Adding back Rent if you own the real estate.

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September 24, 2024

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

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?

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Reply by an intermediary
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.
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Reply by a searcher
from Northwestern University in San Rafael, CA, USA
Are you purchasing the real estate and do you have a separate P&L for it? If so, I think it is cleanest to look at lease comps to determine market rent, layer in operating expenses and capex, and come up with a value for it, placing the real estate asset in a separate LLC. You would ultimately draft a lease between the business and the real estate, such that you then know what corresponding RE costs to underwrite for the business (add back rent and real estate costs currently on the P&L and net off the new figures). Setting the rent at market avoids "transfer pricing" wherein you are buying a business that only makes sense when its CRE is subsidized. It also gives you the flexibility to sell off the CRE if capital markets conditions are propitious.
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