“One lessee told us that having turned round his pub, after a year his rent was increased by 50% and his pubco told him that ‘the rent had been set too low for the previous tenant’ although there had been no mention of this when he had taken on the pub. In another case a lessee was presented with a 100% rental increase at her first 5 year review even though there had been no change in the local environment or economy – the only difference being the money she had invested in upgrading, as she put it, an old and shabby building”.
These scenarios may sound familiar. These are extracted from paragraph 68 of the BEC report published in May 2009. The conclusion drawn by the Committee was that: “it is difficult to measure the extent to which trade has increased because of improvements to the premises funded by the lessee. Nonetheless, we consider it is manifestly unfair for pubcos to profit from increases in trade brought about by such changes: here, too, transparency on how rent is calculated and access to figures for comparable premises would properly strengthen the lessee’s negotiating position”
RICS Guidance
The RICS Practice Standards guidance note gives its view on the capital and rental valuation of public houses, bars, restaurants and night clubs in England and Wales, and states:
“The intention of the parties should be (except where explicitly stated otherwise) that the tenant will not suffer an increase in rent directly as a result of having to carry out the improvements.”
It identifies two approaches the valuer will usually consider, the first requiring him to: “analyse comparable evidence of properties that are similar to the subject premises as they were in an unimproved state. The difficulty that arises is that comparable transactions may not relate to properties that offer similar trading potential as a consequence of the potential improvements”.
It continues:
“The other approach involves the assessment of the FMT (Fair Maintainable Turnover) and the FMOP (Fair Maintainable Operating Profit) of the improved property, but with an additional allowance to the tenant for the cost of carrying out the improvements at the valuation date. This deduction will usually be treated in the same way as interest on tenant’s capital, although the valuer will need to consider the best approach to amortisation of the cost. This would depend on the quantum of investment of a hypothetical term and the expectation that an REO (Reasonably Efficient Operator) would undertake similar improvements. The intention is the same – to not penalise the tenant for having carried out improvements by an increase in rent”.
This guidance leaves a number of points unanswered
- It is likely to be extremely difficult to find comparable evidence of properties that are similar, but in an unimproved state, except in very exceptional circumstances. Furthermore the longer the time goes on, the harder it is to draw any direct comparisons with other properties and it is difficult to recall what the premises were like in their unimproved condition. Kimbells have had experience of a case where an institutional landlord was trying to tell the tenant that the premises should be considered in their unimproved state. As the premises were under a very long lease, with some 80 years to go before the lease expired, the freeholder appears to have overlooked the fact that in future years nobody will be able to remember what the premises were like in their unimproved condition!
- Experience has shown that when improvements are carried out this will often involve an element of repairs, which the tenant is likely to have been required to carry out to the premises under the lease. It is also likely to include moveable items as well as tenants’ fixtures and fittings (which can be removed by the tenant at the expiry of the lease), which will generally be disregarded at rent review. In most cases the premises will be valued, upon review, with vacant possession. This might have been assumed in the RICS practice note but it is not actually stated.
- In terms of the amount of the allowance to the tenant, some of it may depend upon the likely life of the improvements. But how long should you continue an allowance to the tenant and in what amount? The improvements may be carried out some time before the relevant review, and the next review may be in either 3 or 5 year’s time. Are you to assume that an allowance to the tenant should continue to be provided for the unexpired residue of the term of the lease – i.e. beyond the next rent review date – or for a shorter period of time?
Although the assumption that the tenant must not be penalised for carrying out the improvements is to be welcomed, the practice note does not offer clear guidance on how to approach these types of issue, nor does it appear to identify or recommend any detailed methodology for dealing with them.
The RICS Code can be found here
