How much money does your brokerage really make?

If you’ve ever talked to someone about the value of your real estate brokerage, there’s a pretty good chance you’ve heard the term EBITDA.

Maybe someone told you, “Your brokerage is worth three times EBITDA,” or “four times EBITDA.”

Okay. But what exactly is EBITDA?

And, probably more importantly, is EBITDA actually how much money your brokerage makes?

Not necessarily.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It’s pronounced “ee-bit-dah,” and while the term became popular in the 1980s, you certainly don’t need a finance background to understand it.

The easiest way to think about EBITDA is to start with the net income on your company’s financial statements and make a few adjustments. Interest expense, income taxes, depreciation and amortization are generally added back. If the company earned interest income, that would generally be removed.

Why?

Because we’re trying to get a better look at the earnings generated by the actual operation of the business.

And that’s where EBITDA becomes useful in a real estate brokerage valuation.

But it’s also where some of the confusion begins.

When people in residential real estate talk about a brokerage being worth a “multiple of EBITDA,” they’re often not talking about EBITDA in the strict accounting sense. What they’re really trying to understand is something closer to adjusted EBITDA, or what we might simply call the brokerage’s sustainable cash flow.

Suppose your brokerage showed $500,000 of EBITDA last year.

Before assuming that your brokerage actually produces $500,000 a year, we’d want to know what’s inside that number.

Maybe the company paid $15,000 for a vehicle that’s really the owner’s personal car. If that expense goes away when the owner leaves, we’d probably make an adjustment for it.

But maybe the opposite happened. Maybe the owner manages the brokerage full time and pays herself $50,000 for a job that would cost $125,000 to replace. We’d need to consider that too.

Or maybe last year was an incredible year because the brokerage landed a development project and sold 200 homes. That’s real income. Nobody is taking it away from you. But if the project is over, should we assume another 200 home project is going to show up next year?

Probably not.

That’s what we mean when we talk about normalizing the financials. We’re simply trying to figure out what a normal year looks like.

And notice something important: some of those adjustments increased the earnings. Others decreased them.

We’re not trying to make the number bigger. We’re trying to make it more realistic.

Once the financials have been normalized, the question becomes much more practical.

If a qualified new owner stepped into the brokerage tomorrow, what could that owner reasonably expect the business to continue producing based on what has already been built?

That’s really what we’re trying to understand when we talk about sustainable cash flow.

We’re not assuming the new owner recruits 50 more agents, opens another office or finds a new source of revenue. Those things might happen, but they haven’t been built yet.

We’re looking at the brokerage that exists today: its agents, employees, systems, expenses, sources of revenue and the operation the current owner has built.

In other words, what does this business reasonably produce if it keeps doing what it was built to do?

This can be especially important in residential real estate because brokerage owners often wear several hats.

An owner may run the company, recruit agents, manage employees and personally sell real estate at the same time.

Suppose the owner personally sells $20 million of real estate every year and the brokerage earns income from those transactions. If the owner sells the brokerage and leaves, that personal production may leave too.

The income was real. But a buyer isn’t necessarily buying the owner’s future sales. The buyer is buying the brokerage the owner built.

The other side matters too. If the owner performs an essential management job, somebody may still need to do that work after the sale. If the company isn’t currently paying a reasonable amount for that position, the financials may need to reflect what it would actually cost to replace that role.

Again, the goal isn’t to make the brokerage look more profitable or less profitable. It’s to understand what the business itself reasonably produces.

This distinction becomes very important when someone asks, “What is my real estate brokerage worth?”

You’ll often hear discussions about real estate brokerage valuation multiples. But before debating whether the right multiple is three times, three and a half times or something else, you need to understand the number you’re multiplying.

Even the right multiple applied to the wrong cash flow produces the wrong value.

If one person believes the brokerage produces $500,000 a year and another believes it sustainably produces $400,000, they don’t really agree on the economics of the company, even if they agree on the multiple.

That’s why understanding sustainable cash flow is such an important part of how to value a real estate brokerage.

EBITDA is useful. It gives us a common starting point and a way to look at the operating earnings of a business.

But it doesn’t always tell the whole story.

The financial statements still need to be understood. One-time events need to be identified. Personal expenses need to be separated from legitimate business expenses. Owner-generated income needs to be considered. And the cost of replacing work performed by the owner may need to be taken into account.

None of that needs to be complicated.

Ultimately, we’re trying to answer one straightforward question:

How much money can this brokerage reasonably be expected to continue producing based on the business the owner has built?

Understand that number first, and you’ll have a much better foundation for determining what the brokerage is actually worth.