Friday, May 16, 2014

Cap Rates Used In Skilled Nursing Facility Valuations

The baseline metric for the valuation of a skilled nursing facility is the amount of Net Operating Income generated by operations, or more specifically, EBITDAR, consisting of Earnings before Interest, Taxes, Depreciation, Amortization and Rent, divided by rates of return specific to the nursing home industry (known as the “Capitalization Rates” or “Cap Rates”).  Cap Rates are derived from historical nursing home sales data.  In addition, the practice in nursing home valuations is that EBITDAR is calculated net of a management fee computed at five percent (5.0%) of revenue.  (EBITDAR is thus EBITDARM less the management fee.)  While the management fee percentage applied could vary from 3% to 5%, by buyers’ assumptions of synergies from the business combination, 5% is the heuristic benchmark.  This formula is known as the Income Capitalization Model.  It is based on the premise that asset value is predicated on the amount of free and clear cash flow a business generates per year.  In other words, the Income Capitalization Model translates Net Operating Income into value.  Consequently,

Value = Business Income/Capitalization Rate

The Capitalization Rates (denominator) for skilled nursing facility valuations are derived from historical nursing home sales data, so that:

Annual EBITDAR/Sale Price = Capitalization or Cap Rate


Prospective Valuation    = Annual EBITDAR/Historical Cap Rate(s)

For Example,

Prospective Pricing at a 13% Cap Rate = 

    Annual EBITDA/Historical Cap Rate: $1,000,000/0.13 = $7,692,231

Earnings Multiplier is Inverse of Cap Rate:   

13% Cap Rate = 1.00/0.13  =  7.69 X, or
7.69 x $1,000.000 = $7,692,231

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