Two weeks ago, Wetherspoon boss Tim Martin argued that fraudulent property deals may have distorted high-street rents. Tim Munden, head of the landlord and tenant team at property agent Davis Coffer Lyons, responds.
In his recent article in the Morning Advertiser, Wetherspoon founder Tim Martin (The high price of dishonest property deals) raised three issues:
1. The rules and ethics surrounding estate agents who also act as principals in property transactions.
2. The effect of fraudulent transactions setting artificially high rents.
3. The extent to which extremely high rents played a part in the collapse or restructuring of a number of pub companies.
I have no quibble with his first point, but I seriously question his comments on the second and third issues, which simply don't ring true.
The diversion of freeholds to third parties (whether fraudulent or not) does not necessarily lead to high rents because it is ultimately tenants who determine market levels.
Tenants hold the key to rents as all lettings require a willing tenant. In an open-market situation, if a prospective tenant feels that the rents proposed/required by the landlord are unreasonable, they can walk away and, of course, many do just that. A tenant will only pay a rent he feels he can reasonably afford, having assessed the trading potential of the site and the costs involved. In this way the pub market is no different to the retail sector or other elements of the leisure market. If the numbers don't work, you don't do the deal!
In some instances, it may have been profitable for operators to take on undeveloped freehold properties and accept the development risk, but for many, buying freeholds is/was not an option they wish to pursue. It ties up substantial capital and time.
Only a small proportion of lettings in the A3/A4 sector involved the type of property deal Mr Martin speaks of. In many cases there was no change of ownership prior to the letting; the existing landlords obtained planning permission for change of use and had no intention of selling the freehold.
Market value
The fact that a property owner may have acquired a property relatively cheaply does not mean to say the rent paid by the ingoing tenant was clearly excessive. It was often a case of under pricing in an emerging and specialist market, where sellers and their agents misjudged the true market value.
It was commonplace in the 1990s for freehold properties (either investments or vacant possession) to be offered below the true market worth because the selling agent had limited experience of the A3 market and misjudged the underlying rental value. We saw this on many occasions when advising clients on the purchase of A3/A4 investments.
Of course, there may have been situations where managed pubcos would have benefited had they been offered these freeholds because they would have avoided paying the true market rents required by experienced investors or letting agents.
Mr Martin goes on to state that excessive rents led to the collapse of many pubcos, however, in a lot of cases, the excessively rented properties have not been the subject of market lettings but, instead, leaseback deals. Most pubcos have indulged in leaseback activity for the simple reason that rent generally capitalises at a higher multiple than trading profit and it has proved to be a useful means of generating capital. It is my experience that the rents these operators set for themselves were typically above market value and we still see this happening today.
Market guidance
I offer SFI as an example. Some years ago they had premises in High Wycombe at a rent of £52,000 per annum. They had an opportunity to buy the freehold and immediately offered the premises back on a leaseback basis at a rent of £125,000 per annum. They did exactly the same with premises in Eastleigh, converting an original market rent of £37,500 per annum to a leaseback rent of £75,000 per annum, while in Beaconsfield, they set themselves a rent of £170,000 per annum. These properties were offered by SFI with various others as part of a leaseback package and several of them were left behind in various group transfers since.
It is often these types of toxic properties that are left with administrators, leaving the new property owners to pick up the pieces.
In my experience, having been at the vanguard of this emerging sector since the beginning, market lettings will always provide the best guide for rent reviews because they demonstrate what tenants are actually prepared to pay and not what a landlord thinks the property is worth. This also happens to be the approach long accepted by the courts.