RPI - Recurring Pubco Income or Really Painful Increases?

Tenants new and old need to understand what RPI means to their business and their income, says Bar Group chief executive Paul Wigham.

The Retail Price Index (RPI) became a feature of tied leases in the early part of this decade and agreements from all of the main players include provision for RPI to be applied annually to rents, usually in addition to the five-year rent review.

Worse still, RPI clauses in agreements have provided for RPI to be only applied upwards and not downwards, although some of the major pubcos have altered that in 2009.

But why would anyone want to accept this flawed method of achieving rent increases in the first place?

There are myths to dispel. Some landlords claim that tenants like RPI because it cushions them from the five-yearly review. Well, that is mad. How many tenants have said: "Please can you increase my rent early?" It would be financial insanity and I know of no tenant who holds that view.

The fact is that the application of RPI has enabled landlords to guarantee some rent increases and take rent to a higher level at the next rent review negotiation. We all know that it is more difficult to negotiate a rent downwards than it is to resist an increase upwards. It is even worse if the landlord uses RPI and no other rent review — the tenant has no redress to any imbalance.

Inappropriate​

The use of RPI rent clauses also attempts to enshrine the landlord perception that rent always goes up. However, British Beer & Pub Association (BBPA) figures published in the recent Royal Institution of Chartered Surveyors (RICS) report show that on-trade beer sales (and therefore fair maintainable trade — FMT) have fallen 24% since 2004. That would mean that any wet-led business rented on a divisible balance basis would suffer rent declines in the recalculation whatever RPI might be.

The application of RPI is wholly inappropriate to property leases of any sort and is effectively an upward-only rent review that has had a significant negative impact upon tenant income.

The background to RPI is that it is an annual index introduced in 1947 as a replacement to the Cost of Living Index. Effectively, the first RPI was in June 1948 after its first year and was used as a measure of inflation until the Government changed the rules to use the Consumer Price Index in 2003. It is calculated by reference to a basket of goods of all descriptions and therein lies the first flaw.

Proper anoraks can see the full list by going to the Office for National Statistics website (www.statistics.gov.uk) or (easier) the website of the Institute of Chartered Accountants in England and Wales (www.icaew.com) and searching in the Technical and Business Guide section. However, there are 14 main groups with 85 sub-groups, and then a variety of individual costs within.

Bizarre​

There are obvious inclusions — food, clothing, etc. Domestic rent forms one of the 85 sub-groups as do beer on-sales. One of the more "way-out" sub-groups is home-killed lamb (not home-killed beef or pork) and some of the individual inclusions are directory enquiry charges, pet flea drops, private education, underwear (pants and bras only) and PC printers — the list is long and at times bizarre.

But here is the rub. Nowhere in that list is commercial rent. Little in that list applies to commercial rent, let alone pub property rent. This is an index that is primarily used to measure movement in consumer prices and is applied to the calculation of various incomes such as pensions and benefits. It was never intended for use in commercial rents.

No one would set the price of a car by reference to the price of ice cream! So why do tenants accept that their rent can be adjusted by something that is unrelated to the property or the business?

The next salient fact may explain why they really should not accept it. The first index was published in 1948 and since its creation up to December 2008, the index has only fallen on seven occasions — all in the period from April 1959 to March 1960 as a result of Budget decisions leading up to the 1959 general election. That is only seven times out of 727 RPI calculations!

Think about that fact — this 60-year period saw post-war rebuilding, the Cuban missile crisis, the Cold War, the oil crises, the Winter of Discontent, 9/11 and various recessions. The largest fall was 0.8%. The largest rise was 26.9% and on 102 occasions the rise was in double digits.

The nine months published in 2009 have seen RPI falls of 1% to 2%, which may be a reflection on the depth of our economic woes, but the prognosis for significant or regular RPI falls into the future is not good. RPI generally reflects inflation and inflation generally reflects economic growth.

Perfect storm​

As we gradually emerge from recession across the whole UK economy, it is likely to be in the region of 2% to 3% and that is in line with RPI in this millennium to date.

This means that, regardless of the trading patterns or cost changes peculiar to our particular industry, your rent will go up and history tells us that it will be broadly continuous.

To all intents and purposes, over the life of an agreement, RPI is a built-in, upwards-only rent-review clause. So why do we do it? I talk from bitter experience.

During the early part of the decade, it hardly felt like an issue. RPI was low and input prices relatively stable. We never had an issue passing on proportionate price increases and, frankly, we wanted to expand and pub companies did not have to negotiate hard. We finished up with a number of RPI leases in our Orange Sun business.

However, then came 2008. Our sites are wet-led and beer price is the bellwether for our customers.

Fuel, grain prices and duty increased significantly, and so did our cost of sales. We passed on early increases while maintaining GP, but eventually the rate of increases made that impossible. Sales demand was under pressure from the smoking ban and the deterioration in the economy, and the price rises exacerbated this.

The same issues affected site overheads as utility costs and service costs increased. So, we had the infamous perfect storm — falling demand, falling margins, rising costs and falling profits. However, the rent — originally calculated on a divisible profits basis — went up. See the example in the table loosely based on our experience across a number of sites.

Unacceptable​

One final point — landlords in general commercial property do not ask for RPI and none of our private company leases have it.

JD Wetherspoon — the brightest property mind in our sector — does not accept RPI in its leases. Enterprise Inns recently auctioned a number of freeholds with the benefit of Enterprise as the lessee in an agreement drawn up by the pubco. They did not put RPI in those leases. Ask yourself, why? It is a travesty that BII and the Federation of Licensed Victuallers Associations (FLVA) could not make this point to the BBPA in their code proposal.

General rule: do not accept RPI. The tenanted pubcos all state they are happy to negotiate and that their leases are not as fixed as they have said before. Ask for its removal or do not sign the lease.

If you believe that the pub you are looking at must be "the pub" and the pubco is intransigent, then accept the fact that if RPI is 2.5%, the rent going into your fifth year will be 10.4% higher than day one and that when RPI is applied at the end of year five, in the midst of your review, the figure will rise to 13.1%.

My best advice in this case is to agree the rent at the outset and then discount it to reflect the rent increases that you will have built in to your agreement. Otherwise your income will be severely affected.

Paul Wigham is chief executive of Bar Group, which runs 38 pubs, including 18 Enterprise leases, eight Punch Taverns sites and five with Scottish & Newcastle Pub Enterprises.​

• Read The PMA Team's take on RPI: Pub rent RPI: the softly​​