Understanding the Effects of COVID-19 on Valuation Processes

Understanding the Effects of COVID-19 on Valuation Processes

February 28, 2022

The spread of COVID-19 across the world threw markets into disarray, especially in the early stages of the pandemic. This volatile market and the variety of positive and negative effects the pandemic had on specific industries highlighted the need for accurate and timely valuations. Stout professionals shared their knowledge on the effects of the pandemic on valuations, valuation processes, and the market as a whole.

  • Matt Clark – Managing Director, Valuation Advisory, has over 30 years of financial advisory and valuation experience
  • Kim Randolph – Managing Director, Valuation Advisory, has extensive experience providing business valuation and financial advisory services
  • Jason Easterly – Managing Director, Valuation Advisory, has more than 17 years of real property valuation and consulting experience
  • Kyle TenHuisen – Director, Valuation Advisory, has extensive experience valuing capital equipment

How have valuations and valuation processes changed over the last two years since the beginning of the pandemic?

Easterly: We have seen a shift in the type of data we receive, the type of data that we need, and our ability to independently verify physical aspects of the property. For example, for the last two years in real estate, as well as in the machinery and equipment market, assets have not been nearly as accessible as they were in the past. Typically, we perform a physical site visit to inspect the asset, though the pandemic has dramatically reduced that. Because in-person visits became much more challenging, there was a greater reliance on the client providing us data regarding the physical condition of a property, the amenities, and other aspects that we would usually see during a physical site inspection. Even details like the crack of tiles around the side of a pool can give insight into how well the property has been maintained and what sort of capital expenditures there will be in the future.

Randolph: In terms of the actual valuation process within business valuation, we have not seen many dramatic changes, although there has been a need for efficiency on our projects due to the large volume of work and the rate at which people need it completed. Since we can rely on management interviews, the business valuation workflow is not as dependent on in-person inspections.

Has more emphasis been placed on market-based approaches versus other methods?

Easterly: Regarding real estate, we have not seen a greater emphasis on market-based approaches; however, we have seen a distinct difference in the quantity and quality of transaction activity across industry sectors. On one hand, we have ample “real-time” data that moves value expectations almost overnight in sectors such as industrial and multifamily. On the other hand, we have limited transaction activity and disparate market projections for the office and hospitality industries, making value estimates much more challenging.

Clark: Valuation on the business valuation side presented challenges early in the pandemic. The market dropped significantly at the beginning of COVID, making it harder to rely on a market-based approach to valuation. There was a mismatch between the historical data that was not affected by COVID and the stock prices, which had fallen substantially in a very short period. An income-based approach presented challenges too since businesses did not yet understand the severity or longevity of any impacts COVID would have on them.

Randolph: Adding to what Matt Clark said above, there was a significant amount of uncertainty in the market, which we captured in our valuations with sensitivities and changes in the discount rate along with company-specific factors. But as time went on, people began to better understand the pandemic’s effect on specific industries, be it positive or negative. 

TenHuisen: For valuing general industrial production assets, we typically rely on the cost or the market approach, often corroborating the cost approach with market-based assumptions. Analyzing market comparables and certain cost approach assumptions has become more difficult due to the volatility in the market. However, based on the current economic environment, we have not emphasized one approach over the other; we still look at as many data points as possible to have an answer that is triangulated from a variety of different viewpoints. 

How have you accounted for the greater volatility (and general increases in value) amidst the public markets relative to the private transaction market?

Randolph: Private company values typically do not have that same level of volatility, but private company values are not completely detached from public markets. Even if it is a private transaction, buyers are looking to the public market to see what public pricing is, and that often sets their guideposts. Whether you are in a pandemic or not, you really cannot detach the public market from what is happening in transactions because the public market is the baseline for so many trends. 

Easterly: Regarding real estate, generally speaking, the commercial real estate market ebbs and flows collectively. In the Great Recession, it was not as if there was an asset class that remained popular or performed well over all the others; the bottom fell out from the entire industry. However, the pandemic led to a bifurcation in the market. There are some industrial products (such as last-mile distribution) that are trading with significant pricing and velocity. In contrast, industries such as the office and hospitality market saw significant challenges when the pandemic struck — that is starting to diminish, but those challenges remain. Retail is also largely still affected, bearing the brunt of the pain with the advent of widespread online shopping.

As it relates to real estate, how has the pandemic changed the historical comparisons used, and how have you been accounting for that?

Easterly: We have two different real estate markets at the moment, both of which have been impacted by COVID-19.  Sectors such as industrial and multifamily have seen massive increases in demand and thus record-setting transaction volumes and pricing.  This leads to a complete reset in how historical data is used since, in many cases, what happened just last month may no longer be relevant.  

For asset classes such as office and hospitality, we have seen the impact go in another direction, as discussed above. Office demand is down as work-from-home protocols and hybrid workdays have impacted the need for traditional office space. In the first year of the pandemic, business and leisure travel was effectively eliminated, and the impact led many hotels to shut their doors permanently. Thus, to project future “post-pandemic” performance, we have had to rely on historical performance and transaction activity that may be 3, 4, or 5 years old to better understand how those stabilized markets will look.

How has the pandemic impacted the valuation of real estate investment trusts (REITs)?

Easterly: The impact is largely dependent on the asset class or industry sector focus of the particular REIT. We have seen a divergence in demand, utility, and pricing across the sectors, and those metrics have heavily impacted the values of the REITs themselves. Public REITs are, of course, exposed to much more volatility, whereas the private and non-traded REITs are generally being written up or down (depending on the sector) within a certain reporting time frame.
REITs traditionally focus on a single sector within the industry. For example, there are industrial REITs, hospitality REITs, multifamily REITs, etc. Those have been impacted, correlated with the same sort of impacts we have seen in the industry for those underlying asset classes. Some are up, and some are down, tied to the type of asset that they have been focused on.

In addition to this, as interest rates rise, we are anticipating transaction activity to be affected, which could result in a decrease in demand for real estate valuation services.

What are you hearing from clients about the current state of the market regarding valuations?

Clark: The market has been healthy from a trading multiples perspective for some time. Clients are still pushing forward with large M&A transactions. From a big picture perspective, people are still confident in the secondary market, though there is still a bit of volatility in the public markets.

TenHuisen: What we are hearing from various clients across industries is that the strain on the global supply chain continues to effect business and value, especially in the area of new capital equipment.  Lead time for new equipment has improved since Q4 2021, but it is not expected to return to “normal” in the near term. Long lead times for new equipment and increased material and labor prices has a ripple effect to the used equipment market. Generally, used prices of desirable industrial equipment have increased as a result of this dynamic. We are seeing this in both the retail and wholesale equipment market.

Randolph, Easterly, Clark, TenHuisen: Overall, the market appears healthy, though not without its challenges in specific sectors. Whatever industry a company finds itself in, the need for accurate valuations will remain high in order to make strategic business decisions as we shift to a post-pandemic future.