Rent cover is a simple ratio, which is why it is so often computed on the wrong earnings, at the wrong company, on the wrong date.
Rent cover is EBITDAR, earnings before rent is deducted, divided by the rent, measured at the company that actually signs the lease. On an illustrative transaction the group covers its rents 4.00x but the signing subsidiary covers this one 1.68x, and with a 2.5 per cent fixed uplift against 1.0 per cent growth in its earnings, that cover falls below 1.50x in under eight years. The number in the marketing is usually the first one.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
In a sale and leaseback the rent is not discovered in a market, it is chosen by the seller, and the price follows from it. Rent cover is the only test of whether the chosen rent can be paid. It is a simple ratio, which is why it is easy to compute on the wrong earnings, at the wrong entity, on the wrong date.
| Input | Value |
|---|---|
| Group EBITDAR | 48,000,000 |
| All group rents, including this lease | 12,000,000 |
| EBITDAR of the subsidiary that signs the lease | 12,600,000 |
| Rent under the new lease | 7,500,000 |
| Fixed rent uplift a year | 2.5% |
| Growth in the tenant's EBITDAR a year (illustrative) | 1.0% |
| Lease term, years | 15 |
| Pricing yield on the rent | 6.0% |
Rent cover = EBITDAR ÷ rent
EBITDAR = EBITDA + rent expensed above EBITDA
Under IFRS 16 the capitalised leases already sit below EBITDA, as depreciation and interest, so reported EBITDA is close to EBITDAR: add back only the short-term and variable rents still expensed, and take the rent itself from the lease, not the accounts. In Excel: =EBITDAR/Rent, but on two perimeters, side by side: =Group_EBITDAR/Group_Rent and =Opco_EBITDAR/Lease_Rent. Unless the group guarantees the lease, the second is the cover.
| Measure | Earnings | Rent | Cover |
|---|---|---|---|
| Group EBITDAR over all group rents | 48,000,000 | 12,000,000 | 4.00x |
| Group EBITDAR over this rent only | 48,000,000 | 7,500,000 | 6.40x |
| Signing subsidiary's EBITDAR over this rent | 12,600,000 | 7,500,000 | 1.68x |
The 6.40x figure should never be used: it sets all of the group's earnings against one of its rents, as though the others did not exist. The 4.00x figure is honest about the group, and it is relevant if the group guarantees the lease. Without a guarantee it describes a company that has no obligation to pay. The landlord's claim is against the subsidiary, and the subsidiary's cover is 1.68x.
One more figure appears in some packs: EBITDA after rent divided by rent. Here that is 5,100,000 over 7,500,000, or 0.68x, which looks like a tenant that cannot pay. It is the same lease. Cover is struck before rent, so that a cover of 1.0x means the rent is exactly paid; take the rent out of the numerator and the ratio is cover minus one.
A lease with fixed or index-linked uplifts raises the rent every year whatever the tenant earns. If earnings grow more slowly than the rent, cover falls on a fixed path:
Cover in year t = cover today × ((1 + EBITDAR growth) ÷ (1 + rent uplift))t
Years to a threshold = ln(threshold ÷ cover today) ÷ ln((1 + g) ÷ (1 + u))
Here the ratio falls 1.46 per cent a year, and 1.50x is reached after 7.7 years: =LN(1.5/1.68)/LN(1.01/1.025).
| Year | Rent | EBITDAR | Cover |
|---|---|---|---|
| 0 | 7,500,000 | 12,600,000 | 1.68x |
| 3 | 8,076,680 | 12,981,793 | 1.61x |
| 5 | 8,485,562 | 13,242,727 | 1.56x |
| 8 | 9,138,022 | 13,643,994 | 1.49x |
| 10 | 9,600,634 | 13,918,239 | 1.45x |
| 15 | 10,862,236 | 14,628,209 | 1.35x |
Nothing has gone wrong with the tenant in this table. Earnings grow every year. The cover falls because the lease was written to grow faster than the business, and that is the normal case for a long lease with uplifts, not a stress case. To hold the cover, EBITDAR has to grow at the 2.5 per cent the rent does.
| EBITDAR growth | Uplift 2.0%, yr 10 | 2.5%, yr 10 | 3.0%, yr 10 | 2.0%, yr 15 | 2.5%, yr 15 | 3.0%, yr 15 |
|---|---|---|---|---|---|---|
| 0.0% | 1.38x | 1.31x | 1.25x | 1.25x | 1.16x | 1.08x |
| 1.0% | 1.52x | 1.45x | 1.38x | 1.45x | 1.35x | 1.25x |
| 2.0% | 1.68x | 1.60x | 1.52x | 1.68x | 1.56x | 1.45x |
Half a point more uplift costs as much cover as half a point less earnings growth: the two inputs mirror each other, and an uplift that runs a point ahead of the business costs about a tenth of the cover over a decade. A seller who negotiates a higher starting price in exchange for a lower uplift, or the reverse, is trading along this table, usually without drawing it.
Because the rent is chosen and the price is the rent over a yield, every cover level is a price. At a 6.0 per cent yield on the subsidiary's 12,600,000 of EBITDAR:
| Cover at signing | Rent | Price at 6.0% |
|---|---|---|
| 1.50x | 8,400,000 | 140,000,000 |
| 1.68x | 7,500,000 | 125,000,000 |
| 2.00x | 6,300,000 | 105,000,000 |
| 2.50x | 5,040,000 | 84,000,000 |
A buyer who wants 2.00x at signing is asking for a price 20,000,000 lower, 16.0 per cent. The cover discussion and the price discussion are the same discussion, and it is clearer held in money than in ratios.
Compute cover at the entity that signs, on EBITDAR, and project it with the uplift: 1.68x falling 1.46 per cent a year is a different asset from 4.00x. A 10.7 per cent fall in the subsidiary's earnings takes it to 1.50x today; on the uplift alone it gets there in 7.7 years. The free Covenant Monitor workbook for this case runs cover at both perimeters and its year-by-year decay, and the sale-leaseback model template carries the full transaction. The credit side of the same rent is worked in does a leaseback beat the tenant's bonds.
There is no universal level; it depends on the tenant's volatility, the lease length and the uplift. What matters is cover at the signing entity and its path. On an illustrative lease, 1.68x at signing with a 2.5 per cent uplift against 1.0 per cent earnings growth is 1.45x by year 10, and the year-10 figure is the one a lender will test.
On EBITDAR, earnings before rent, so that 1.0x means the rent is exactly paid. Dividing EBITDA after rent by rent gives cover minus one: on an illustrative subsidiary with 12,600,000 of EBITDAR and 7,500,000 of rent, 1.68x becomes 0.68x for the same lease.
Cover falls by the ratio of one plus earnings growth to one plus the uplift each year. With a 2.5 per cent uplift and 1.0 per cent growth that is 1.46 per cent a year, so an illustrative 1.68x reaches 1.50x in 7.7 years and 1.35x by year 15, with nothing wrong in the business.
Chapters 4 and 22 of Sale and Leaseback measure rent cover at the group and at the entity that signs, and its decay under indexation; the free Covenant Monitor workbook computes both. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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