Examination of Witnesses (Question Numbers
80-99)
MR MARTIN
WILLIS, MR
DAVID MORGAN
AND MR
SIMON CLARKE
18 NOVEMBER 2008
Q80 Mr Binley: The whole business
of trading pubs to the tenant in the way you have just heard operates
and you know well. Is it the best way of dealing with this issue?
Mr Willis: As far as valuation
is concerned it is the profits method of valuation regardless
of whether the business is traded as a tenancy, as a leased pub
or a managed house. The same philosophy works and the same valuation
method works. The decision as to whether a public house should
be managed, tenanted or leased is down to profitability and the
threshold of profitability which will move it from one sector
to another.
Mr Morgan: I consider the existing
method is eminently fair if it is operated in a fair, open and
transparent manner. Therein just lies the key, the openness and
transparency.
Mr Clarke: I think it is the right
method to use. The problem is, as David so rightly says, that
it is easily open to abuse in that you have to consider the weight
of the parties, particularly with a pub. On the one hand you have
a tenant who is probably a one-man band operating his own pub,
he does not have a great deal of time, he probably has not got
a lot of comparables to work on. On the other hand you have a
potentially multi-million pound company that has an open cheque
book, a rent review department specialising in purely this sort
of thing. The weight is against the tenant at the outset. The
tenant, of course, could employ the services of a surveyor but
that is quite a costly experience, particularly at the outset
when you have a BDM who comes in for a friendly chat to propose
a rental increase.
Q81 Mr Binley: Is that the only time
you see the BDM?
Mr Clarke: I have only been co-owner
of a pub for three years and we only really saw our BDM during
the rent review negotiations. He has since moved on and we have
a new one now who has been in since the rent review. I have to
say it probably suits us that we do not see that much of him,
just as much as it suits him not to come. We have no real benefit,
I do not think, from monthly visits.
Q82 Mr Binley: Another supplementary
to that first question, would valuers lose massive amounts of
income if we changed the present structure in the way that many
believe would be for the better?
Mr Clarke: Do you mean removal
of the tie?
Q83 Mr Binley: Yes.
Mr Clarke: The valuation technique
is the same really whether there is a tie there or not in that
the valuers, as said by Mr Jacobs earlier, do not generally take
into account the wet rent element. So when we come to a rent review
situation today, be it free of tie or tied, the formula is based
on the turnover figure—an estimated turnover figure—and
applied to that is a gross profit costs and at the end is an earnings
before income tax which is split between the landlord and the
tenant.
Q84 Mr Binley: So the wet rent element
which is totally subjective as we have learned is totally within
the hands of the pubcos. You do not get involved in that element
at all.
Mr Morgan: We have to interpret
the circumstance of the varying levels concerning the discounts
offered, if any, into the overall assessment concerning gross
income. Having actually worked out the fair maintainable trade
in fact the next item along the line is actually the gross profit.
That will then be linked to the amount of the discount, if any,
that the licensee then has. That is the area that includes or
excludes the wet rent factor.
Mr Willis: Wet rent and dry rent
are trade terms; they are not actually recognised as part of the
formal chartered surveyor training. As Mr Morgan has quite correctly
said, the principal evaluation to rent is to assess the fair maintainable
trade for the public house. That is the trade that the reasonably
efficient operator—that is a recent term that has come in
following the international valuation standard—will expect
to achieve from those premises taking into account all of the
circumstances of the facilities, competition, location et cetera;
running the business in a proper manner; and assuming the property
is properly repaired, maintained and decorated. That is the starting
point of the profits valuation. You then move down through the
profits (P&L), through the gross profit, which will clearly
take into account any elements of the lease which bring in a tie.
It will take into account discounts that are given and each individual
lease and each individual property will be different. He will
then work out the operating costs of the business, that is all
operating costs down to the net profit before depreciation, tax
and amortisation. To get to the rent there is a small adjustment
then to take into account the working capital and the investment
that the tenant has put into the business. That leaves what is
called the divisible balance. It is that figure that is then apportioned
between the landlord and the tenant, the landlord for providing
the property and the tenant for his risk and reward in running
the business. The starting point is invariably 50/50 but there
is no rule to say that it should be 50/50; it will totally depend
on the risk and desirability of the business.
Q85 Mr Binley: All this clever stuff
then is primarily based in terms of the wet side on an imaginary
figure.
Mr Willis: No, it is all forms
of income to the public house (letting, food, machines, everything);
it is not an imaginary figure because the training for the chartered
surveyor who is a specialist as a licensed property valuer is
to source his database, to source other businesses and know what
is going on in that particular area for that type of business.
He will, if possible, be given the actual accounts for the business.
Not all lease agreements require accounts to be put over but more
and more often now accounts are being requested and tenants are
being more forthright and putting their accounts forward. That
will give a good steer to the actual costs but it is the fair
maintainable trade, in the same way that could be below or above
actual trade. If you have an operator who is above average or
an exceptional operator the fair maintainable trade will be below
his actual trade; if the business is actually in need of repair,
maintenance, decoration or perhaps is not being run to the most
optimum level, then indeed the fair maintainable trade might by
higher. The most important part of any valuer's job is to read
the market, analyse actual transactions (that will be lettings
and rent reviews), understand those transactions and apply that
evidence to the valuation that he has before him.
Q86 Mr Binley: In your submission
you talked about the appropriate gross profit margins. How do
you arrive at that if it is not imaginary?
Mr Willis: It is factual. You
can get hold of a price list; you can find out exactly what gross
profit is being made on any element. It is harder, admittedly,
for food items because people could be buying from cash and carry.
The wet trade, if it is a full tie, the pubco, giving a rent review
will give him the complete price list at that time and GPs can
be worked out. They are also, as I say, looking at other businesses
so there is a comparison approach which is a standard valuation
approach, working all the way through the profits valuation.
Q87 Mr Binley: Is the role of the
landlord a massive factor in this respect which you cannot assess?
Mr Willis: I am sorry, I do not
understand the question.
Q88 Mr Binley: Is the role of the
landlord in running his pub and attracting business a massive
factor in assessing how a pub will do and how can you assess that?
Mr Willis: From experience, just
walking round public houses. Any valuer who is a chartered surveyor
who is a specialist in licensed property or any form of the profits
valuation is covered by the RICS rules of conduct and the guidelines
and the valuation information. Part of that is that he must be
experienced. It is integrity and experience in client service
which are the fundamental key to the chartered surveyor role.
Mr Morgan: If I can assist in
the overall aim of the point, there is a considerable disparity
between the actual accounts—in other words what the actual
licensee or landlord does—and also what he is expected to
do and herein lies a huge problem. The pubcos have this assumption
that the individual licensee should be, for want of another word,
the perfect tenant. Say, for instance, your books show that you
are doing 50% worth at gross profit you are then told that you
should be doing 56%. This is the whole substance of it. Having
been informed of that and having then started off a calculation
from an area that is not substantiated from the tenant's accounts,
then having underestimated the overhead costs specifically in
the area that I find every single day is the underestimation of
actual wages costs. I have over and over again the sort of mantra
"That's what they do in managed houses" and I do not
ever get shown the managed house accounts that then would justify
in a food-led premises where you might get wages rates anything
from 26% to 35%, "Oh, they should be 15% because that is
what we have in managed houses". You then start off with
a complete disparity over how the thing is actually worked. The
snag is that you then get the chartered surveyor or the surveyor—because
they are not always chartered surveyor—who then represents
the pubco. Surprisingly he will also have in his mind the perfect
tenant and you have the situation where in theory you should be
guided by those accounts but in actuality it is only just a starter
for ten because at the end of the day you are informed of firstly
the trade that you should do; secondly, the margins that you should
achieve (and if you have not achieved it then you are not a very
good tenant); thirdly, you ought to be running the place on an
utter shoestring whereas in actual fact if you then have to say,
"Look, here are the staffing rosters, here is how much it
costs". That is irrelevant just because managed houses do
this. You are on a complete loser to start with. Also—which
then rather reverses the question—you are informed of the
actual amount of the rent in the first instance without any explanation
whatsoever. You are told, "This is the rent and that's what
you'll pay", no explanation. That is perhaps a longwinded
way of answering the question.
Q89 Mr Binley: I am grateful for
that; thank you very much indeed. Mr Clarke, do you have anything
to add?
Mr Clarke: We had our rent review
due in November 2006. We started negotiations in May 2006. Initially
the process is the BDM comes in and has a quick chat, probably
about something else and then slips in, "Oh, by the way,
you've got a rent review coming up". In our case the review
was from £52,000 to £59,000 which was RPI increases
on the original £47,000. If we want to have an argument about
it there is evidence to suggest that it could actually be more
than £59,000 but we are going to get it all done and dusted
and there will be no trouble. We actually requested at the outset
a valid rent review notice. We had a letter from them indicating
there was a rent review due but there was no proposed rent in
that letter. I queried whether that was in fact valid as there
was no proposed rent. It took two months before we physically
got a rent review notice that had a proposed rent in it. At this
point we still had not got calculations to back that up. I simply
dug my heels in and said that until I got some sort of calculation
I could not judge whether that was right or wrong. Eventually
that came through and took the form of a very simplified calculation,
not dissimilar to one that I think you have been circulated with
today. Over the period then of the next eight or nine months the
rent went from £59,000 to £54,000 to £52,000 (which
was actually our rent passing). All the way along this process
we had said that whilst they had explained in that ten and ten
equals a hundred they had not told us where the tens had come
from. We had no evidence to validate that. At that point we were
offered £50,000 (which is £2000 less than our existing
rent). Most people would say we should have bitten the bullet
there but we took it to arbitration on the basis that no evidence
had been put forward during the whole process. It was only there
that evidence started to come to light and that was actually supplied
by allocated agents. The one thing I think is important to make
clear is that wet rent (it has the word "rent" so everybody
assumes it is all calculated in and it is part of the formula)
is simply the amount the tenant misses out on in the form of discounts
because he pays over the odds to the landlord. When you have a
free of tie tenant they pay a rent, using easy numbers, of £50,000;
the same pub tied, the rent may be £30,000 but the wet rent
might be another £30,000. That is taken out of the equation.
You look at it as a naive newcomer to the trade, see £50,000
and £30,000 and take the £30,000. Nobody has really
gone into a great deal of depth in telling you that you are actually
going to pay another £30,000 in loss of discount.
Q90 Mr Binley: It is sad that most
people would not have your ability to argue on that basis and
simply take what the pubcos tell them.
Mr Clarke: I think most tenants
probably do and I am sure questions will be raised as to why more
do not go to arbitration. I think it is simply a massive misunderstanding
of how it all works. I am a chartered surveyor but I had not actually
been involved in pub valuations until our rent review commenced.
Q91 Mr Wright: If we turn the clock
back to where the predecessor committee actually made certain
recommendations which have not been ultimately carried out and
one was about the transparency of the valuation process, obviously
you have just explained that process. How can we actually make
it more transparent so that people are aware of how they come
to these rents? Do the pubcos want to hide this so that you are
not aware as Mr Clarke's experience demonstrates?
Mr Willis: Taking the gentleman's
point about the tenants being left in the dark, there are a couple
of points that need correcting. The rent review mechanism is built
into the lease. When the rent review notice is due to be served
and whether it should state a rent is a factual matter from the
lease. The pubcos and the smaller breweries have been taking on
improved codes of practice and quite a number of the pubcos now,
including some of the smaller brewers, have been through the BII
accreditation scheme which marks them and scores them on addressing
certain issues from your previous committee. Certainly one of
the points is that tenants should be given the breakdown of the
rental proposal. Different companies provide that at different
stages and certainly a number of the pubcos have actually address
chartered surveyors in the industry explaining how that will be
presented and what will be included in it. That is a starting
point. It is not perfect and they are not all doing it, but a
major number of them are now and they specifically want that breakdown.
So that is the first stage, the tenant actually understanding
where the pubco is coming from on rent. The issue of comparables
and evidence is a fundamental of valuation. It is not good practice,
as in Simon's case, for anybody to run all the way to arbitration
without presenting comparables. It is absolutely fundamental to
dig out comparables at the turnover level, the gross profit level,
the profit level and the rent level. They may be different comparables
for the different levels of the valuation. They are the market
transactions. All the chartered surveyor's role is is to read
the market and apply those terms and to help the client if it
is a tenant or indeed the tenant should be able to understand
and ask questions from seeing the breakdown of the valuation.
Mr Morgan: The reality, however,
is considerably different. The situation exists that I have probably
every day three to five standard referrals nationwide and they
come from all elements of the industry, from those who are in
particular trouble through the Licence Trade Charity, from others
who have huge leased houses, some in fact with turnovers of over
a million pounds. As the conversation starts I always ask the
same question, "Have you been shown how the actual rent was
worked out?" Answer: "No". This happens every single
instant that I can think of, with certain exceptions. The exceptions
are—surprisingly, but they are—in fact the little
regional brewery companies, some of whom are particularly punctilious
about being able to present exactly how they got to where they
got to. Yesterday I had three referrals; none of them had had
any explanation whatsoever as to how the rent was done. They were
told, "Here is the rent". In that situation you do not
get the good cop/bad cop scenario. You start off with a hugely
high amount of rental hidden always behind the laptops; the laptop
hides any form of calculation. Some people actually sign up to
that huge amount of rental, but that is just a few. There is then
the negotiating stance: "I will then come down because I
like you. I will go and fight your cause. I will go to the top
and I will make sure you are really looked after." That then
comes down to the second level of rental. Then there is the third
level of rental and if they really had to be pushed to get there
then that is what they might just settle at. The interface, because
it is adversarial, is the BDM or BRM. They are obviously in the
business to get the highest rent they are able to get. They are
looking after shareholders' interests and their own job; they
are not there to cut the rent down. If they are able to get as
high as they are able to, they do. In the instances that I have
had which have effectively ended up in arbitration, you never,
ever have the comparables in any form from the pubco representative;
they do not exist. There was one that I handled last week where
we knew that the pub within half a mile was in the hands of the
same pubco. I happened to know the new tenant in that particular
pub. I asked the representative what was the rent from the pub
next door. He said, "I can't tell you. It's completely confidential."
And so the scenario goes. There is no transparency; it does not
exist.
Mr Clarke: I do not have a great
deal to add to what David has said, however, to answer your question
on how there can be more transparency a couple of things immediately
spring to mind. If there were some form of central register of
transactions that took place be they new lettings, lease renewals,
rent reviews, then I think that would open up a great deal of
evidence for a lot of people because it would be publicly available.
When there is an arbitration the arbitrator at the end of the
whole operation would issue an award. Included in that award would
be his valuation after seeing both parties' the submissions. That
should be publicly available and easy to get hold of. At the moment
it is very difficult to get hold of. More to the point, if pubcos
want to argue that they are being more transparent, when their
BDM goes into that initial meeting he should say, "Here's
your new rent, it's a little bit more than you were expecting
I know" and if the tenant says, "Can you tell us, for
example, the five nearest pubs to me that own? You've got 7500
pubs, you must have a couple of pubs nearby that you can tell
me what sort of barrelage they do? Can I have the names and phone
numbers of the licensees so I can ring and talk to them myself
and ask what rent they are?" The argument would probably
be that a degree of that would be confidential accounting information,
but the pubcos themselves will tell you that they would use the
barrelage figures if the pub was going to go on the market, it
would be included in the property particulars. You would be able
to look immediately and see that that pub does 250 barrels, that
pub does 200 barrels, that one 350 barrels. What is the difference?
That one has a better location, this is bigger, whatever. In our
situation we have a pub directly opposite also owned by Enterprise
Inns. We asked repeatedly for the detail of that rent review which
was two years prior to ours. Their rent review is £36,000;
we were already paying £52,000. That pub is bigger, has a
car park and has game machine incomes. Why is ours more than theirs?
Show me the analysis of it, that is all we ask. We never got that.
Q92 Mr Wright: Again our predecessor
committee recommended an itemised register of pub rental assessments
that would be concurred across the board.
Mr Morgan: That would be fantastic
but that does not exist.
Mr Willis: The RICS would not
agree to that. There is no rental register for any form of commercial
property (offices, shops, industrial properties). There are rental
indices which show direction of movement of rent but no specific
register. The reason for this is that no two properties are the
same; no two leases are necessarily the same. In the public house
sector we have a great plethora of different agreements and leases
ranging from the six month tenancy right through to 20 or 21 year
leases. Each of those has different terms; each of them has different
tie provisions. We come right down to the issue of tenants' improvements.
There was an example given to you in the earlier session of a
rent of £1000; that was probably a ground rent, it was not
a commercial rent for the public house. There was an example given
to you of a rent on a commercial property value to square footage
which was probably a shell rent where the initial tenant had to
go and fit out the premises. Without putting all of this evidence
on the register it would be a very simple thing that a little
knowledge is a very dangerous thing. It is exactly the reason
chartered surveyors train and go through their training and gain
their experience in order to analyse transactions. I have to say,
from a personal point of view, if I am acting for a tenant I go
and actually talk to the nearby public houses; I do not ask the
BDM from the brewers to give me the telephone numbers, I go and
knock on the door and chat to them. There is nothing to stop people
doing that.
Q93 Mr Wright: A lot of the tenants
could not afford to employ their own chartered surveyor.
Mr Willis: No, and this is exactly
the reason why the pubcos were asked to look at codes of practice.
To put the record straight, I have acted for tenants and I have
been given the breakdowns early on. I agree with Simon that the
number of comparables that are provided at the early stages perhaps
could be improved, but there is nothing to stop a licensee himself
going and talking to his local competitors about rent and things.
Certainly as a valuer you would do it; you are there and it is
part of your training to resource evidence in the market and analyse
that evidence.
Mr Clarke: It should be said that
there is a register for residential premises so I cannot see where
there cannot be one for pubs.
Mr Morgan: The helpful factor
of having a register—which I wholly support—is that
if you have three pubs as indeed Martin was saying you can get
a distortion. If you have 30 pubs they tend to even out a little
bit. If you have 300 pubs you then get a general tone. If you
have a whole stack of comparables they generally tend to form
a pattern and you can interpret the pattern as you will. Obviously
the tenant does not want the rent to go up and the landlord does.
If the evidence is en bloc you have anomalies which I would
completely concur with, but the general image of that particular
tone is of assistance.
Q94 Mr Hoyle: Is it normal for commercial
leases to be linked to the RPI?
Mr Clarke: For commercial leases
it is perhaps not normal. In the pubco leases it is extremely
common.
Q95 Mr Hoyle: That has replaced the
UORR.
Mr Clarke: The UORR is the up
and only rent review clause. In our situation we have an inflationary
increase every year and in the fifth year we have an upward only
rent review clause included in our lease. I have to say at this
point that we went to arbitration, we argued that our rent should
be reduced and it was reduced accordingly. The upward only rent
review clause is still in our lease despite the fact, as you mentioned
in the earlier session, we were told by Mr Harrison that it would
be removed as soon as legally practical.
Q96 Mr Hoyle: In 2004 it was Enterprise
Inns who stated that and you were successful in taking Enterprise
Inns on that issue.
Mr Clarke: It was interesting
because in our particular situation I think it was all down to
the reading of the lease. The arbitrator's role, had he been instructed
to establish the rent under the terms of the lease, his conclusion
would have been: despite the fact he knows it should have been
less it would have been the same (£52,000) because it is
an upward only rent review clause. However, the terms of the lease
dictated that the arbitrator's role was to establish open market
value.
Q97 Mr Hoyle: It is very lucky that
you are a chartered surveyor as well, otherwise this could not
have been done.
Mr Clarke: I would love to say
that it was down to me but there were a number of very, very knowledgeable
people who helped me.
Q98 Mr Hoyle: It is good that you
had the access to that knowledge and that is why the poor old
landlord cannot take on the pubcos.
Mr Clarke: They would not risk
it. At the end of the day we won our arbitration and it still
cost us half the arbitrator's fee and our own.
Q99 Chairman: You are dealing with
amateurs here; we often slip into the wrong language. Landlords
and tenants we do understand the difference straightaway. We know
what you mean but you will have to work out what we mean when
we know what we say what we mean. I think I know what I meant
just then.
Mr Willis: There is an anomaly
that has been identified which is the situation of arbitration
and the upward and downward only reviews. A number of pubcos have
built into their codes of practice that regardless of whether
it was an old lease which had an upward only review they will
waive that right. As Simon quite rightly said, the role of an
arbitrator which is a quasi legal role actually requires the arbitrator
to be given instructions at the outset to say that if the rent
was to go below the rent passing it would be accepted. Essentially
the upward only rent reviews are in certainly the older leases
and there is an anomaly there.
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