RPI leases: get your maths right

The pubcos have increasingly introduced RPI leases, but tenants need to take an appropriate view on the initial rent, argues Daniel Mackernan of property agent Davis Coffer Lyons

Historically, most leases had upwards-only rent review clauses and during the recession, when rents could not decrease, they could be seen as onerous and landlord-friendly. 

As a result of Government intervention, brewers and pub companies were forced to look closely at their leases and introduced upwards and downwards rent reviews on their tied pubs.

Free-of-tie pubs are not bound by these Codes of Practice and still have upwards-only rent reviews.

Some pub company leases now have rent indexation on new agreements in line with the Retail Prices Index (RPI).

Whilst this may benefit a tenant if there is negative RPI, this has happened only in nine out of 12 months in 2009 and prior to that the previous negative RPI was in 1960. RPI was running at 5.3% in March 2011.

Some pub companies believe it is appropriate to review rents in this way because it helps them plan their finances and to reduce the impact that a three or five-yearly review may have on the business operator (by eliminating what may appear to be a sizeable increase that may have to be absorbed in one year). In reality though, RPI really cushions the landlord and keeps rents moving upwards even during a period when there is no rental growth.

Upwards only​

The impact on annual rent can be seen as follows: a rent of £50,000 per annum set in March 2006 would have had a five-yearly cyclical review in March 2011.

RPI over the period would have resulted in the rent increasing from £50,000 per annum to £59,555 per annum — which is a 19% increase over the five-year period.

If turnover had fallen during this period then the business may have become unsustainable.

Rent reviews under pub company Codes of Practice have a right to appeal to a third party. But if the landlord uses RPI and no other measure at review then there is no ability for the tenant to redress any imbalance. RPI is effectively, therefore, an upwards-only rent review.

Some pub companies are limiting the effect of RPI by introducing a cap whereas others will have a collar to buffer any drop below a certain level.

While some pub companies advocate RPI as a good idea, when the pubcos are themselves lessees, they do not offer RPI as shown by the current Enterprise Inns sale and leasebacks. And JD Wetherspoon offers a mere 5% increase over a five-year period, which was recently reduced from the annual 1.5% per annum (7.5% over a five year period).

Bid adjustment​

If RPI is in your lease then perhaps there should be an adjustment to the rental bid at a discount to reflect the rent increases that you would have to build in over the period.

In the above example, the rent to turnover, assuming the turnover was £400,000 per annum in March 2006 and assuming the turnover had not risen (due to a fall in market demand as a result of the recession), the rent to turnover ratio rose from 12.5% to 14.89%. The compounding effect of cost price inflation and overhead inflation, in particular utility and wage costs, as well as rateable value, would result in a much lower profit.

In the above example the rent bid would have to be lowered to compensate for the rent rise over the five-year period.

The choice of a lower rent bid may be outweighed by other lease terms and tie status, which may outweigh the perceived impact of RPI.