-quarter average of 3.8, yet below the five-year average of 4.4. Since peaking at 5.6 in Q3 2018, the Price/EBITDA ratio has generally declined, hitting a low of 3.3 in Q1 2021. The chart below showcases the DealStats average Price/EBITDA ratio since Q4 2015.

The data suggests that the valuations of publicly and privately held companies have taken divergent paths over the past five years. As of December 31, 2021, the S&P 500 P/E ratio was 27.3% greater than the December 31, 2016 P/E ratio. In contrast, the average Price/EBITDA ratio for privately held companies as of Q3 2021 was 2.4% lower than the average Price/EBITDA ratio as of Q4 2015. One possible explanation for the declining median Price/EBITDA ratio for private companies is an increase in the “size premium.” The “size premium” is the tendency for larger companies to typically trade at higher multiples than smaller companies; due to being perceived as less risky and having greater access to capital. Further analysis of the data supports our hypothesis; as shown in the chart below, median Price/EBITDA ratios for privately held companies with less than $10 million in revenue declined between 2016 and Q3 2021. In contrast, median Price/EBITDA ratios increased slightly for private companies with more than $10 million in revenue.

Another possible reason is that the types of businesses that are typically publicly held or privately held differ. For example, although they are privately held during their early stages, technology firms typically go public eventually. Additionally, as the world economy has become more dependent on technology, the valuation of technology firms has risen steeply over the past five years, with the S&P 500 Information Sector index returning an annualized 28.93% over the past five years.

Regardless of the reason for the divergence in the valuation trends of public and private companies, the data clearly shows that small privately held companies have underperformed both larger privately held companies and public companies in general over the past five years. In the near term, we expect small privately held companies to continue to underperform both larger privately held companies and public companies due to small private companies typically experiencing greater negative effects from higher interest rates and inflation.

COVID Impact on Valuations

by Madeline Strachota

Since March of 2020, clients have asked us about the impact of COVID on the value of their business or real estate. We believe that there is no one-size-fits-all, uniform “COVID discount” nor “COVID premium.” Sectors of the economy have encountered different positive and negative microeconomic impacts from COVID. In fact, sub-sectors of the economy have been impacted differently by COVID. Even within those sectors, the underlying fundamentals of businesses have led to various outcomes. In the hardest hit sectors of the economy, companies with strong fundamentals have been able to weather the storm better than similar companies without strong fundamentals. In sectors where there has been growth opportunities from COVID, companies that have quickly scaled their online, curbside, or delivery sales, have faired better than their competitors who were not as nimble. For example, we appraised a business that saw a 75% increase in annual sales during the global pandemic because they were prepared to serve customers through online sales.

Given this variety in outcomes, the impact of COVID on business and real estate valuations poses a unique challenge to appraisers. It requires forecasting cashflows and determining discount rates when the future of COVID is opaque. It also requires particular attention to detail when analyzing comparable sales. We have noticed a trend among business and real estate owners during this time. For sectors of the economy that have benefited from the COVID impact, business owners are eager to sell. Oftentimes, owners in these sectors want to sell when their cashflow is up, hoping to convince buyers that what may be a short-term uptick in cashflows is a sustainable increase to the bottom line. Alternatively, we have observed many businesses and real estate owners delay sales of their businesses or real estate in the most negatively impacted sectors to avoid a perception problem. So, many of the business and real estate transactions in negatively impacted sectors have been sales where the operator did not have strong fundamentals underlying their business. For example, highly leveraged real estate in badly hit sectors, such as central business district hotels, may have undergone financial distress, causing the owners no option but to sell at a discount to intrinsic value.

Therefore, the sales comparison approach to value presents unique challenges right now—are the sales of like-kind property really comparable to the assets being appraised? Although the real estate may be the same property type, in a similar location, the sale must be analyzed to determine if it was a sale under distress that caused a depression in price beyond the intrinsic value of the asset. Furthermore, sales of real estate or businesses in booming sectors of the economy must be analyzed to determine if the forecasts assumed overly optimistic long-term performance. For example, in the business where we observed a 75% increase in sales, we determined that some of the change in consumer preferences for this brand’s products will be sustainable, although the sales will largely return to pre-COVID levels and growth rates in the future.

In summary, a thorough financial analysis on a case-by-case basis is necessary to determine if a “COVID discount” or “COVID premium” is applicable to a business or real estate. So, be cautionary when receiving a cursory answer to the question—what is the COVID impact on value?

Rising Inflation in America

by Thomas Blomgren

One of the major talking points over the past year has been rising inflation in the United States economy. Whether it be at the gas pump, grocery store, or in workplace wages, rising prices have touched just about every part of life. According to the Bureau of Labor Statistics, U.S. inflation increased at a greater annual rate in 2021 than any other 12-month period since 1982, creating a 39-year high. The consumer price-index rose 7% in December from the same month a year ago. This rise in prices can be attributed mostly to strong consumer demand paired with supply chain constraints and shortages. Rises in inflation affect consumers and companies in a multitude of ways. Large inflation gains erode the purchasing power of consumers in the marketplace. However, this rise in prices encourages people to spend and invest more in the short term, due to the lower value of holding cash. Then again, this spend-and-invest cycle will only accelerate inflation due to increased demand, creating a vicious cycle of rising prices. The rise in prices has not been felt equally across different industries. For instance, used auto prices have skyrocketed due to a semiconductor shortage that greatly limits the supply of new cars. Meanwhile, prices for services centered around education and medical care have risen just slightly. Also, rising inflation has led to higher wages in the workplace. Having said that, the gains in wages are dulled by the effects of inflation. According to a CNBC article dated November 10, 2021, the average wage growth year over year through October 2021 was 4.9%. However, when accounting for inflation, real hourly wages have decreased by 1.2% in that same time period. Currently, the Federal Reserve is discussing multiple interest rate increases in the next year aimed at slowing inflation, although it is unclear how these increases will affect the economy and the spending power of workers over the year to come.

Reuse of Existing Structures

by Brock Boatman

Adaptive reuse of existing properties continues to be an interesting development opportunity in the Twin Cities, particularly in downtown Minneapolis. However, the data suggests that not all opportunities are equal. The simple example is the continued conversion of aged warehouses and offices in the North Loop, where conversion to residential uses has been well established for years. A recent example of a new project that is underway is Solhem’s Security Warehouse conversion to apartments. Including new construction and properties still in lease-up, downtown Minneapolis apartment vacancy is still near 5%, with starting rent near $1,700. Reuse in this market sector is still well received, although new opportunities are diminishing as supply dries up.

In another adaptive reuse market, owner-users are still being drawn to the Downtown Minneapolis market. A recent example is the purchase by the Red Lake Nation to create a new student campus near US Bank Stadium. The Nation recently purchased the former Tiger Oak Media building and the adjacent properties for use as a new campus for their college. Previously, the buildings here had been a combination of offices, retail, industrial, among other uses in their 100 years of existence. Conversion to a classroom and administrative offices was a natural fit for an owner-user willing to invest the dollars to make these well-located structures beneficial to their cause.

The Rand Tower conversion to a hotel at the end of 2020 was unfortunately poorly timed yet helps demonstrate that existing structures that may no longer be viable as an office use can still find a purpose for reuse. While all hotels have experienced challenges over the last two years, the historic structure located in the heart of Downtown Minneapolis is currently experiencing above average occupancy rates as of the beginning of 2022 and reaching more than 80% occupancy on weekends and event nights – particularly Vikings games and other US Bank events. The Rand Tower conversion took obsolete office space off the market and created a new use that the market is utilizing. The largest reuse space is the Dayton’s project. Finally opening in early 2021, this million square foot project has only secured one major tenant, Ernst and Young. This project, with an extensive amenities package that not all developments can provide, does present a unique challenge; the large floor plans cannot easily accommodate a user smaller than around 5,000 square feet. This requires the project to find more home run type tenants in order to stabilize, a challenging prospect given space that has become available in City Center and the relocation of RBC. The Dayton’s project was always going to be a risky venture as a speculative development, and the unforeseen challenges of the last two years only added to the risk undertaken by investors and lenders.

Adaptive reuse of existing properties is always going to be a challenging undertaking, and the market’s reception can be mixed; however, we would expect to see continued development of this type with investors with the right creative mind and opportunities to keep these projects moving forward.

State of the Real Estate Market

by Robert Strachota and Ellis Beck

Over the past year, we have seen continued growth in real estate. Here is a breakdown by market type.

Single Family Residential

Determining what is normal in these abnormal times is a challenging proposition. Pending sales contracts of single-family homes were up 0.8% from November 2020 and up 15.9% from November 2019. Over the last decade, home prices might have increased in the range of 3% to 5% per year. Year over year increases over the past 12 months show an increase of 8% to 9%. The median sale price of a home that sold in the 16-county Twin Cities region from November 2020 through November 2021 was $340,000. The average home sat on the market for just 27 days, and there is no indication that the spring 2022 market will bring relief for buyers.


The apartment market seems to be returning to its pre-pandemic trend of growth at a slower pace. Rent increases this past summer were flat but now are edging up again. However, suburban rent hikes largely exceeded those of the urban submarkets. At the end of 2021, trailing 12-month net deliveries are near an all-time high, with approximately 12,000 units currently under construction. Metro-wide occupancy is near 95%, which for most of us reflects a balanced rate for a long-term investor. The slowdown in renter demand in the Minneapolis city core, and St. Paul, will most likely continue moderate rent growth for the foreseeable future. Concessions and other incentives should remain common through early spring 2022. Twin Cities rental growth is currently 3.6%, exceeding the area’s five-year average yet trailing national markets.


Unfortunately, business travelers are not back; the leisure traveler has the travel bug. Explore Minnesota has found that people are ready and willing to engage in leisure travel this winter. Roughly 82% of surveyed Minnesota travelers planned domestic U.S. trips this winter. Approximately 50% plan to visit destinations more than 500 miles from home, and approximately 48% of those surveyed are planning trips that include time in Minnesota. Generally, travelers expect pre-pandemic levels of customer service, product quality, and pricing. For those who will not be traveling, COVID-19 is the top reason for not planning to travel in the next six months. Obviously, new variants of COVID-19 and restrictions surrounding them are the wild card in any projection of the future of the local hospitality market. The downtown hotel market is struggling as reflected by recent sales of the Marquette and Westin hotels. The Marquette traded at a loss of $14 million from the 2016 acquisition price of $74.5 million, a 19% loss. And the Westin, which sold for $66.4 million in 2015, sold for just $47.2 million in October, a 29% loss.


Minnesota has over 8,300 manufacturers making a wide range of products. Manufacturing is growing in Minnesota with employment in this sector rising over 11% since 2020. Real estate used for manufacturing is not constructed on a speculative basis. Usually, a manufacturing facility is built for a specific user. When that user grows and needs a new building, they leave behind a second-generation manufacturing building that is available for a startup. The opportunities to build new manufacturing space and the availability of second-generation space are balanced in terms of supply and demand. Numerous government incentives supplement all manufacturing startups. In summary, Minnesota manufacturing has strength in a broad range of industries. It has momentum to grow, but there is an acute shortage of workers that will keep the lid on expansion for the near term.


There appears to be no end in sight for the industrial warehouse boom. Despite clogged supply, demand for major distribution facilities and warehouses seems to be “off the charts” in the Twin Cities. Other regional hubs like Dallas, Atlanta, Chicago, and Denver are experiencing the same shortages of space.

The pandemic has accelerated the already growing trend of e-commerce. Some call this the Amazon Effect. To manage growth, businesses of all types are leasing space to store more inventory and reduce reliance on material supply flows. Despite rampant new development, record-setting demand has kept the Twin Cities vacancy rate below 4% for 22 consecutive quarters. The strongest performing industrial market in the Twin Cities is the Northwest submarket.

Retail Malls

Considering the economic damage brought on by the one-two punch of the pandemic and civil unrest, the Twin Cities retail market has been somewhat resilient in the past two quarters. The retail sector is made up of several submarkets, such as malls and big box stores. In the Twin Cities, these markets make up 29,700,000 square feet. There is virtually no new construction, and there won’t be for many years. These sectors are plagued by big box store closures and bankruptcies of numerous tenants. Most landlords have sued dozens of tenants for overdue rent in 2021. All malls continue to see foot traffic down compared to pre-pandemic levels. Even the metro’s “best in class” malls are suffering from the pandemic’s impact. Older malls and areas with below-average demographics are having the most difficulties backfilling large scale vacancies. Reported vacancy rates for market power centers are in the 11% to 12% range. It is likely that the vacancy rates reflect the occupancy level but not the amount of rent being paid; we at Shenehon believe that landlords may only be collecting 80% of all rent due. Rental rates in these sectors have been flat at $20 to $30 per square foot plus operating expenses, and they will not show any meaningful increase for the next one to two years. For malls in particular, creativity is the theme as landlords and developers will reconfigure and redevelop obsolete or underperforming retail spaces. The goal of the creativity is to explore unique venues that will draw traffic and again engage the consumer’s interest. Despite the e-commerce expansion, most retailers are confirming their commitment to brick-and-mortar retail.

Community Strip Centers

Community Strip Centers have not received the same amount of negative pressure from COVID-19. While the pandemic nearly gave the malls and power centers the “knock-out punch,” certain retail segments (i.e. grocers, pet supplies, coffee, sporting goods, alcohol, discount clothing, and home improvement supplies) were propelled by the pandemic. How many of you wait in drive-through lines for your Starbucks or Caribou coffee? Most of us, even at the height of the pandemic, were visiting our community/neighborhood strip centers with more regularity than in pre-pandemic times because we were not traveling out of town. As with anything, there are exceptions to this rule, with restaurants being the biggest example. It is anticipated that restaurants will likely be the area of this sector to recover.

TC Office Market

The Metropolitan Twin Cities downtown office market, which is composed of 46,100,000 square feet, reached an all-time high vacancy rate in the third quarter of 2021. This 46.1 million square foot market includes all Class A, B, and C buildings. Think of the total office space as the equivalent of 30 IDS buildings in a row. The current vacancy rate as of January 1, 2022, is 14.3% of all space, or 6,700,000 square feet. This is as if we had four and a half empty IDS buildings. While we have not returned to pre-pandemic levels of downtown office vacancy, we are seeing improvement.

Inflation Update

by Emma Niemela

Following the report of 5.4 percent inflation for the trailing twelve months ended June 2021, the Federal Reserve is predicting elevated inflation to be a temporary phenomenon, normalizing after the “perfect storm of high demand and low supply” ceases. However, multiple chief executives have differing opinions.

According to the latest Bureau of Labor Statistics (BLS) update, the seasonally adjusted Consumer Price Index (CPI) for all urban consumers rose 0.9 percent in June, the largest one month change since the 1.0 percent increase in June 2008.

Notable category increases in the month of June, included used cars and trucks increasing 10.5 percent, food increasing 0.8 percent, energy increasing 1.5 percent, gasoline increasing 2.5 percent, and the index for all items less food and energy increasing 0.9 percent. These increases show recovery from the price declines due to COVID last year. A chart containing comprehensive BLS data is shown below.

Inflation reflects rising prices for goods and services and often happens when a nation’s money supply is growing faster than the economy; however, there are multiple triggers. Demand-pull inflation happens when an increase in the money supply creates demand for additional goods and services, the effect is accentuated when there is limited supply of those goods and services. Forgivable loans and personal stimulus checks given during the COVID-19 Global Pandemic triggered this type of inflation, increasing the money supply and creating demand while many supply chains were experiencing disruption due to the Pandemic.

Cost-push inflation results from input price increases. Increased cleaning costs and increased material prices as a result of supply shortages have contributed to increased overall costs for producing goods and services during the Pandemic. Supply shortages are expected to alleviate as the impact of COVID-19 fades; in fact, lumber prices are reaching pre-Pandemic norms. Lumber futures closed at $634 on July 23rd, down from a high of $1,711 on May 10, 2021, as shown by data from Yahoo Finance in the chart that follows.

Built-in inflation is driven by expectation that prices will continue to increase in the future. Companies such as PepsiCo, Conagra, and Fastenal voiced plans to increase prices because of expected inflation at their most recent earnings calls. Fastenal already raised prices in the second quarter and intends to continue this trend, as the initial increases were well received.

However, as reported by the Wall Street Journal, not all companies are following this pattern; FreshDirect is currently lowering prices on berries, salmon, and ground beef. The online grocery delivery company is looking to attract more customers by absorbing inflation for the time being. This varied approach is a good signal, as it shows not all companies are raising prices in expectation of future inflation, a move which would add fuel to the inflation cycle.

Wages are tied to built-in inflation, as employees demand wages to maintain their cost of living. As wages rise, costs and prices of products and services also rise, continuing the cycle. Many employers have raised wages to attract employees as the labor market has become more competitive. However, these labor cost increases motivate investment in automation. For example, Applebee’s has recently implemented tablets which allow customers to pay at their table without a waiter. John Peyton, CEO of Applebee’s parent company, Dine Brands Global, Inc., called this move a hedge against labor inflation in a recent earnings call.

The Federal Reserve’s dual mandate is to aim for price stability and maximum sustainable employment. The recent developments in wages and employment discussed above add complexity to these goals, as it can be hard to determine adequate benchmarks. The Fed has been using pre-pandemic employment levels to define “maximum employment,” but with automated labor hedges making certain roles smaller or obsolete and many people re-evaluating their lifestyle and leaving the workforce early, it may be necessary to use a new benchmark. Employment and inflation go hand in hand, and so long as the labor market is transitioning, there will be an effect on inflation.

Last August, the Federal Reserve communicated inflation expectations slightly above two percent following periods of inflation below two percent, resulting in a long-term average of two percent. Even though current inflation is well above two percent, the Federal Reserve has stated that is does not plan to raise interest rates in the short-term as it attributes current inflation to one-time price increases due to the re-opening of the economy. So long as businesses and consumers are not acting as if they altogether expect high inflation, the Federal Reserve will maintain its stance.

Comparing Controlling Interest Transactions – Common Mistakes Valuation Analysts Make When Using the Controlling Interest Transaction Method to Value a Business

by Cody Lindman

When valuing a business, valuation analysts consider three approaches to value: the income approach, the market approach, and the asset approach. Two of the most common valuation methods within the market approach are the guideline public company method and the controlling interest transaction method. When utilizing the controlling interest transaction method, the most frequently used transaction database is DealStats. Below are some of the most common mistakes we see other valuation analysts make when utilizing a transaction database such as DealStats.

Searching the Incorrect Industry for Comparable Transactions

When utilizing the controlling interest transaction method, the first step is to search for comparable transactions. It should be easy, right? All you have to do is search by the subject company’s SIC or NAICS industry code. The process should be easy given that companies list the NAICS code most applicable to their business on their federal tax return, right? Wrong. Although some valuation analysts may not admit it, determining the correct SIC and NAICS code for a business is a critical part of the valuation process and more difficult to get right than you would think. One of the reasons for the difficulty is the fact that most businesses do not fit cleanly into a particular SIC or NAICS code. In these instances, it is up to the appraiser to determine what they believe is the most appropriate SIC or NAICS code. As for the NAICS code listed on the subject company’s federal tax return, we have found that the code listed is incorrect approximately half of the time. When this occurs, the valuation analyst must research the subject business, examine the possible NAICS codes, and select the most accurate one.

Including Transactions Involving Companies Dissimilar to the Subject Company

After some difficulty, the valuation analyst has now determined the subject company’s SIC and NAICS code. After searching by either the subject’s SIC or NAICS code, the valuation analyst now has a list of comparable transactions. Now all they need to do is multiply one of the subject company’s financial metrics by the analogous median multiple of the comparable transactions to determine the value of the subject company, right? Wrong. The most important and often overlooked step in utilizing the controlling interest transaction method is to attempt to fully understand and question each of the comparable transactions. As we discussed previously, determining the correct SIC or NAICS code for a business is difficult. Therefore, it should not be a surprise that the people who categorize the comparable transactions sometimes make mistakes and mis-characterize the industry in which a business operates. Additionally, some of the transactions may involve businesses that are significantly smaller or larger than the subject company. Lastly, each transaction is subject to different terms, such as how the transactions will be financed, what is transferred, etc. It is up to the valuation analyst to look at the financial metrics, read the description of the acquired business, and understand the terms of the transaction to determine whether the transaction should be included as a comparable.

Failing to Account for the Differences in Asset and Stock Transactions

One of the most important things to note when analyzing a transaction pulled from DealStats is whether the transaction is characterized as either an “asset sale” or a “stock sale.” In a typical asset sale, the transaction is structured whereby the buyer acquires the inventory, furniture, fixtures, and equipment (FF&E), and intangible assets while the seller retains the company’s cash and receivables and pays off the company’s debt. A stock sale is considerably more straightforward; a buyer purchases all of the target company’s shares that are issued and outstanding. Although both types of transactions can be used to value a business, valuation analysts should be aware of the differences between the two structures. One way to handle the differences is to separate asset sales and stock sales into two different groups and then apply the corresponding multiples separately. However, this can be challenging if there are only a few asset sales or stock sales. Alternatively, a valuation analyst can restate the selling price of asset sales to convert them into a stock sale equivalent or vice-versa. This is normally the approach that valuation analysts at Shenehon undertake because it allows us to consider all of the comparable transactions on an apples-to-apples basis. To convert an asset sale to a stock sale equivalent, a valuation analyst would add net working capital to the asset sale price (however, if inventory changed hands in the asset sale, it should be subtracted from net working capital so as to not double count it). Converting a stock sale to an asset sale equivalent can be more difficult, as the process requires that a purchase price allocation (PPA) was performed. If specific allocation information is not available, it may be impossible to convert a stock sale to an asset sale equivalent, potentially making it necessary to eliminate that particular transaction. The general process for converting a stock sale to an asset sale equivalent is to determine the total asset value of the acquired business and then subtract the value of all assets acquired except for inventory, FF&E, and intangibles. The resulting value is an asset sale equivalent value.

New Legislation Allows Appraisers to Perform Evaluations

by Natalie Mandley and Christopher Stockness

The State of Minnesota recently passed legislation that allows appraisers to provide evaluations in addition to the appraisals they are already licensed to provide to the public. What does this legislation mean and how does it impact you?

What has changed?
The Appraisal Institute provides this explanation of what this legislation means: “In most states, a state-licensed or state-certified real estate appraiser is required to comply with USPAP [Uniform Standards of Professional Appraisal Practice] when developing an opinion of the value of real estate, as is required by the IAEG [Interagency Appraisal and Evaluation Guidelines]. Many financial institutions do not want a USPAP-compliant appraisal when they are permitted to use non-USPAP compliant evaluations. Instead of using the most competent and qualified professional to obtain a market value opinion, financial institutions go to other non-appraiser professionals (i.e., internal bank staff, financial analysts, accountants, brokers/salespersons, etc.) to obtain real estate valuation information. This results in greater risk to the banking system and lost business for appraisers.”
Appraisers in the State of Minnesota may now provide evaluations. Previously, all opinions of value prepared by appraisers had to comply with USPAP, thus excluding them from providing evaluations which do not comply with this set of standards. Non-appraisers, typically financial professionals, could prepare evaluations, as the development and presentation of the opinion of value in an evaluation; however, until August 1, 2021, appraisers could only prepare appraisals (opinions of value that comply with USPAP). When providing an evaluation, an appraiser does not have to comply with USPAP, but must disclose it is not an appraisal when providing the evaluation to the client.

What is an evaluation?
Simply put, appraisals must comply with USPAP, while evaluations do not. In addition, evaluations are restricted to properties below a particular value threshold (less than $500,000 in value), or to opinions of value in certain circumstances. An evaluation is an opinion of value that must follow Interagency Appraisal and Evaluation Guidelines imposed by the federal government, but does not have to comply with USPAP, which governs the opinion of value presented in an appraisal.

What is an appraisal?
Appraisals must comply with the Uniform Standards of Professional Appraisal Practice and, in Minnesota, can only be provided by licensed appraisers. Appraisals generally are more thorough and in-depth than evaluations and are required in most situations involving commercial real estate.

When can an evaluation be used?
For commercial real estate, which is our focus, evaluations are typically allowed if 1) the transaction value is less than $500,000; 2) an appraisal is not required by federal law. Additionally, one may use an evaluation when a recent appraisal has been done and 1) related market conditions have not changed in the interim; and 2) the purpose is refinancing only, with no new funds being loaned. For almost everything else in commercial real estate – transactions with values over $500,000 for which an appraisal has not been recently provided, or where required by federal law – an appraisal is needed.

Although evaluations may be appropriate and cost effective in certain situations, our experience is that most of the valuation work completed at Shenehon Company would not be considered a candidate for an evaluation. However, in instances where an evaluation may be a permitted option, it is our opinion that an appraisal that complies with USPAP is still the appropriate valuation service for clients. Estimating a reasonable and well-supported opinion of value through an evaluation still requires a level of analysis that is consistent with an appraisal and compliance with USPAP is not a significant hinderance in the process but instead aids in providing consistent valuation methodology, allowing appraisers to maintain the trust of clients and the public. Furthermore, in arenas such as the court of law or the Internal Revenue Service, appraisals remain as the accepted form of valuation.

Although this legislation allows appraisers the opportunity to be engaged in assignments that may have otherwise been completed by a less qualified evaluator, we believe there is potential for confusion in the marketplace. For instance, we anticipate there may be confusion about the difference between an appraisal and an evaluation, particularly in terms of the quality of analysis received. Appraisers that choose to take on both evaluations and appraisals will need to take extra care in educating their clients on the differences and to make certain, particularly in performing evaluations, that their role is clearly understood.

We will also be watching to see what role evaluations will have in the marketplace in instances where a valuation is not required by federal law. Valuation work for purposes not regulated by federal law can comprise an extensive amount of potential assignments and it will be interesting to see how appraisal professionals will choose to determine when an evaluation is appropriate rather than appraisal.

We will be monitoring how evaluations will be utilized by appraisers and the valuation industry as both adjust to this change in legislation. A primary concern that we have is that evaluations tend to be a way of providing valuation services at a low-cost point with the tradeoff being that the accuracy and quality of valuation may be sacrificed at the hands of time and money.

COVID-19 and Currency Circulation

by Emma Niemela

Across the United States, businesses are displaying signs stating, “no cash”, “credit or debit only”, or “exact change only”. These signs appeared in July, seemingly connected to COVID-19. Concerned about whether cash is becoming extinct, I investigated why these signs are appearing and what it means for the future of coins and cash in America.

At a high-level, this issue is rooted in the national reaction to COVID-19. Ever since March, people have changed their habits, making efforts to stay isolated, doing more shopping online, and using touchless payment methods. As a result of these actions, coin circulation in the United States has dramatically declined.

To clarify, there is not a shortage of currency in the United States. There is actually currently more currency in circulation than in recent years. This is illustrated in the following chart from the Federal Reserve Bank of San Francisco. The chart below documents the accelerated increase in currency issued by the Fed beginning in March of 2020, compared to the annual increase in currency circulation from 2017 through 2019.

It is important to note the above chart includes both cash and coins. Looking specifically at coins, the U.S. Mint has increased coin production from the 2019 average of 1 billion coins per month to about 1.6 billion coins in June and expects to produce about 1.65 billion coins monthly through the year end.

The Federal Reserve Bank of San Francisco also provided information on consumer payment choices in their supplemental Diary of Consumer Payment Choice (Diary) which was published in July of 2020, including data from April and May of 2020. This supplementary Diary was created to examine consumer habits during COVID-19 because of the increased demand for currency and claims that consumer payment habits were dramatically changing.

The July 2020 Diary asked participants about their cash holdings, changes in payment behavior, and cash avoidance. The Diary data supports four main conclusions: many people did not make in-person payments, most people are not avoiding cash, people are holding more cash, and online payment behavior does not appear substantially different.

The participants answered questions between April 15, 2020 and May 12, 2020. During this time period, 63% of participants reported they had not made any in-person payments since March 10, 2020. The fact that a majority of participants went a month, or perhaps two without making a single in-person payment shows the dramatic effect of initial social distancing efforts. However, it is noteworthy that only 28% of the total participants stated they were avoiding cash, a much smaller number than the 63% which had not made in-person payments.

On average, participants carried $81 in cash, an increase from $69 in 2019. The average amount of cash stored elsewhere also rose to $483, compared to $257 in 2019. This tendency to hold onto cash has contributed to the fewer coins in circulation.

The impact of business re-opening is not captured well by this data set. A majority of states began to re-open throughout May, whereas the last Diary participants responded on May 12. This limits the data’s use in predicting future habits, as the majority of businesses were closed during the study period.

Some businesses have struggled to react to the coin shortage, especially if their customers tend to make small-value payments. The 2019 Diary of Consumer Payment Choice found cash represented 49% of payments under $10 in October of 2019. Chipotle is one business falling into this category and facing a potential class action lawsuit as a result.

Plaintiffs in Pennsylvania accuse Chipotle employees of repeatedly shortchanging customers; for example, one customer paid with a $20 bill and received $4 in change instead of $4.49. The plaintiffs ask the Court to stop Chipotle from refusing to provide cash-paying customers with correct change, require Chipotle give cash-paying customers a credit toward future purchases if they lack correct change, stop Chipotle from charging consumers more for not using a credit card, and to award any other relief deemed appropriate. These accusations highlight the struggles some companies have faced while responding to the lack of coins.

It appears the shortchanging may have been a store-specific issue and result of miscommunication among employees. Chipotle‘s Chief Corporate Affairs and Food Safety Officer, Laurie Schalow responded to Delish, a website focusing on food news and recipes, with the following statement: “Chipotle’s policy is to give customers the exact change they are owed when making a cash purchase in our restaurants. If a restaurant is low on change as a result of the nationwide coin shortage, our policy is to only accept exact change or other non-cash forms of payment. Restaurants that are impacted have signage posted on the door as well as inside, and employees have been instructed to alert guests prior to ordering. We encourage customers to contact us immediately with any concerns so we can investigate and respond quickly to make things right.”

Given that coins will take some time to get back to normal circulation, it is important that businesses have a plan in place to deal with the present situation. Many companies have created plans similar to Chipotle, though there are also stories of business owners who needed coins and drove many miles to get them or organized a community coin drive.

The U.S Coin Taskforce was created to make recommendations to resolve the issue of low coin circulation. The taskforce includes members of the American Bankers Association, Independent Community Bankers of America, Credit Union Associations, Department of the Treasury (U.S. Mint), Armored Carriers Industry, Food Marketing Institute, Coin Aggregator Industry, and the Federal Reserve System. This taskforce is collaborating to strategically allocate coin inventories by simplifying the process consumers use to deposit loose change, discouraging stockpiling by individual institutions, and working with the Mint to determine necessary coin supply levels.

It does not appear that coins and cash are about to become extinct, simply that they, like all of us, have been affected by COVID-19. The U.S. Mint is running at maximum production, and many stakeholders are working together to return coin circulation to normal. The most impactful recommendation from the U.S Coin Taskforce is for consumers to bring in change to trade for cash. It will take time, but currency circulation is expected to return to normal.

The Complexity of Valuing Greenhouses

by Henry Walter

The experience of driving through the fall countryside and seeing farmers and tractors harvesting crops may soon be replaced with visions of large industrial buildings packed with fully autonomous watering, air circulation, and advanced lighting systems. Global food and technology changes have accelerated this movement, which presents unique real estate valuation challenges for appraisers.

According to the Food and Agriculture Organization of the United Nation (FAO), border closures, nationwide quarantines, and supply chain strains from the 2020 Global Pandemic have limited communities’ access to food. Additionally, the growing global population is predicted to reach 9.1 billion people by 2050, which the FAO predicts will necessitate an increase in food production of 70% globally. With supply chain disruptions, food access, and the growing global population gaining attention, entrepreneurs and investors are experimenting with ways to maximize yields while decreasing their footprint.

Conventional farming uses manpower, heavy machinery, and farm animals to till the soil in large agricultural fields. Over time, this process degrades soil, depriving it of vital nutrients and minerals required to maintain high plant yields. Technological advancements in farming can improve this process and produce higher yields, as demonstrated by agricultural output in the Netherlands. A nation that is approximately the size of Connecticut, the Netherlands is the second largest agricultural exporter, by value, in the world thanks to the use of high-tech greenhouses. In addition to producing higher yields, high-tech greenhouses are more environmental-friendly compared to conventional farming since they use a fraction of the water, fertilizers, and land. These facilities also benefit from lower labor and transportation costs because they can locate closer to metropolitan areas.

High-tech greenhouses are a newer form of real estate, which presents challenges for valuing these assets. The advanced design and technology featured in these specialized properties require a detailed and diligent analysis in order to provide a reliable and well-supported opinion of value. The appraiser must develop a thorough understanding of how these special-use buildings function in order to understand the value potential.

Once the appraiser has identified and fully researched the variety of features present in a greenhouse being appraised, he or she must then consider these unique property features when applying all applicable approaches to value. Real estate appraisers may employ three approaches to value: the cost approach, the sales comparison approach, and the income capitalization approach.

  • The income capitalization approach estimates the value of a property by analyzing its income streams and/or its potential to produce income.
  • The sales comparison approach uses the principle of substitution to determine how much a buyer would pay for a comparable property.
  • The cost approach is a valuation method estimating the price a buyer should pay for real estate based on the cost of building an equivalent building. The costs include acquisition of land and total construction costs, less economic depreciation.

Valuing high-tech greenhouses requires more due diligence from the appraiser for several reasons: the income capitalization and sales comparison approaches lack sufficient reliable market data. This is due to the fact that many facilities are owner-operated, and typically, the owner is leasing the real estate back to a related company. Rental rates in these situations do not reflect market rents, so rents must be adjusted to reflect the appropriate market rates. However, without reliable market data, it is challenging to accurately adjust rents. The application of the income capitalization approach depends on if data sufficient to support this approach is available.

An appraiser may elect to apply a sales approach, but like other approaches to value, he or she may be limited by the availability of data. Shenehon tracks the sale of specialized real estate assets such as high-tech greenhouses. For example, we have been tracking several Real Estate Investment Trusts (REITs) that are actively acquiring mechanized medical marijuana greenhouses through sale-leaseback arrangements. REITs are interested in these medical marijuana greenhouses because the supply of these property types is limited, and there is a growing demand for their use. Medical marijuana is legal in only 33 states, all of which require several permits to operate and may have state mandated limits to how many greenhouses can grow this plant. The sale-leaseback program allows medical marijuana companies to reinvest the proceeds of the sale into their operations since obtaining financing is often tricky for such companies as their product is federally prohibited from utilizing traditional financing sources.

In 2020, Industrial Innovative Properties, Inc. (IIPR) acquired several medical cannabis greenhouses, with the intention of improving and expanding capabilities and capacity of each facility through their tenant improvements. According to IIPR’s sale-leaseback program, they aim for:

  • Deals in the $5 million to $30+ million range.
  • Lease terms for 10 to 20 years on a triple net lease.
  • Initial base rent that is 10% to 16% of the total investment.
  • Rental rate annual escalations of 3% to 5%.

Their acquisitions ranged from $5.5 million with $29.5 million in tenant improvements in New Jersey to $26.8 million with $22.2 million in tenant improvements in Massachusetts. These sales provide useful data for determining value using the sales approach.

The cost approach is one of the more accurate ways to value the greenhouse due to highly specialized buildouts, but only if records of construction costs were kept. If the sworn construction statement is available, a thorough analysis of the building’s physical depreciation, as well as estimating the functional and economic obsolescence present in the property, must be completed. In cases where construction statements are unavailable, estimating the building construction costs can vary widely, resulting in significant differences in opinions of value. The plant intended to be grown in the greenhouse also has a major impact on the cost to build the structure. For example, Bayer CropScience built a 300,000 square foot automated greenhouse in Marana, Arizona for their corn-genetics research for $100 million compared to Bright Farm’s 280,000 square foot specialized greenhouse in Sellingrove, Pennsylvania designed to grow lettuce, which was built for $20 million. Different light cycles, temperatures, and carbon dioxide levels of plants require varying degrees of automation and sophistication in the buildouts.

From rural farm to city center, acrylic to polycarbonate, hydroponic to flood floors, and tomatoes to marijuana, no one high-tech greenhouse is the built the same. The limited market data and the difference in tenant improvements, purchase price, and construction costs highlight the complexity of evaluating such a unique asset. Understanding that complexity and valuing unique properties is one of things Shenehon does well.