Same building, same residents: the lease sells the upside to the operator in exchange for rent cover, and the cover is only as good as the operator.
RIDEA earns more for as long as the operations hold up, and less as soon as they do not. On an illustrative $25.0 million, 100-unit community, owning the operations under a management contract yields a going-in 6.35 per cent against 5.88 per cent for a triple-net lease at 1.25x cover, and 7.49 against 6.34 per cent a year over five years in the base case. In a downside the operating yield averages 4.68 per cent, while the lease keeps paying 6.34 per cent only for as long as a tenant at 0.80x cover can afford it.
Worked in full in Senior Living and Healthcare Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
In a triple-net lease the investor owns the real estate and an operator rents it, paying a fixed rent with an annual escalator and carrying every operating cost, capital expenditure included. The investor's income depends on the operator's ability to pay, measured by rent cover: the operator's earnings before rent over the rent.
In a RIDEA structure, named after the US REIT Investment Diversification and Empowerment Act, the REIT owns the operations as well, through a taxable subsidiary, and pays an independent operator a management fee. The investor receives everything the community earns after the fee, and pays for capital expenditure. Outside the US the same choice is described as an operating or management-contract structure against a lease. The building, the residents and the staff are identical; what changes is who keeps the upside and who absorbs the downside.
| Input | Value |
|---|---|
| Units; occupancy | 100; 88% |
| RevPOR, revenue per occupied unit a month | $6,000 |
| Operating costs before management fee, share of revenue | 66% |
| of which variable, per occupied unit a month | $2,400 |
| Management fee, share of revenue | 5% |
| Capital expenditure reserve, per unit a year | $2,500 |
| Lease: rent cover on EBITDAR at signing; escalator | 1.25x; 2.5% |
| Price paid, either structure | $25.0m |
Revenue = units × occupancy × RevPOR × 12 = 100 × 88% × 6,000 × 12 = $6.336m
EBITDARM = revenue − operating costs = $2.154m; EBITDAR = EBITDARM − 5% fee = $1.837m
RIDEA income = EBITDAR − capex reserve = $1.837m − $0.250m = $1.587m
Triple-net rent = EBITDAR ÷ 1.25 = $1.470m
Excel: =EBITDAR/Cover for the rent, =EBITDAR-Units*Capex for the RIDEA income
On day one the RIDEA owner earns 47 basis points more on the same price. The two incomes would be equal only if the lease were written at 1.157x cover, the ratio of EBITDAR to EBITDAR after capex. Any cover above that is income the owner gives up in exchange for having the operator stand between it and the operating results.
| Scenario | Occupancy path | RIDEA yield | Triple-net yield | RIDEA minus lease, 5 years | Lowest rent cover |
|---|---|---|---|---|---|
| Upside: RevPOR +4.5% a year | 90 to 92% | 8.65% | 6.34% | $2.89m | 1.36x |
| Base: RevPOR +3.5% a year | 89 to 90% | 7.49% | 6.34% | $1.44m | 1.29x |
| Downside: RevPOR +2.0%, costs +5.0% | 82 to 86% | 4.68% | 6.34% | -$2.07m | 0.80x |
Costs grow at 3.5 per cent a year for the variable part and 3.0 per cent for the fixed part, except in the downside, where wage pressure pushes them to 5.0 and 4.0. Weighting the scenarios 25, 50 and 25 per cent, RIDEA earns $8.85m over five years against $7.92m from the lease, $0.93m more, with a range of $4.96m between the best and worst cases against none on paper for the lease.
The operating leverage is why. One point of occupancy is $72,000 of revenue and $39,600 of income after the fee and variable costs: 2.5 per cent of the RIDEA income, all of it straight to the owner. Under the lease it moves rent cover by 0.027x and the owner's income not at all.
The lease's flat line in the downside is an assumption, not a fact. By year 5 the operator earns $1.329m before rent and owes $1.663m: cover of 0.80x. An operator in that position renegotiates or fails. If the rent is reset from year 3 to 1.10x cover of EBITDAR, the lease pays $6.84m over five years, a 5.47 per cent average yield, and year-5 rent falls to $1.208m. That is still $0.98m more than the RIDEA owner receives, so the lease protects, but by about half of what the headline says.
Comparing the RIDEA yield with the lease yield as if they were the same kind of income. The 47 basis point day-one gap is not free money: it is the price of the operator's guarantee, paid as rent cover. A RIDEA buyer pricing at the lease's cap rate is paying for income it will not always receive; a lease buyer who ignores cover is buying a fixed rent from an operator whose own margin is falling, as how fast rent cover falls on an index-linked care home lease shows.
The two structures agree in value only at one rent cover. The book's companion files show the same point on a care home priced as a trade and as a lease: the valuation gap closes only at the cover where the lease takes exactly what the operator can spare.
The arithmetic of a fixed rent against an operating business, on the book's own 70-bed home, is in the free workbooks for this book, and the relationship between cover, yield and multiple is worked in what multiple an investor is really paying at 1.80x cover.
A structure in which a REIT owns both the property and the operations, through a taxable subsidiary, and pays an independent operator a management fee instead of collecting rent. The owner keeps EBITDAR after the fee and pays capex. In the illustration that is $1.587m at acquisition against a triple-net rent of $1.470m.
Because the rent is paid out of the operator's earnings, and cover is the cushion between them. At 1.25x on EBITDAR the illustrative operator keeps $0.367m above the rent. In a downside where occupancy falls to 82 per cent and wages outrun fees, cover falls to 0.80x by year 5 and the rent depends on the operator's balance sheet.
When the rent equals EBITDAR less the capex the RIDEA owner would fund. In the illustration that is a cover of 1.157x. Every point of cover above it is income the owner gives up for protection from operating results: at 1.25x, 47 basis points of yield on the $25.0m price.
This article is one calculation from Senior Living and Healthcare Real Estate. 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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