Adding back Rent if you own the real estate.

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by a searcher from Yeshiva University
in Los Angeles, CA, USA

1yr ago

Adding back Rent if you own the real estate.

I am looking at a deal where the business owner also owns the real estate. Normally the business pays rent to a separate LLC. The broker is adding back "Rent" to Ebidta. Does that make any sense?

1 Like

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reply by an intermediary 1yr ago
from California State University, Northridge in Los Angeles, CA, USA

Adding back Rent would make that EBITDAR. For reference, if someone buys both the business and real estate and wants to spin-off the real estate via sale-leaseback, one metric that would be looked at would be "rent coverage" which is a ratio of EBITDAR / Rent. This is how PE views it. While I don't fully agree with the metric, it's the way things work in many cases. It's also a way to make sure rent can still be paid if the business financials take a dip.

Minimum rent coverage should be 2-2.5x but that's still pushing it and the higher the coverage the better. For example, $10m in EBITDAR and $2m in rent is 5x coverage. Another ratio is "health ratio" or "occupancy cost" which is rent as a % of sales or revenue. Under 10% is ideal but pushing it and the lower the % the better. You might look at the prior example and think $2m in rent is crazy, but if the rent is in-line with market rent or even below market, you can sell the real estate at a much higher multiple than the business and use the proceeds for growth, debt paydown, or other higher and better uses. Real estate sells on Cap Rates like businesses sell on multiples. Cap Rate multiples are simply 1 divided by cap rate. For example, a 7% cap rate is a 14.2x multiple.

Many other factors are looked at. Happy to chat, DMs are open.

reply by a searcher 1yr ago
from The University of North Carolina at Chapel Hill in Atlanta, GA, USA

If you are acquiring the real estate and the value of the real estate is included in the purchase price (i.e. one price, one transaction for both the OpCo and the RE), then it is appropriate to add back the rent to EBITDA. If you are not going to be paying rent, then you shouldn’t include rent in EBUTDA. Many years ago, this approach was standard. Sellers started separating the OpCo and the RE because it often leads to a higher value for the seller. However, that is not always the case, particularly in high multiple industries or if the RE isn’t particularly valuable.