by Tim Stapleton
Development or use of property for leisure purposes, in support of other property or as a free-standing scheme, is once again popular. The appraisal of such schemes as part of the property portfolio, as distinct from the equity portfolio, is a continuing problem. One solution is to derive a rent within the financial appraisal and thus enable leisure property to fit the property investment and funding model.
A typical leisure development, or the implementation of a leisure user within an existing property, needs to meet six appraisal hurdles requiring a wide range of professional skills:
- conception, concerned with creative appraisal;
- initial feasibility, in order to identify a strategy and tactics for key issues;
- financial business plan, to estimate income and expenditure including grants, repayment of capital and return on capital;
- funding feasibility, the matrix of property, business, tax and grants;
- physical feasibility, to include detailed design and consents;
- operational feasibility, the management of the facility and staffing.
The financial business plan will often — indeed usually — show a negative income in the first two years, owing to the need to build up throughput by marketing and promotion within the annual planning cycle of the tourism and leisure industries.
While not wishing to minimise the importance of the other five appraisal hurdles, the funding is a particular problem of both confidence and technique, since leisure property is not (yet) often recognised as “institutional” in character and the funding is, as a result, a complex of property and business finance.
One way to overcome the property investment/funding problem initially is for the landowner to sell a long leasehold of the leisure site, or core-and-shell element of a part of a building structure, where such a physical parcel is not free-standing. In order to preserve all the benefits of sound estate management that lease should not be for a longer term than that of normal occupational leases. Such an arrangement transfers the financing of the entire facility on to the leisure operator.
The major plc operators tend towards the provision of their standard facility within a set of well-proven criteria, with the benefit of corporate equity finance rather than site-specific project or property funding.
The smaller and arguably more innovative operator needs to raise finance on a site-by-site basis, and though grants from statutory agencies play a vital role, the majority of the finance needs to come from the private sector. However detailed and attractive the business plan, including provision for interest and repayment of capital within a 10- to 15-year time horizon, funders look for some security. There are perhaps three possible approaches to arriving at a property value.
First, the value of an alternative non-leisure user of the property interest that might reasonably be achieved, subject to cost and time allowances for legal and physical aspects. This figure could be more or less than that of the two remaining alternatives.
Second, a property investment value of the interest in the leisure user, which will always be less than the final alternative.
Third, a value of the property interest in possession, by a leisure operator.
The issues can be illustrated by considering a project, heritage, water or activity-based in a ring fence site of 2 to 5 acres, and related either to other leisure uses, perhaps by a pedestrian trail, or to commercial uses.
There are likely to be a range of facilities on site of three main types:
- commercial properties, typically retail;
- the attractions;
- catering
The attractions can be priced by either an entry charge to the site or a charge at each attraction: the former is usually the more satisfactory for many reasons, part operational, part psychological.
The schedule distinguishes the property investment and business investment characteristics of each of these three types of facilities and identifies a method of determining a rent for each.
The fundamental restructuring of the licensed trade — based on the recognition that pubs are retail property assets particularly suited to selling alcohol, and that such assets have the capacity to deliver a capital return on disposal, or a rental income, paid by a tenant seeking to maximise his profits by marketing the most effective combination of drink, food and entertainment — will make a helpful contribution to the licensed rental part of this analysis.
A new leisure facility requires estimates of throughputs, revenue and costs for a minimum of 10 years, and specialised consultancies are active in this field.
The surveyor, acting for the leisure operator or funder, when presented with these forecasts needs to exert his critical faculties to the full. Some questions worth asking include:
- How will the estimated visitor throughput arrive and gain entry?
- Can the design capacity of the facility handle the peak days of visitors which the catchment study suggests will attend?
- Will the profile of the visitors in the catchment study match the facilities, both physically and in terms of the envisaged average amount spent?
- What traders on your applicants’ register would take the supporting retail units?
- What makes the facility more attractive for a repeat visit than other facilities within an appropriate competitive travel time?
- What is the likely “wet day performance” of the facility?
- How flexible is the facility in user and physical terms? For example, caves are an ideal wet/cold weather attraction, but have a strict throughput limit and therefore need some associated activity to take the stress out of the peaks in visitor numbers: they also tend to be somewhat inflexible.
Simple observation of similar properties provides an excellent guide to potential visitor behaviour. Modest expenditure on surveys will enable the questions referred to above to be asked with an edge of authority, by the counting of:
- Vehicles and the time on site.
- Bar and restaurant customers and their spend, every 15 minutes from, say, 12.30 pm to 2 pm and 7 pm to 9 pm on wet and dry days with allowance for festival days can usually provide annual turnover figures to within 10%.
- The capacity of individual attractions and queuing behaviour.
With reference to the visitor attraction and catering parts of the schedule, the identification of a rent brings the project back within property appraisal.
Perhaps the clearest statement of the comparative application of the principles of equity and property appraisal methods is found in the new chapter on leisure property by David Butters in the recently published third edition of Principles into Practice (Estates Gazette) edited by Bill Rees, which adopts the following example for a facility with a turnover of £400,000.
Clearly the estimation of rent is critical and a starting point is to find a figure which is typically between 7.5% and 12.5% of turnover and between 25% and 50% of net profit: in this case between £30,000 and £50,000 and between £25,000 and £50,000. Here there is an excellent overlap which justifies £40,000.
It is therefore possible to arrive at an investment capital value of £444,000, inevitably less than the freehold interest in possession by the leisure operator, £624,000. However, this separation enables property funding techniques to be applied to the capitalised rental element. As with any new type of property, once this happens on a threshold of properties, comparables are created.
Business equity funding techniques can be applied to the capitalised residual profit. There is in fact a need for a third tier of finance and that is the regular improvement/refurbishment/theming expenditure. This is normally categorised as tenant’s improvements and thus to be disregarded for rental purposes, and some form of turnover apportionment is required. One solution is to agree a payback period when the landlord’s consent is given.
Finally, reference must be made to background papers to be found in the RICS Assets Valuation Standards Committee Guidance Notes.
Two of the background papers (Nos 7 and 11) have some particular contribution to make to leisure property. BP7 is titled Open Market Valuation Having Regard to Trading Potential, and BP9 is titled Valuation of Goodwill, the latter having been prepared by the Valuation and Rating Committee. Both originated in January 1986.
Their interrelation is perhaps best illustrated by paragraph 10 of Background Paper 7:
Members are also referred to SSAP 22 Accounting for Goodwill which at paragraph 15 of the Explanatory Note in Part 1 specifically takes into account representations made by the Assets Valuation Standards Committee and states:
“Some property assets are valued on a basis which has regard to the trading potential which attaches to the property. This trading potential is sometimes thought of as goodwill, but such a basis of valuation would normally exclude any goodwill which is personal to the present owner or management, and which would not pass with the property on a sale with vacant possession. This practice is acceptable in certain limited categories of business. Where it is followed, the assets concerned should be disclosed separately and the notes to the accounts should make clear that this practice has been followed and that the amount at which the assets concerned are stated does not exceed their open market value, having regard to the trading potential of the business.”
Whereas Background Paper 11 considers and distinguishes between:
Valuations of goodwill;
Compensation for injury to goodwill on compulsory acquisition;
The valuation of property with trading potential; Valuation as a going concern.
Goodwill is helpfully defined as:
The privilege granted by the seller of a business to the purchaser of trading as his recognised successor, the possession of a ready formed connection with customers, considered as a separate element in the saleable value of a business.
Two of the conclusions of the paper are of great importance to leisure properties.
The special value which attaches to properties with trading potential should not be considered goodwill but as part of the open market value of such properties,
and
Goodwill as such is independent of a particular property and only has a value if it is transferable.
The paper then distinguishes the role of the General Practice surveyor, in the assessment of the value of properties having regard to their trading potential, from that of accountants concerned with the market value of goodwill and the valuation of a business as a going concern.
The main issues are as follows: to solve the funding problem of leisure property we need to agree ways to both find and quantify a property rent for each of the three types of facilities; this property investment capitalisation will inevitably be less than the value of the freehold/long leasehold interest in possession; the operator will then be able to raise finance in appropriate tiers of property, business and theme. The relevant parts of AVSC may need regular review to ensure that they do not freeze professional approval too early in the evolutionary process.
The greater availability of loan finance over the last two years is starting to unblock the leisure-funding log jams, but chartered surveyors nevertheless need to debate and validate their methodology as specialist consultancies develop
