OPINION: Pub valuations as a going concern

If it’s closed, you would make adjustments to reflect it is not trading.

Pub valuers must assess the trading potential, even when a pub is closed and, in doing so, adopt the reasonably efficient operator (REO) model that fundamentally puts to one side any under or over trading and assumes the business is owned and operated by… well, a reasonably efficient operator.

So, we must first work out what the fair maintainable trade (FMT) – ‘turnover’ – is from preferably analysing the past three years’ profit and loss accounts, and considering the future trading potential then deduct the costs of purchases and operational expenses to arrive at an opinion of ‘net profit’.

It is this net profit, or more properly referred to as fair maintainable operating profit (FMOP) that valuers capitalise by using a year’s purchase (YP) multiplier to produce an opinion of ‘market value’ for the property and business.

What is YP?​

If the business is freehold, it will of course implicitly include the property elements as the YP must reflect not only the trade in hand, but the underlying value of the property from which the business trades.

If the business is leasehold with a tenant operator paying rent to a landlord, the operator will not own the freehold interest (the land and property) and therefore the market will pay substantially less for a business without the freehold property elements. In this instance, the market is buying the lease that enables the business to trade.

Both sets of multipliers will implicitly reflect location, size, condition, trading characteristics, and the leasehold YP will reflect lease length, the various terms, the rent and rent review provisions.

Now, you might be wondering what the YP is or means.

The YP is how long it would take you to get your money back (the purchase price, excluding purchasers’ costs) if the FMOP remained the same year after year, which of course it won’t. So, let’s say we are valuing a freehold owner-operated pub in the Midlands that does a steady trade year on year, serving a good selection of beers, wines, spirits and minerals and traditional pub grub and we have applied a 7.0 YP to our assessment of FMOP. The 7.0 represents seven years​ to achieve pay back (seven​ years’ purchase​). The YP is the reciprocal or the inverse of the yield (100/7=14.29%) and yields are an important benchmarking and comparison metric.

Risk equals quicker payback​

Property is illiquid, so there should be a yield gap between gilts (which are liquid and can be sold relatively quickly), other investments, and property to reflect the different risk and liquidity aspects. Gilts/UK bonds used to be referred as the ultimate risk-free rate of return as it was thought (and hopefully still is) most unlikely that the UK Government (UK plc) would default on its loans (and the downgrading by analysts that would result), but I’m not an economist, so won’t venture any further comment or opinion.

Therefore, a yield of 14.29% (derived from the 7.0 YP adopted above) reflects all the property based and operational risks attaching to owning and running a business, compared to say a pub let to a ‘decent covenant’ tenant producing a rent of say £80,000 per annum, which might attract a yield of say 8.00% (12.5 YP).

So, the riskier and more volatile the opportunity, the quicker the buyer will want to be paid back (a lower YP). An investor (as distinct to an owner-operator) will be prepared to wait longer for pay back (accepting a higher YP) in the hope the rent will keep rolling in year after year from a good tenant with little or no management effort… save as to perhaps just collecting and banking rent. This is huge oversimplification of the investment approach, but I hope you get it.

So, if I can help you or your clients with any pub, restaurant or any form of leisure or hospitality valuation or advisory work, please contact me at this email address​… and I promise, the answer isn’t always 7.0 YP.