HC 1369 Pub Companies

Written evidence submitted by Garry C Mallen

1 INTRODUCTION

I gave evidence at the BESC enquiry in 2009 as a member of IPC, I am also an ALMR Council Member with 6 leasehold premises ( 2 of which are tied ) under management, a landlord of 3 Freehold premises which are let out on long term free of tie leases and I have a practice which conducts rent reviews on behalf of clients within the tied and untied sector.

2 Following the BESC I was invited to join the Royal Institute of Chartered Surveyors Forum to review and revise its valuation Guidance Paper, which took place during 2010. The new Guidance Note 67/2010 was issued in December 2010 which I believe is universally accepted as a much improved document.

3 The ALMR and IPC have highlighted in their evidence that little regard is being paid to RICS Guidance and Benchmarked Costs. I support and endorse these representations and wanted to provide the Committee with some actual examples of rent reviews carried out under the new self-regulatory regime which demonstrate how it has failed to materially change the experience of the lessee.

4 Attached at Appendix A is a spreadsheet showing landlord valuations for seven premises, and although a summary of each is attached as appendix C – I. I have detailed below a summary of the first premises to highlight the lack of adherence to the Lease, The Codes of Practice and RICS Guidance GN 67/2010.

5 Roadtrip, EC1V, I have had extensive knowledge of these premises over the last 12 years and have acted on behalf of the last three tenants, carrying out the initial rental agreement and the rent review in 2006. I have the barrelage figures back to 2004, and up until my current client acquired the lease by assignment, the historical barrelage had been considerably less than 150 barrels. Since my client has taken over and developed the outside area with a temporary planning permission to incorporate a large decked area, and operated the premises in his undoubtedly unique manner, the barrelage has steadily climbed from 111 to nearly 350 barrels. Despite my client clearly overtrading the premises, the landlord has provided a rental valuation based upon 320 barrels, and is looking to increase his rent by almost 70%. The Code of Practice provided by this landlord clearly states " In the event that you are achieving a greater level of trade than that which we believe would be achieved by a reasonably efficient operator, we will disregard this level of outperformance from our rent assessment." The lease for this premises also clearly states in section 2 of the Seventh Schedule that the following should be disregarded:

(i) any goodwill attached to the property by the carrying out on of business by the tenant in occupation under this lease at the relevant Rent Review Date and..

(ii) any increase in rental value attributable to any authorised improvements carried out by and at the expenses of the Tenant during the term except under obligation owed to the Company ( whether or not under this Lease )

In my view it is very clear that the landlord company is seeking to take advantage of the fact that my client is clearly overtrading the premises, and attempting to apply an increase in rent which effectively will penalise my client for having the ability to trade so well. My client was able to increase the trade from 111 barrels in 2008, to 250 barrels in 2009, he then obtained Temporary Planning Permission in late 2009 for an outside terrace for which he pays a separate rent to Hackney Council, this helped to increase the barrelage further to 319 barrels. The landlord company is insisting on using 320 barrels as the FMT, yet the temporary planning permission only lasts 3 years. This particular landlord company states in their Code of Practice that they train their regional managers in making rent appraisals and that they use and follow the guidance published by RICS, which they clearly do not.

Appendix A

6 FMT - The establishment of FMT Volume is paramount in valuing a trade related property, and this is where I believe the first and greatest area of contention arises. Fair Maintainable Trade is, as it suggests, meant to be both Fair and Maintainable, and yet all too often in my experience FMT figures are being used that are far in excess of the current barrelage, or the barrelage within the previous number of years. You will see at Appendix A the actual barrelage purchased for 2010 highlighted in pink, and the four year average highlighted in green. Compare these to the barrelage used as the FMT Volume highlighted in yellow and you will see that in most cases the FMT used is much higher than the previous years barrelage, and in one case it is 65% higher than the previous years barrelage. In all the examples the FMT used is much higher than the four year average despite the fact that annual barrelage has been in decline for some years as is evidenced by the historical barrelage and is also evidenced by the BBPA Statistics which show a decline of 28% over the last five years.

7 Gross Profit Percentage - The second area of contention arises over the Gross Profit percentage being used. In my experience, the percentage that is used is higher than that being achieved or potentially could be achieved, unless in the case of exceptional tenants, where the landlord companies use the exceptional tenants actual GP because it’s high. It is not a difficult exercise to assess the selling prices for a particular market, and since the cost of the goods is known to the landlord companies, then it is a simple calculation to arrive at the market gross profit percentage. In my experience, this exercise is rarely carried out by the regional managers dealing with the rent reviews.

8 Costs Percentage – The costs percentage, not surprisingly, is the only area of the valuation that the landlord companies constantly under assess. The ALMR Benchmarking Survey, which is the most authoritative survey of its kind, would suggest that operating costs, excluding rent and management are circa 40%. As is evidenced in Appendix A, only one of the seven valuations is remotely close to a realistic operating cost percentage. The remaining examples show a cost percentage of between 32.4 - 34.6%, and one example shows the costs allowed at an astonishing 27.7%. These running costs are simply not enough, and there is ample evidence available to the landlord companies. The ALMR Benchmarking Surveys have provided robust information concerning operating costs, and I attended a meeting in July 2010 with Enterprise Inns to discuss the results of the surveys, and to discuss data, which they had requested from Milestones Accountants, which was gathered from nearly 700 Enterprise tenants. The data supplied by Milestones and included within the ALMR Submission, shows remarkably similar operating costs to those contained in The ALMR Survey, and in some cases higher costs than those shown in the ALMR Survey, and markedly higher than those shown in the seven examples shown at Appendix A

9 The Rental Bid – This is the percentage of the divisible balance (DB) that the Reasonably Efficient Operator would offer to the landlord for the rent. The Divisible Balance is calculated by deducting the operating costs from the gross profit achieved. Historically this bid has been 50/50, but following the case Brooker –v- Unique Pub Properties Ltd Claim No 7BS11690, 7th September 2009, and further clarification via the new RICS Guidance Note GN 67/2010 Section 6.9, this bid is now considered to fall somewhere between 35 and 65 per cent. In the seven examples in Appendix A, it clearly shows that the landlords rental bids fall between 47.8% and 62%, which I believe to be excessive for a tied leasehold premises. I would consider that rental bids for most supply tied leasehold premises would vary according to levels of discounts from the wholesale selling price, whether or not they are subject to RPI increases, and location of the premises. If one reasonably assumes a 65% bid would apply to a free of tie premises in exceptional locations, then a supply tied premises in a less desirable location, would in my opinion, attract bids around 40 -45%. The RICS GN 67/2010 contains a section dedicated to the tied lease market, and section 7.19 states " The Reasonably Efficient Operator (REO) would consider many factors, some outlined in paragraph 6.12 against the background of the supply and demand for such properties. In respect of the effects of supply agreements, the REO may have regard to the fact that free houses are available in the market. Therefore, it could expect to make an increased profit as a result of being able to buy products in the open market and not at the prices charged by the supply tying landlord or its nominated supplier." It is absurd to think that the REO would bid 62% for a supply tied premises in Rochester, as has been put forward by the landlord company of The George in Rochester, as evidenced in Appendix A.

10  The valuations used to formulate Appendix A show an expected tenant income which is the difference between the divisible balance and the proposed rent. On the face of it, these amounts appear reasonable, but given that they have been based upon unrealistic assumptions, then they bear no resemblance to reality. In Appendix B I have used a number of more realistic assumptions and applied them to the same premises to highlight how unreasonable to landlord valuations are. The assumptions are :

FMT – I have used the four year average of each of the premises for the purposes of this assumption, despite the fact that BBPA figures show a decline of close to 28% over the last five years.

Gross Profit Percentage – For premises in Inner London I have used a GP% of 57.5%, for those in Greater London, Kent and Sussex I have used 55% except for the premises in BR3, which is a fully tied premises without any discount where I have used 50%. In the past few years the expected gross profit achievable has declined dramatically with the introduction of the Duty Escalator and the increase in VAT to 20%.

Costs – The evidence available in the ALMR Benchmarking Survey, and indeed that supplied by Milestones of nearly 700 Enterprise tenants would suggest that the operating costs are around 40% excluding rent and management. For the purposes of this example I have used 40% for Inner London, and 37.5% for those in other areas.

Rental Bid – Given the clarity obtained through the Brooker –v- Unique Pub Properties Ltd case, and the guidance from RICS regarding the tenants bid, I have used 45% for supply tied premises with some discount, and 40% for supply tied premises without discount and being subject to RPI increases.

11 The resulting changes within the valuations are dramatic, and you will see within Appendix B that the drop in proposed rent is significant. The two most important factors within this spreadsheet are the revised Expected Tenant Income, and the Expected Tenant Income if the quoted rent has been applied. Allowing for the assumptions outlined above, the Expected Tenant Income is around £25 -35,000 which I believe is a much more realistic figure than that shown in Appendix A. The Expected Tenant Income if the quoted rent in Appendix A has been applied, results in the Tenant making less than £12,000 in five of the examples and actually losing money in one.

12 The recent Code of Practice Survey Overview - Questionnaire Results show that more than half of the existing tenants are not aware of dispute resolution processes, and many will agree to rent reviews without the knowledge of whether they have been prepared properly or not. In many cases the tenants agree to unsustainable rent reviews because they are not aware of the valuation process, nor are they aware of The RICS Guidance Notes and they are not advised to seek professional assistance.

SUMMARY

13 Since the BISC recommendations in 2010 the only meaningful change within the tied rent review process has been the introduction of valuations being provided by most landlord companies. However, in my experience, most of these valuations are unrealistic and are being prepared by regional managers or business development managers that have no training in carrying out rent reviews. Of the seven premises contained within Appendix A, not one of the regional managers knew anything about RICS GN 67/2010, and none of them were aware of the ALMR Benchmarking Survey providing data regarding operating costs.

Landlord companies are still allowing valuations to be compiled and presented to tenants with unrealistic FMT volumes, despite them holding a great deal of comparable evidence or making any allowance for the declining beer market.

Landlord companies are still allowing valuations to be compiled and presented to tenants with unrealistic operating costs, despite the evidence being available to them through the ALMR Benchmarking Survey and Milestones data, and despite the guidance given in the RICS GN67/2010 Section 7.22.

Landlord companies are now allowing valuations to be compiled and presented to tenants with over inflated rental bids, despite the advice given in Brooker –v- Unique Pub Properties Ltd, and guidance given in the RICS GN 67/2010 Section 6.9.

Historically, landlord companies have used the RICS valuation methods because public houses are trade related properties, and it has served their purpose to do so. Following its review, and promises made to BISC, The RICS has prepared a new Guidance Note which is much more equitable than the previous paper. This new guidance note is being routinely ignored by the landlord companies. In fact some landlord companies are attempting to circumnavigate the new guidance paper by issuing new leases without rent reviews, but with an RPI clause which is, in practice, an annual rent increase. During TISC, BESC and BISC most of the landlord companies have stated that they no longer rely upon their upwards only rent review clauses, yet they now apply RPI clauses which are upwards only rent review clauses. The landlord companies state that RPI can go down as well as up, but this has only happened in 9 months over the last fifty years, and they were all in 2009.

It is all too common that a regional manager prepares the valuation without any reference or consideration to, the financial and benchmark data that is available.

In my opinion, it should be made mandatory that the landlord companies provide valuations in accordance with The RICS GN 67/2010, and to use only trained personnel in preparing those valuations.

20 June 2011