The freehold option lifeline
The pub universe is in the midst of very rapid change. Some observers predict that by 2012 around 8,000 pubs will have disappeared from the 30,000-strong tenanted and leased universe (around 60% remaining as pubs, but independently owned, the rest going to alternative use).
Come 2012, lots of tenanted and leased operators are still likely to be owning many pubs where they've had to write down the book value because they're not producing the income they once were. These pubs are sad orphans, unlikely to attract the investment they need from the tenanted pubco for all the obvious reasons.
Imagine a new kind of lease for this type of pub — the freehold option lease. The trick for the pubcos is to float the boats stuck on the mud (the alternative is a once-and-for-always loss of value when they are sold). Imagine a situation where in-coming licensees are given an extra incentive by being offered an option (a registrable interest in land like a lease or a freehold interest) to buy the freehold at, say, year five at a sensible pre-set value, but more than current book value.
So take a pub earning just £30,000 per annum for the pubco — worth around £250,000 on current multiples. Imagine a high-quality licensee incentivised to invest by being offered the chance to buy the freehold for a figure above the book value on completion of five years of tenure. The licensee gets cheap entry and a huge incentive to build business and invest. The pubco attracts highly incentivised licensees, and gets a number of years of good quality and enhanced earnings and a major gain on book value (compared to year one) at year five. It's a great way of creating shareholder value over time. The option lapses, of course, if the tenant leaves the pub.
Equally, what's the 'disbenefit' of allowing a tenant to exercise the option early, from year three onwards perhaps? The freehold option lease could create a fantastic avenue for licensees to create a property tenure ladder for themselves over time.
For those companies interested in the long game, a freehold option lease might be a great way to restore value for their shareholders pub by pub. For what it's worth, I negotiated two "freehold option leases" during my time running an East Midlands pub company that's still going strong.
One was with Mansfield Brewery that was inherited by Marston's, an option to buy a freehold for £135,000 at Year Three (a near-derelict pub requiring heavy investment back in pre-boom 1998) and one with Lincolnshire brewer Bateman's for around £700,000 at Year Three (a hotel in Yorkshire with a good level of trade).
Both options were exercised. And the freehold option was a massive incentive to invest as tenants. We went in cheap and came out with two freeholds. Isn't that the tenanted model at its best?
