David is joined by Otto Cuyler to take a deep dive into appraisal concepts as they relate to soft costs, collateral value, prospective values, and more.
About this segment of Blackbird TV
Recorded: September 21, 2020
Published: February 9, 2021
I’d like to introduce my friend, Otto Cuyler. Otto from Cuyler FoodPro. It’s great to be with you here. You know we do a lot of collaborations together and we discuss a lot of things, what is important to your customers? It depends on the customer and the application. As you know, I think you know when when you and I are in a liquidating mode where liquidation is imminent that’s one thing because we’re going to market. Lenders obviously want to lend as much money as they can within reason and so yes the good news is they hire someone that’s an expert in their field or at least that’s what we promote in our semi-annual meetings presentations to American Society of Appraisers, we constantly promote that an expert in the field is who you should choose to go in there, yes they want a loan but they want to know the bifurcation of hard costs and soft costs so that’s really mired in the background before the research where when you’re looking at the depreciation schedule of any particular company and they go “yeah we’ve got $10 million of value here,” that’s never true. Anywhere from 10 to 80 of that book value on the equipment side could be installation costs. Those are sunken costs that you’re not going to recover. That’s exactly right, so what they want to that point is they want to know what is the “hard cost” they want to know what things really will have value if it has to be market value in exchange, or to be removed on an individual basis, which is, typically on the sell side, that’s typically how an auctioneer would do it, they would offer it as an entirety, they would offer lines as a whole, but in 95% of the time equipment sells piecemeal and that’s how they want to view it and that’s why they want an expert that buys and sells with their own money because we witness the auction, so we know what that side is, but we also work with customers. We know what they wantm we know what they’ll pay for particular configuration or condition, and those are the numbers that they want. That speaks to what it is they need, what their team needs, some people want forced liquidation value, and orderly liquidation value, fair market value is a little bit different than that because there’s no time frame so what is the most that could bring, willing buyer, willing seller. They want to know that objectively I think is my answer to your question. They want those definitions fulfilled objectively with a lot of background about how you got to where you got. So a lender making a loan on a build-out for a yogurt factory, and they could put 100 million dollars into some of these plants, you and I have been in, so much of that investment is a soft cost relative to the collateral value that they can get back when things go sideways, if things go sideways. If it’s a new build and you’re being asked to opine on the value of that equipment that’s going in there, is that bank—and maybe this is a question for the lender—most of that’s going to be based on the cashflow of that equipment as it’s working and generating revenue to pay back that loan, and then they’re measuring the risk to reward of that client over time versus what their bottom line could be if it goes sideways. Yeah that’s that’s above my pay grade, the part where they evaluate credit, the credit department is independent typically with my clients of the equipment management folks. We work with equipment management folks. And they’re separate for a reason, and sales guys are separate as well. So sales guys sell, and they want they want the full 10 million but the reality is the collateral is, let’s just say half of that or 5 million, and then it’s going to be ultimately some percentage of that as far as collateral value so 10 million quickly shrinks down to a much less value, but they seem to know that these days, more than 10 or 15 or 20 years ago. They kind of know where it’s headed because the work that you and I have done in the speaking that we’ve done and presenting to the industry both bankers and appraisers their expectations are a little better than they used to be instead of freaking out about how 10 million turned into 4, from a collateral standpoint. That’s good, that’s a good return! Yeah. Yeah the soft cost to build a factory and to install a line is huge, I remember a plant that you and I looked at that was under construction when we looked at it and I remember with fondness, watching the welders put the sanitary pipe in, and you and I commenting on how talented these guys are. When you look at that the cost to do that and the cost of those journeymen and all those people and building all that just to flip the switch so liquid can go through that pipe is such a huge number. It’s all a sunken cost. Dairy, yes. Great point. The dairy industry typically represents, we have a matrix that talks about what typical install costs are for various industries, beverage, vegetable, meat, poultry, those kinds of things and dairy. Dairy is at the top of that list in terms of what the percentage of the total cost was installation and that’s a great example the the tubing is extraordinarily expensive. Not so much the tubing itself, but the installation. Because these are certified welders, it’s up in the air, it’s just a lot to it, and then the controls, it’s so heavily laden with automation. None of which you recover, It’s super that the industry is going in that direction, with automation, but you recover very very little of that I mean even less than 10 cents on a dollar with automation and piping for that matter. And that really hurts when you’re talking about a million dollars worth of piping in a plant. It really hurts it. That plant is a really good example that you and I looked at that plant after we were in there. It was sold it. It traded twice didn’t it? It had a second build out we didn’t even see the finished product, we just saw barely the finished product of what we looked at the first time. There was a second build out, then it came back on the market again, and it’s currently active. That didn’t that didn’t go well. They struggled to get bidders and it happened right during the pandemic, which you know it’s hard to know the specifics of whether that was an issue or not but because I don’t know what products they were ultimately producing because of the build-out but it was a kind of a remote location you know difficult to access and the property the real property wasn’t that wasn’t that great. But yeah, as a percentage, dairy leads the way in soft cost without exception. That’s a great perspective, and I and I’ve never heard that before, thanks for sharing it. I just want to tie back to what you said about automation and I want to I want to draw a quick analogy into sheet metal fabrication, and time and time again, I’ll be in a factory where there’s a laser and it’s got six towers next to it, and a robot that goes and plucks sheet metal off and “oh we’ve got this great automated system, and we spent a million dollars, and it’s got a robot that brings it over,” almost inevitably has zero value on the back end of that. So to the extent that automation helps the current user, it really doesn’t translate into good collateral. Would that be a valid statement in the food processing world? If you wanted to be succinct about it, absolutely. Automation is a wonderful thing, but it does not translate well into value, except when you’re doing a fair market value installed or any kind of installed basis where you’re including that, because it rolls all of that into it, both from an assemblage perspective, a mechanical assemblage, where you’ve got a working unit, that’s really what you’re appraising, you’re not taking individual pieces and adding them up like we typically do. You’re taking the whole thing and looking at it as a going operation, not from a profitability standpoint but what is this worth as an entirety, and the automation plays a huge role in that because if you start to remove it, then you have to re-incur those costs. All new programming, all new integration. You would think that we scripted this but that ties right back to where you began with soft costs, and the only time that a soft cost is really recoverable is when you’re discussing an in-place value, as you point out, and back to that same plant that flipped as a going concern, and then you can recapture those soft costs in a going concern. The soft costs are very difficult to value from an appraiser’s perspective, from my perspective, and I know that you have a very complex matrix on how you do that and you’re almost secretive and proprietary about it, I know that you share some of that with your ASA friends from time to time, but could you talk just a little bit about how you approach soft cost valuation? I don’t know that ours is unique, but it is objective and subjective the way that you look at it. There’s a lot of different approaches that are not necessarily wrong, and they’re not necessarily right, I think it’s based on perspective. We, to simplify it, in its simplest form, we would say that as time goes forward that the, if you take depreciation on equipment, we do a lot of forward-looking work, estimation if you will what’s some something going to be worth at the end of the lease or somewhere on the timeline? So we’ll do day one, year one, through year five or year seven, which is a typical loan term. And the way that we look at the depreciation of this on the soft cost side is that whatever the machinery depreciates, the soft costs depreciate. Now that’s arguable, I’m not an engineer. I’m not going to try to calculate future install costs, because now you’ve got two candidates pushing for increased wages, across the board in any industry for that matter, so everybody has a living wage. Okay well ultimately that’s going to affect soft costs, so I don’t try to anticipate the future in terms of increasing costs. We try to simplify in saying in relation to the equipment soft cost was X percent right 25 let’s say of the total project so we are if we depreciate the equipment by 50% we’re going to depreciate the soft cost by 50%. From a cost strictly a cost perspective. And I’ve found that there’s people that will disagree with that vehemently, because they want to take another more scientific approach, which you can do that but at the end of the day it’s close because we’re a lot of times we’re looking at forward-looking values. You get another look at it in real time three to five years from now, or whenever that is. So at the simplest form, that’s how we look at it. Different things have different soft costs. A standalone machine may have very little soft cost, where a dairy complex, if you will, where you’ve got a lot of pumps a lot of valves… a lot of valves… you could have hundreds of valves, where each one has a sensor, there’s a wire to every one, there’s a pipe or two pipes to every one, so you have to kind of break those things down and look at them very carefully. Not something that an appraiser that’s inexperienced in a particular field, at least a rookie, shouldn’t, it should it should fall on somebody that’s a veteran in that area, so that you can say this is hard this is soft and you know how does it relate to the entirety now and in the future. I don’t know if that answers your question. It does, and it’s good information, because very often the accountant at the firm has a different perspective because their objective is to escalate their depreciation to move that expense line right down to zero, so they can write it off right now which creates a capital gain problem down the road in the event that they need to sell something. I mean the accounting perspective is completely different from the valuation perspective, based upon the market value, the forced liquidation value, and how that all weaves together in the form of collateral. Yeah that’s exactly right, so for example when somebody sends me a depreciation schedule which we essentially demand before we even look at anything, so we we know what happened when it happened how much they spent on each piece. We’ll go down through there say okay here’s this depreciation schedule they have a remaining book value just on the equipment side of let’s say five million dollars, and they want to borrow you know whatever five million dollars, so saying okay well that’s not what it’s going to be, let’s take a look at it. So what we do is you go down through that excel worksheet and you highlight just right out of the gate you highlight all of the either hard costs or soft costs and you separate them and you find that percentage that we just talked about and so the five million all of a sudden becomes something different from. That there is however a relationship we believe between depreciated value and fair market value installed. Because you are inclusive of all of the soft costs. If you look at a company that’s been in place for 10 or 12 years, a lot of things are zero on their books, but they still have some value because the way the curve works it never gets to zero, in the market. Something’s always worth, we’ve been used equipment dealers for 75 years, we’ve made a living for an entire five decades on that margin where something comes down to ten percent, stays there. Yeah well after after it’s fully depreciated I believe the term of art is “salvage value,” but right that’s from an accounting perspective. Yeah so there is a relationship between those two things, which is interesting, and we try to… even though people ask for orderly liquidation and fair market value, when there’s a high book value, we tried to look at for market value installed anyway, based on this conversation which is, we’re really kind of looking at percentages, so it’s not a long hard scientific look, just to give them to manage their expectations, because if they have 5 million on the books and you’re at 2 or 1.5, the way you and I would typically do it for collateral, if you start to move up the fair market value and then you move up again to fair market value installed, you start getting closer to the five, and they go “oh okay that makes sense to me.” Saying well yeah it is five million dollars, but that’s not what you asked me to do, you asked me to do this. If there’s an auction and Blackbird Asset Services does the auction and promotes it in the industry as any good international marketer would do, it’s 1.5. That’s what you’re going to get, that’s the check that you’ll have on your desk net. That’s the way we try to, that’s what our clients want to know when they’re worried about a criticized asset if you will or a credit issue they want to know what that check’s going to look like sitting on their desk, and it might be harsh, but that’s what we tell them. Great perspective. Otto Cuyler, my friend. Cuyler FoodPro thanks for joining us. My pleasure David, thank you.