Leaseback Income and how to consider it.

It is in these harder economic times that leaseback agreements are perceived to be an area within the business that has the greatest risk, particularly as occupancies fall and tariffs recede. The agreed leasebac rental payout to the Landlord by the manager does not change, despite the above.

Valuers of Management Rights generally utilise one of two methods when dealing with Leaseback Income being the application of a simple multiplier to the Net Operating Profit arising from Leaseback Income to a more detailed ‘What If’ Analysis.

Scenario: A predominantly permanent complex of 215 townhouses with 160 in the letting pool (140 permanent & 20 holiday let). The first steps within the ‘What If’ Analysis is to assume that the 20 Leaseback/Holiday Let units form part of the standard Form 20a Permanent let units. The then ‘standard’ letting commission, cleaning/linen and consumables costs are added to the gross Leaseback Rents received to provide a grossed up income on this basis.

However cleans/linen and consumables have an industry recognised hard cost to the manager/operator of about 50%, hence this cost is then deducted from the new gross income. This then results in a Traditional Net Operating Profit (TNOP) from this portion of the business.

However what it does not identify is the Risk Component of the overall Leaseback Rents Received. Therefore the TNOP is deducted from the Verified Leaseback Profit to reflect the Risk Income component. The exercise has then produced two NOPs, one Traditional and one Risk. This is where two distinct multipliers are adopted. As an example we provide the following:

Leaseback Rents Received $548,019
Commission $ 65,762
Cleans/Linen $ 56,576
Consumables $ 2,000
Gross Income $124,338
Less Expenses
Cleans/Linen/Consumables $ 29,288
Traditional NOP $ 95,050
Stated Leaseback Profit $162,728
Less Traditional NOP $ 95,050
Risk Income $ 67,678
Traditional NOP @ 5.5 $522,775
Risk Income @ 2.75 $186,115
Total Leaseback Market Value $708,890

However it should be noted that this approach is not utilised for absolutely every business where there are leaseback units involved. For example there are businesses with two or three short term lets. The risk that those units represent to the overall business is relatively minor and assuming they have had a regular trading history, could virtually be treated as traditional income.

At the other end of the scale however are those complexes that only have leaseback agreements with the landlords and are running the complex purely as corporate accommodation.

In these cases the multiplier adopted is reflective of many factors but particularly the state the corporate letting market.