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What multiple is an investor really paying at 1.80x cover and a 6.0 per cent yield?

The three ratios quoted in every care home deal are two judgements and one arithmetic consequence.

Julian R. Sterling · from Senior Living and Healthcare Real Estate

An investor who requires a 6.0 per cent yield on the rent and a lease written at 1.80x cover is paying 9.26x EBITDARM, not the 11.00x the trade market quotes. The three ratios are locked together: cover times yield times multiple equals one. On this home the trade is worth £16,816,691 and the lease £14,155,464 — a difference of £2,661,227 that somebody is holding.

Three ratios, two judgements

Every care home transaction is described with three numbers. The multiple of EBITDARM the trade is worth — here 11.00x. The yield an investor requires on the rent — here 6.0 per cent. The cover the lender requires — here 1.80x. They are quoted as three separate judgements, reached by three separate parties, in three separate documents.

They are not three judgements. The trade is worth the multiple times EBITDARM. The lease is worth the rent divided by the yield, and the rent is EBITDARM divided by the cover. If one home has one value, those two expressions are the same expression, and they agree only when cover × yield × multiple = 1. Nothing has been assumed except that a building cannot be worth two amounts at once.

So any two of the three fix the third. Quote all three and one of them is either redundant or wrong.

Any two of the ratios fix the third. There is no combination in which all three are free.

Hold these two	The third becomes
An 11.00x multiple and a 6.0 per cent yield	1.52x cover
An 11.00x multiple and 1.80x cover	5.05 per cent yield
A 6.0 per cent yield and 1.80x cover	9.26x multiple

What the cover requirement costs

The home in question earns EBITDARM of £1,528,790. Valued as a trade it is worth £16,816,691; valued as the lease that the lender's cover and the investor's yield produce, it is worth £14,155,464 — both figures describing the same building on the same day.

The same home, valued as a trade and valued as a lease.

Valuation	Amount
Value of the trade at 11.00x EBITDARM	£16,816,691
Value of the lease at 1.80x cover and a 6.0 per cent yield	£14,155,464
Difference	£2,661,227
The multiple the investor is actually paying	9.26x

A lender who asks for 1.80x cover rather than the 1.52x the other two numbers imply is not asking for prudence. At an unchanged yield he is asking the seller for £2.7 million of value. The answer to that request is not an argument about prudence; it is a repricing of the yield. Relaxing cover from 1.80x to 1.52x is worth the same £2.7 million to the borrower, which turns a relationship conversation into an arithmetic one: does the extra margin cost less than that over the life of the facility?

Why the rent is not a negotiation

The identity holds because the rent in a care home is not set the way a rent is set anywhere else. There is no market rent, because there is no alternative use and no alternative tenant facing a different trade. There is a lender's cover test, and the rent is what falls out of it: rent = EBITDARM divided by cover.

The rent is an output. Nobody negotiated £849,328.

Line	Amount
EBITDARM	£1,528,790
Required cover	1.80x
Rent	£849,328
Rent per registered bed	£12,133
Rent as a share of revenue	17.2 per cent

The last line is the tell. Rent at 17.2 per cent of revenue is not a market convention; it is the EBITDARM margin of 31.0 per cent divided by the cover of 1.80x. Anyone who quotes a care home rent as a share of revenue is quoting a margin and a cover at the same time without knowing it.

The line the cover is tested on matters as much as the level. Tested on EBITDARM the lease covers 1.80x. Tested on EBITDAR — after the management charge the operator cannot actually remove — it covers 1.51x. That is 0.29x of cover, or £246,666 a year, and it is decided by one clause.

What to do with it

• Multiply the three ratios in any memorandum that quotes them. If the product is not one, ask which number is the residual. Whoever wrote the document will usually not know.
• Price a cover requirement rather than debate it. Between 1.80x and 1.52x sits £2,661,227 at an unchanged yield, and the seller is entitled to ask for it back in the yield.
• Give the seller the choice the identity reveals. At a trade market of 11.00x and a lease priced at 9.26x, selling the operating business is worth £2.7 million more than selling the lease. A seller who has not computed the identity does not know he had a choice.
• Do not conclude that the two valuations price the same risk. They coincide numerically at the implied cover and nowhere else. The trade prices a business with a licence, a manager and a referral network; the lease prices a contractual income from a tenant who holds all three.

That last point is where the money goes after a sale and leaseback. What the operator keeps once the rent is paid is £432,797, geared 3.53x to EBITDARM, and the transaction creates value only if a leased operating company trades above 6.15x. The identity says the difference between the two valuations exists. It does not say it has disappeared.

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