It is that dreaded time for tenants when the rent review is due. So how can you make sure that you are able to negotiate the best deal with your landlord and ensure you make a profit?
With the last-minute delay in the introduction of the market rent-only option (MRO), it could also be that licensees face a battle to be given this alternative. While the debate continues over demands for pubcos to honour the implementation date of 26 May 2016, there will still be a number of licensees who will be heading towards their next rent review.
Peter Taylor, director at Christie & Co, confirms that while the MRO option has taken a back seat “there will still be a large number of licensees out there facing the prospect of a cyclical review” which he describes as a “daunting prospect”.
Stephen Taylor, managing director at Guy Simmonds admits that the phrase ‘rent review’ can strike terror in the heart of many tied publicans.
But being ready to negotiate that rent review is essential to the health of licensees’ businesses.
Licensees should think seriously about getting themselves and their paperwork prepared for any impending rent review processes.
Stephen Taylor advises lessees to get their houses in order by ensuring all documentation, stocktaking and accounts are up to date. He advises lessees to do some research, which should mean: “You know more about your business than does the pub-owning company.”
Daniel Mackernan, director of licensed leisure at Savills, agrees that licensees need to be properly prepared.
“It is advisable to start putting together information at least 12 months in advance, and to re-read your agreement and code of practice to ensure that there are no specific time periods you need to adhere to,” he advises.
The rent review process generally starts with the landlord notifying the tenant of the intention to implement a cyclical review. At this time, the pubco often gives an idea of the rent they may be seeking.
How the rent is calculated
The basis of the review will be set out in the lease agreement and will include a range of both ‘assumptions’ and ‘disregards’.
“Typically they assume the use of the premises, the lease length, improvements that might have been made, critically by whom, and also any effect attributable to the business and current trading performance by personal goodwill,” says Tom Nichols, managing director at Everard Cole.
“Both parties should generally keep a record of these factors such as improvements, previous trading history and the condition of the building when it was taken over. These all have a fundamental effect on any rent.”
Importantly, any rent review considers any future forecasted trade, overhead costs and profitability.
This is known as predicting the fair maintainable trade of a pub based on an average competent operator.
David Morgan, director at Morgan and Clarke, warns that some pubcos are not using the correct data to predict future trade.
“The largest error made by pubcos is the reliance on British Beer & Pub Association or Association of Licensed Multiple Retailers statistics,” he says.
“By their very nature this is a backwards look, not a forward look, as the statistics are based upon data either from year-end accounts or management accounts, which can be up to 18 months out of date. It is essential to future-forecast, specifically concerning sales trends either upwards or downwards and for the cost of the trading operation.”
He also advises that staff costs, raw material costs and utilities be factored into this equation. Morgan says the large number of rent assessments that underestimate staff costs is “remarkable”.
Meanwhile, Stephen Taylor says that tied rents are mainly arrived at by the pub-owning company projecting a bottom-line net profit (known as the ‘divisible balance’) and then basing the rent on a percentage split of that balance. The split is usually 50:50 meaning the lessee is being asked to pay a rent of half the projected net profit.
The dangers in rent setting
Guy argues there are numerous potential dangers for the lessee in this approach to rent setting.
He warns that while the profit on which the rent is based is purely a projection, it is calculated by the pub-owning company, not the lessee who operates the business.
“The projections of turnover/sales volumes are notoriously optimistic (some might say fanciful),” he says.
“In the real world, is it possible to get 72 pints of saleable ale from a firkin cask? Pub companies seem to think it is! Is your pub company being realistic by using top-end margins where another local pub is selling at heavily discounted prices?”
Disclosure of trading accounts
Unless the lease stipulates that the lessee has to provide that information, there is no obligation to disclose it.
Peter Taylor says: “Generally speaking, the tenant should consider very carefully before passing over information about accounts — particularly if there is a possibility that they may subsequently engage the
services of a surveyor to undertake the negotiations.”
However, he says there may be an exception if the landlord has waived their right to an upwards-only rent reviews. The tenant should check whether they are required to demonstrate that trade has fallen, and the reasons for that reduction, by disclosure of accounts.
If your landlord is supporting a proposed rental by using the example of other pub rental rates in the area then it is time for the lessee to do their own research.
Morgan says it is “more than likely” these will have been “cherry-picked”. He advises the lessee to take the trouble to visit the other properties in the area and actually find out how the rent review was negotiated and settled.
It is also essential to check that these rental settlements are genuinely comparable by making sure that the discounts are similar, he says. He also advises the licensees to check their pubco website for pub availability and check the rents offered.
Stephen Taylor agrees: “Try to do research on your competitors in terms of their offer and pricing. You might be pleasantly surprised to find how willing some local publicans might be to reveal their own terms.”
So you have your rental offer from your pubco but you think it is a bit steep. This then is the time to enter the negotiation process.
Nichols warns: “If a new rent is proposed, the tenant has a right to challenge this if they believe it to be unfair and should do so without delay, otherwise the new rent could be legally imposed by default.”