Pub rentals: what if everyone was free of tie?
What would be the true cost of removing the tie? Fleurets chairman Barry Gillham takes an in-depth look at the pros and cons.
Conventional wisdom is that pub rentals are based on 50% or so of a pub's net profit after allowing for the level of tenant investment. This is a gross simplification, but a very high proportion of pub rents are in the range of 40% to 60% of potential profits
There are checks and balances on the "profits test" approach. This is mainly "how much have pubs recently been let for on freely negotiated open-market lettings on similar lease terms."
The proof of open-market lettings is always to be preferred to either the profits test in a theoretical vacuum, or comparison with other rent reviews. These can lead to inaccuracy piled upon inaccuracy if not properly — and fairly — interpret.
Most tied leases "give" a lessee a discount on the purchase of beer in the range of nil to £65 per 36-gallon barrel. It has been widely reported that an individual owner of a freehouse can currently negotiate a discount of £165 a barrel. At worst, therefore, a lessee going free would achieve an extra profit of £100 a barrel.
If we assume the same rental calculation at 50% of net profit, this would add £50 a barrel to his net profit — say £10,000 extra rent on a typical 200-barrel pub. Now let us look at it another way. A 200-barrel pub might have a turnover in the region of £200,000 and as a tied pub make a net profit of 25%.
It would have a tied rent of 12.5% of turnover, i.e. £25,000. With an extra £20,000 profit by way of free trade discounts, profits would rise to £70,000 (35%) and the rent would rise to £35,000 (17.5%). In the real world of open-market lettings, 12.5% of turnover for a tied pub is readily achievable.
It is about right in the Midlands and the north, and towards the lower end of the spectrum in London and the south east. Profits of 35% and rents of 17.5% for the majority of free-of-tie leases are at the top end of the spectrum, excluding prime city-centre locations, and may prove too rich for the blood of people contemplating taking a lease on pubs similar to Coronation Street's Rovers Return. Would you pay an annual rent of £35,000.
You pay what you have to
In truth, many tied tenants have cut expenses to the bone — because they have to. A rent of £25,000 also implies a profit to them of £25,000. But in reality it is often less, because of one-off unavoidable costs, such as a £5,000 bill for a drains problem or extra wages for bar staff who have to take three months' sick leave.
A tenant faced with making £35,000 a year will breathe a sigh of relief. He may take on an extra member of staff, do some much-needed redecoration or renew furnishings and carpets.
The fact of the matter is that existing free-of-tie tenants do not have to penny-pinch, and accounts that I see more often show 28% to 32% profit than 35%. Only very exceptionally do they show more than 35% net profit.
The limited amount of market evidence for free-of-tie rents is therefore closer to 14% to 16% of turnover than to 17.5%.
Will the market change?
Of course it will. Instead of the evidence of free-of-tie leases being thin on the ground, it will apply to more than 50% of the pubs in the country. It won't all be as uniform as my examples show.
At the bottom end of the leased market, there are pubs that only make £25,000 net profit before rent. To leave a tenant a living wage (say £16,000) the rent may be only £9,000. If free-of-tie discounts added £10,000 to the profit of these pubs (to £35,000), the rent could jump from £9,000 to £17,500 with the tenant's share increasing from £16,000 to £17,500. Equally, at the top end, pubcos would be keen to negotiate a larger slice of the action — for example, on a 500-barrel house there is an extra £50,000 to be shared, and tenants may be happy to negotiate an extra £20,000 a year for themselves, allowing the rent to escalate by £30,000 a year and the profit cake to be divided 58%:42% in favour of the landlord. But when it comes to re-letting that pub in the open market — without the comfort of proven accounts — the rent may look just too frighteningly large to most potential operators — perhaps £100,000 rent on a turnover of £500,000.
Is the barrelage discount guaranteed
Of course not. The brewers have been squeezed by the major pubcos until their pips squeak. When faced with negotiating individual deals with 35,000 licensees, you can expect £165 per-barrel discounts to be a thing of the past.
Multiple tenants will be able to negotiate good deals. Tenants of large barrelage pubs in towns can expect to get fairly good deals. People buying less than 100 barrels a year in rural hamlets may have to pay a delivery charge on top of list price.
There is a danger then of tenants negotiating rents based upon current discounts; rents being fixed for five years and barrelage discounts being cut or eroded by price rises.
What about declining barrelage volumes?
We have all read about these. On top of declining discounts per barrel, tenants may be selling fewer barrels. The transfer of "wet rent" for "dry rent" transfers this risk from the pubco to its tenants.
But rents can be reduced
Don't be so sure. Most pubcos have agreed to allow rents to be reviewed downwards or upwards at rent review. Many have also said they will help out lessees in trouble in times of recession between rent reviews.
Although the Government has pressed all property companies to remove upward-only rent reviews from their leases, the fact is that very few have. The freehold owner of a pub let on a free-of-tie lease will be a property company or individual with one source of income. He will not have the same degree of common aim for a pub to be successful as a pubco.
Loss of pubs
Over time you can expect leases to be changed so that a tenant could use the pub for whatever use planning permission could be obtained, such as dog kennels, solicitor's office, or a bookmakers. What is known as an open-user clause means that rent can be charged, based upon the best rent that would be paid by any one of these uses — not just what a pub user can afford, even if the property is still being used as a pub. Ultimately the lessee will assign to a bookmaker or a solicitor because he won't be able to afford to stay.
How do we know what will happen?
Before 20-year leases were introduced in 1988 by Inntrepreneur, pub rents were generally less than 10% of turnover. The Watney Mann turnover leases were generally at 7% to 8.5% of declared turnover (and in those days, before the VAT man, turnover was not always declared!).
The very few assignable leases in the market sold for three to five times net profit. I did some calculations at the time. If a tenant paid 14% rent instead of 10% for two years on a net profit of (say) £50,000, his profit fell from £30,000 to £22,000 for two years — a loss of £16,000. But if he sold his lease in year three for £80,000, and his inventory was worth only £15,000, he made a profit of £65,000. Overall he was almost £50,000 better off.
The right to build up and sell on a successful business was the prime reason for people suddenly agreeing to pay rents of 14% instead of 10%. But as assignable leases proliferated, their value fell to around 2.5 to 3 x profit. As the recession gradually took hold, leases have sold for only once to twice net profit and often dilapidations have wiped out any sum receivable by the lessee.
Current pubco owners blame high premiums paid for many of the problems of current lessees. But they have forgotten the level of rent was escalated to current levels by the promise of being able to reap the benefits of a lessee's success by way of capital gain.
Will levels rise or fall?
We can expect chang
