Why were the property valuations in the recent Trump case so far apart, and can parallels be drawn for business valuation going forward?

Donald Trump has, in the last week, been successfully sued for “grossly and fraudulently” inflating the value of properties for personal gain. By inflating valuations in this way, Mr Trump was found to have enabled himself and his organisation to inflate their net worth and get better rates on loans– resulting in them now being ordered to pay (at least) $355m in fines.

In one example, Judge Arthur Engoron (presiding) noted as far back as his pretrial ruling that Mr Trump exaggerated the value of Mar-a-Lago, Mr Trump’s residence in Palm Beach, Florida, by as much as 2,300% when compared to valuations determined by tax appraisers for Palm Beach County.

But how can valuations for what is essentially bricks and mortar be so far apart? And what does the case of Mar-a-Lago say for how difficult the valuations may be for shares and businesses, which would tend to be subject to greater uncertainty in the absence of any residual land value and with (typically) less predictable income streams?

Mar-a-Lago

Mar-a-Lago was built nearly 100 years ago at a cost of $7m (c.$120m in today’s money) and is a 126-room mansion operating as a private club. Mr Trump acquired the property, which by then was in a state of disrepair, in 1985 for a total of c.$10m (c.$30m today), of which $3m was for the furniture and antiques already within.

Its status as a private club was seemingly set in stone under a 2002 agreement between Mr Trump and the National Trust for Historic Preservation, signing over “rights to develop the property for any usage other than club usage” into perpetuity, in exchange for tax breaks. Other restrictions which apply to the property include a cap on the number of guest suites, prohibitions on advertising the guest suites for public use and any redevelopment or subdivision of the site.

During Mr Trump’s presidency, the property became heavily associated with his leadership – during which he even hosted dignitaries as important on the world stage as Chinese president Xi Jinping at Mar-a-Lago.

The valuations

Noting the unique nature of the property, the property was valued by the Trump Organization “as high as $739m” according to the prosecution case, “on the false premise that it was unrestricted property and could be developed for residential use”. Noting the restrictions in place on the property as noted above, and the fact that the club was generating revenues of <$25m p.a., the New York Attorney General (prosecuting) asserted that the value “should have been closer to $75m”.

This would still imply a multiple of 3x revenue – which could arguably be described as being bullish in itself, in light of our own analysis which suggests that publicly listed companies in similar industries in North America tend to trade at around 1.0x - 1.5x revenue. Indeed, the Palm Beach County tax appraiser had separately valued Mar-a-Lago at $18m - $28m for property tax purposes.

So – within a reasonably narrow timeframe – we have valuations ranging from $18m to $739m for an asset which would not typically be expected to be subject to such a wide divergence in valuations. This is before considering testimony from a local real estate agent, valuing the site at over $1bn, or Mr Trump’s own testimony that the site would be worth “between a billion and a billion five”.

Use of property

The most obvious difference relates to the allowable use: in fact, the restrictions were so specific that there were even limits as to the number of seats allowed in the dining areas (a quandary compounded by the rule that food preparation was prohibited in the guest suites!).

However, when former Financial Controller at the Trump Organization Jeffrey McConnell valued the site at as much as $612m in the accounts, it was valued as a private residence.

It is, of course, arguable that an acquirer might be able to negotiate lifting such restrictions and convert the property back into a private residence. There would be no guarantee of this, however: indeed, Mr Engoron ruled that “there [was] no legal grey area surrounding the permanent nature of the deed restrictions”.

Even if a purchaser was to buy the property with a view to converting the property into a private residence (or converting the site in some other way), they would almost certainly seek some discount to reflect the risk of such a conversion of rights not being achievable.

Valuation methodology

When valuing the property as a business premises, both the local tax authorities and New York Attorney General’s office would have given consideration to the forward-looking profitability of the site: that is, what revenue and income was the private members’ club able to generate, and what does that mean in ‘present value’ terms.

If a property is valued as a private residence however, a more direct market approach – of making comparisons against other reasonably similar properties – would have been more likely.

A relatively meaningful benchmark for this may have been a sale of a smaller Palm Beach property approximately three years ago by the Kennedy family, which sold for approximately $70m. Again, this would have been sold as a private residence, but would arguably have had some bearing on the views of our hypothetical market participant.

However, Lawrence Moens – the local real estate broker – stated that his own valuation approach was “not re-creatable”, and that to understand his valuation method it would be necessary to “go inside [his] head”. This drew the stern comment from Mr Engoron that “to be admissible, expert testimony must have some objective basis and must be subject to objective scrutiny”.

Trophy asset status

Given the associations with Mr Trump, it is certainly arguable that the premises would likely be able to command a premium over its underlying real estate value. This would reflect the unique ‘trophy asset’ nature of the site – although any such ‘premium’ would be incredibly difficult to quantify.

This might be seen as a positive thing for Mr Trump’s defence: after all, it can’t be proven that there wouldn’t be somebody out there wouldn’t pay a huge premium that would support his valuation.

Against this however, even where assumptions do need to be made in arriving at a valuation, it is still usual to add some form of analysis or context. In Mr Engoron’s ruling, he noted that not only would Mr Trump’s assertion of the $1bn - $1.5bn value make Mar-a-Lago the most expensive ‘private residence’ listed in the country, but the most expensive by approximately 400%.

It is also interesting to note that, at the time Mr Trump bought the property in 1985, Mar-a-Lago already had presidential connections. In 1973 heiress Marjorie Merriweather Post – who first constructed the building – donated the mansion to the US Government, only for it to be returned in 1981 (because of high maintenance costs).

Conclusions

So what important lessons are there for us business valuation experts, and anyone interested in the valuation of shares and businesses, to take away from this case about property valuations?

• What a business could become going forward is relevant, but any upside should be appropriately risk-adjusted.

• Whilst valuation is subjective, that does not mean it can be performed adequately without sufficient rigour being applied.

• Applying the right approach, given the situation, is key.

• Finally, a valuation must understand the context of the wider market, and not ignore relevant facts!