We own the commercial facility our operating company occupies and have charged below-market rent to minimize our operating company expenses. How will the buyer's Quality of Earnings firm adjust this, and how should we normalize real estate lease costs before going to market?

Question

Tyler Smith · Accepted Answer

Below-market rent is one of the easiest adjustments for a buy-side Quality of Earnings team to attack. When you charge below-market rent to your operating business, you artificially inflate historical EBITDA. The buyer's accounting firm will immediately identify this related-party transaction, determine true fair market rent, and calculate a negative EBITDA adjustment for every historical period under review.

To protect your valuation, you must address this issue on your own terms twelve to eighteen months before marketing the business. Hire an independent commercial real estate appraiser to conduct a formal market rent study. Use that appraisal to establish a commercially reasonable, arms-length triple-net lease between your real estate holding entity and the operating business. Execute the lease agreement, start paying the market rent through the business checking account, and record the payments clean on your general ledger.

By implementing market rent proactively, you control the adjustment narrative. In your sell-side materials and confidential information memorandum, you present the adjusted lease numbers transparently as a pro forma bridge. If you fail to do this, the buyer's diligence team will select the highest possible comparable rent metrics they can find in the submarket, reducing your EBITDA by the maximum conceivable dollar amount. Every dollar they add to facility rent removes five to eight dollars from your enterprise purchase price at closing. Formalize the lease early, document the market comps, and take the valuation weapon out of the buyer's hands.