Unlocking Value: How HOA and Condo Management Companies Are Valued

What is a Valuation "Multiple"?

Investors use a variety of methods to value businesses, with perhaps the most popular being multiples of revenue and EBITDA. EBITDA is defined as earnings before interest, taxes and depreciation and is, in theory, supposed to mimic the cash flow of the business before any outflows that are specific to capitalization or taxation (accounts which can vary based on the owner of the business).

EBITDA Multiples Explained

Why do investors apply a "multiple" to arrive at valuation? Primarily because it is a simple mathematical equation. Consider an HOA/condo management business that generates $5 of EBITDA/cash flow per year. What would you pay for that business? The answer is dependent on what annual return you are looking to earn.

Let's say you are a private investor looking to earn a 25% annualized rate of return. You would propose paying 4.0x cash flow (or a "4.0x multiple"), or $20 for the HOA/condo management business. The business will continue to generate $5 of cash each year (into the pocket of its new owner, you), and at the end of your five year investment horizon, you will collect $5 of cash flow and sell the business for $20, or 4.0x the most recent year's EBITDA/cash flow. Your annualized return would be 25%.

Now, let's say the HOA/condo management business is generating $5 of EBITDA/cash flow per year but is expected to generate (through anticipated and believable growth) an additional $1 of cash each year thereafter. What would you pay for that business to reach a 25% return?

The answer is perhaps surprising to you. An investor targeting a 25% return in this scenario should bid 12.0x EBITDA/cash flow, a significant jump from 4.0x in the prior example. The $1 growth in EBITDA/cash flow per year creates a significant benefit for you, the buyer, which you compensate the HOA/condo management seller for handsomely. The lesson here is pretty clear: a believable growth story creates significant value for the seller.

In later posts we will delve into additional ways that buyers can increase the multiple they pay (and therefore outbid other potential buyers) by financing a purchase via a combination of debt and equity. We will also delve into other details such as tax impacts and structuring.

Why Revenue Multiples are Unreliable

We also occasionally hear about revenue multiples guiding valuation expectations. While the output of a transaction could be articulated as a revenue multiple, a revenue multiple should never specifically guide valuation. Why? Revenue composition varies significantly by HOA/condo management company and some revenue lines create significantly higher cash flow conversion. Consider the following simple example:

A buyer that considers revenue multiples may choose to value the businesses the same, given they exhibit the same amount of revenue. But if we dig further:

We find that the staffing model differences drastically change our view of the profitability of each. Both companies report onsite managers' associated revenue net of their costs, but because Company B's revenue composition includes a much higher portion of such work, its EBITDA/cash flow is significantly higher. There are other pitfalls/examples we could use to show that revenue is not a good way to conduct valuation, but the overarching theme is that not all revenue sources generate the same amount of cash flow.

Key Takeaways on Valuation Multiples

Valuing HOA and condo management companies typically involves applying EBITDA/cash flow multiples, reflecting the expected return and growth potential. While EBITDA multiples offer a relatively reliable guide, revenue multiples can be misleading due to varying cash flow conversions.

For more information on the HOA management industry, valuation metrics, or other questions, please contact contact@camadvisors.co or visit camadvisors.co.