While the sale of most assisted-living facilities tends to include both the real estate and the business, it is not uncommon for the business to be sold separately from the real estate. Sometimes it’s also a matter of the seller keeping the real estate and leasing it to the business buyer.
When a facility is operating and stabilized, the income approach to value is usually the best measure of the business and the real estate. We use this approach in a few ways when the business and real estate are separated in a sale. For more on what income approach means, click HERE. But to separate the business value from the real estate value, requires three steps.
Step 1. We figure out the value of both the business and the real estate combined, using that income approach. That’s a simple matter of dividing the net operating income by an appropriate capitalization rate.
Step 2. We allocate the net operating income (NOI) between the real estate and the business. This can be a really subjective step, since it depends on who’s doing the analysis and what result they prefer. For example, if you set the lease expense higher, there is less NOI left for business income and, therefore, less business value. On the other hand, if you lower the lease expense and increase the business share of NOI, then you’ll have less real estate value but more business value.
By the way, since real estate NOI is generally valued higher than business income, a seller may achieve a better result by keeping the lease expense higher when selling the business separate from the real estate. But don’t make the rent so much that the business owner goes broke trying to pay the rent. That means that the division of the NOI is a balancing act that takes some serious thought.
Step 3. The business value–or the real estate value, depending on how your analyst divided the NOI–is subtracted from the total value calculated in the first step. The result will then tell you the other value.
So what’s the best way to go? It depends. The fact is that the three step formula above doesn’t always produce the best result. In the case of selling the business separate from the real estate, 1 + 2 doesn’t necessarily = 3. For many assisted living facilities, we generally see businesses sell for three to four times the net income after the lease expense. Net leased real estate typically sells for about ten times the net operating income from the net lease.
Sometimes assisted living facilities are sold in two pieces: the business and the real estate. When that happens, make sure that you take time to do the math and find the best result.