by Ian Hayward
For many people leisure property is a comparatively new type of property with which they have to deal. In recent years large sums of money have come into leisure and, not surprisingly, many people are now taking a keen interest. This is, to a large extent, due to the increasingly sophisticated tastes of the public who, with higher disposable incomes, are now inclined to spend substantially more on their leisure activities. Previously there have certainly been enough problems, in terms of litigation on lease renewals and rent reviews, on the more common types of commercial property. Leisure has, potentially, even more problems. This paper endeavours to highlight some of these difficulties, which seem to arise mainly because there are exceptions to, or variations on, many of the “rules”, or methods, of valuation.
The range of what might be considered leisure property is enormous. Many institutions and other investors, having thought long and hard about leisure property (and in many cases they may still be thinking about it), will not touch it except, perhaps, where it forms a small element of what they consider to their more normal commercial investment activity. The main reason for this reluctance, in terms of property investment, is that leisure property is far too volatile. Many types are, in fact, never let, as the costs of development are enormous, particularly when one has regard to the volatility of the enterprise. Many leisure properties are therefore developed by the specialist operators and the development is funded by some other means.
I am confining my part of the lecture to urban situations on properties where lettings are not uncommon. In many cases these lettings are of premises that may have some possible alternative use or, perhaps, have been converted from some other use, or may form part of a larger development. Broadly, the range of leisure properties with which most surveyors are concerned, in terms of lease renewal and rent review, is as follows:
Public houses, restaurants and hotels
Theatres and cinemas
Clubs and nightclubs
Dance halls and discotheques
Bingo halls
Casinos
Bowling alleys
Billiards and snooker halls
The common feature of all such premises is a licence, or licences (cinemagraphic, theatre, gaming, liquor etc). The licence, by its very nature, creates a monopoly situation in the case of most leisure properties: thus any rent agreed under an actual letting in the open market is essentially a business decision. One might say: “Is not any decision to take a property in the open market a business decision?”
Of course, but the difference is that on premises for which there is a regular market and for which a licence is not normally required, one considers the rental values by reference to transactions on similar properties. It was held in W J Barton Ltd v Long Acre Securities Ltd (1981) 262 EG 877 that in the case of properties which are normally valued by reference to comparables and on which there is open market evidence, the profitability or otherwise of the operation carried on is not material. In many cases it is not possible, or is extremely difficult, to value leisure properties by reference to transactions on directly comparable premises. In fact, in many actual transactions in the open market, the rent or price is assessed by reference to the actual or likely profitability of the operation.
As many of the properties in the categories mentioned are rarely the subject of a true open market letting, how does the surveyor go about assessing the rent?
I will deal shortly, in a little more detail, with the individual types of property but, suffice to say, the surveyor whose task it is to advise on, or determine, the rental value of leisure property is in many cases largely doing the job of an experienced operator in the field.
Security of tenure
In general, all leisure premises, with the exception of public houses, have enjoyed security of tenure under Part II of the Landlord and Tenant Act 1954, and following the recommendations of the Monopolies and Mergers Commission report on the brewing industry, the Landlord and Tenant (Licensed Premises) Bill, shortly to be sent for the Royal Assent, will repeal section 43(1)(d) of the 1954 Act, which has hitherto excluded public houses from statutory protection. Broadly speaking, as Paul Morgan has mentioned, any tenancy entered into on or after July 11 1989 will be protected and any tenant under a previously existing lease will be protected from July 11 1992. Thus, from the latter date, public houses will be treated the same as any other business tenancy. In the interim period it will still be necessary to ask oneself: “When is a pub not a pub?”
Paul Morgan has explained this in some detail but, broadly speaking, the definition, obvious as it may seem, is that it is a pub when the property is licensed for the sale of intoxicating liquor and is not an hotel or a restaurant. Paul Morgan referred to Ye Olde Cheshire Cheese Ltd v Daily Telegraph plc [8] 2 EGLR 107; [1988] 39 EG 88. The well-known establishment concerned appears to most people, at first glance, to be a public house. The dispute, in fact, related to a part of the basement beneath the old Daily Telegraph building used as a bottle store and a function room. It was held that one first looked at the entire premises of which the subject property forms part and then considered whether the activities in the whole involved a substantial proportion of sales, other than the sale of intoxicating liquor. Quite a lot of sales in public houses relate to items which are not intoxicating liquor, so it is necessary to consider liquor in relation to everything else. I stress that the measure is sales; profitability does not come into it.
When tenants become protected, rents under the new leases will be assessed on the basis set out in section 34 of the 1954 Act (as amended). This includes the usual disregards as to the tenant’s occupation, goodwill and most improvements together with the specific disregard which requires one to ignore any addition to the value that is attributable to the tenant’s licence.
It is perhaps appropriate to consider briefly the case of New Zealand Government Property Corporation v HM & S Ltd [1] 1 WLR 870, which, although it relates to all properties, actually concerned the ownership of the “trade fixtures”, namely the seating, curtains, bar fittings and the like, within Her Majesty’s Theatre, in London’s Haymarket. It was held that the tenant retained the right to remove his fixtures so long as he remained in lawful possession. In many leisure premises, and particularly theatres and cinemas, the costs of fitting out today are enormous. It is, therefore, particularly important to consider whether, at the expiration of a lease, or on review, it is a vacant shell which is to be valued or fully-fitted-out premises. The difference, in terms of rental value, can be considerable. Furthermore, it is also quite common to have an inventory attaching to a lease setting out items which might be regarded as a tenant’s fittings and finishings but are, in fact, included with the lease. These need to be considered carefully.
Turning now to the main problem area, the licence, section 34 of the 1954 Act specifically refers to the disregarding of the increase in value attributable to the licence, when related to licensed premises, but since premises licensed for the sale of intoxicating liquor have hitherto been excluded from the protection of the 1954 Act, one must question what licences are referred to when disregarding the addition to value. It seems that the additional value attributable to all licences is to be disregarded and a liquor licence is certainly one that is likely to be held in connection with many leisure operations.
As Paul Morgan has explained, one disregards not the licence itself but the addition to the value of the holding that is attributable to the licence. Clearly, if there were to be no licence available to the tenant then the property would have little, or no, rental value for the use that is likely to be permitted in the user clause. In the case of all licensed premises, one needs to assume that the tenant is able, or will probably be able, to obtain a licence. That is not to say that there will not be some element of risk or, more likely, some expense involved. That expense may, in some cases, be considerable.
Rent reviews
Rent review provisions in most leases follow the 1954 Act with or without the amendments of the Law of Property Act 1969. Many clauses go further and require one specifically to assume the presence of a willing tenant and vacant possession. Neither of these is actually mentioned in the 1954 Act although they are implied, except where there is an existing subtenant whose occupation is to be taken into account. Rent review provisions usually require one to have “regard to the terms of the lease” and thus the user clause may be of considerable interest, particularly following the Town and Country Planning (Use Classes) Order 1987. This groups in Class D2 various leisure activities, and thus a landlord may not be precluded from looking at some more valuable use, if a change is to be permitted with the landlord’s consent that is not to be unreasonably withheld.
In disregarding the goodwill and occupation, one is assuming that a tenant is starting up a new business. That may take some time and thus the hypothetical term may be of considerable importance. This was one of the matters considered in the case of Ritz Hotel (London) Ltd v Ritz Casino Ltd [9] 2 EGLR 135; [1989] 46 EG 95. One of the points was that the hypothetical term was to be “equivalent to the term hereby granted”. The question was: “When did the term commence?”
It was held that the 21-year-old term was to be from the actual commencement date of the lease and, while one should assume the tenant’s rights under the 1954 Act, a tenant may still be vulnerable, particularly where, as in this case, he is the occupier of part of a landlord’s larger premises.
If the tenant is clearly defined, without an assumption as to the inclusion of any subtenant or occupational tenant, and the actual tenant is not in occupation and does not hold the appropriate licence or licences, then possibly one may have regard to the previous occupation of the subtenant and any additional value to the holding which may be attributable to the subtenant’s licence. This was considered in the case relating to the headlease of Crockfords Casino, Daejan Investments Ltd v Cornwall Coast Country Club [5] 1 EGLR 77; (1984) 273 EG 1122. I will refer again to this case a little later.
Rental valuations
Most commercial properties are valued by reference to comparables. Many leisure premises, however, are not let in the open market. While any property transaction is essentially a business decision, in the case of leisure premises it is more of a business decision than a property one. Such properties on which there are transactions, be they freehold sales or lettings, frequently have regard primarily to the actual or potential profitability of the operation. In some cases the rental value is calculated by the comparatively simple process of taking a percentage of turnover or a price per unit of throughput. In others it is necessary to carry out a full “profits valuation”. This is the basic method that is used for many leisure properties.
In a valuation by reference to profits, the rent is the annual amount, as a proportion of profit, which an operator will pay for the premises in which the business is conducted, leaving an adequate return for operating the venture. Alternatively, it is the annual sum that the operator will pay rather than invest a capital sum in purchasing the premises, assuming that they are for sale. The object is, first, to assess the reasonably maintainable level of profit or, as it is frequently called, the adjusted net profit, ideally by looking at accounts over a period, in order to see trends. It may well be necessary, however, to forecast such a profit in order to assess the rental value.
From this adjusted net profit, a percentage will be applied to the rent. The percentage will depend upon the volatility of the type of business and the actual record of the operation, if available. In assessing the percentage, which, in most cases, is between 25 and 50% of the adjusted net profit, it should always be remembered that if any difficulties arise it is the tenant who is squeezed first.
The adjusted net profit is the total turnover, or gross profit, less all expenses but adding back any rental paid or interest on money borrowed. On the other hand, as an expense, it is normal to allow for interest on the capital employed in the business and either a management charge or proprietor’s remuneration. The latter is often incorporated in accounts as a head office charge. Traditionally, depreciation was added back, since, for tax reasons, this could be an artificially high figure. In practice, in recent years, with rapidly changing tastes and high costs of refurbishment at ever more frequent intervals, in a number of leisure operations depreciation is now considered, in many cases, to be an appropriate allowance in arriving at the adjusted net profit. Of course, one also has regard to what may appear to be abnormally high, or low, expenses in the accounts.
While interest on capital is a normal adjustment, an operator is required, in the case of gaming premises, to have a “gaming float”. This is frequently a considerable sum of money. In practice, rather than depositing such a sum in the bank, a casino operator is able, for a comparatively modest expense, to have a corresponding overdraft facility with his bank. That facility is rarely, if ever, taken up.
The profits valuation has been made many times more difficult by the decision of Mr Justice Scott in the second case on Crockfords, Cornwall Coast Country Club v Cardgrange Ltd [7] 1 EGLR 146; (1987) 282 EG 1664. It was decided in Cardgrange that one could not look at the accounts unless they would have been available to prospective tenants in the open market.
This begs the question of whether or not one can look at the accounts of other operations. Clearly, one cannot look at such accounts if they are not available to prospective tenants in the open market, but the situation is that there are surveyors likely to be advising prospective tenants, or the actual tenant in a particular case, with a knowledge of the accounts of similar operations. Of course, all that information which they have obtained from other clients, in connection with other instructions, is confidential.
It seems, therefore, that where a dispute is to be settled by the courts or by a third party, such confidential information cannot be admitted as evidence.
Reverting to valuations by reference to comparables, properties are compared in terms of a rate per unit of accommodation or facilities. In leisure premises one might be looking not only at areas on a gross or net internal basis of measurement but also at numbers of seats, tables, persons licensed to be on the premises, rooms and the like.
Since the licence creates the element of monopoly and thus there are frequently only a few of any particular type of operation in any town, there is, unless one is very lucky, usually no comparable transaction in the town upon which to rely.
One must then consider where, or how far, one can go in search of comparables. In practice, where there is an actual open market transaction, the operator will have spent a great deal of time and money in preparing his demographic profile in order to assess the numbers of customers and likely takings of a potential venture. To a greater or lesser extent it will probably be necessary to do this not only for a profits valuation but also where one compares a transaction in one town with a rental value in another.
Types of property and problems which will arise
I will try to identify some of the problem areas in the types of properties which I have mentioned and deal very briefly with the methods used in valuing them.
Public houses and restaurants
The first question is to determine whether one is dealing with a pub, pure and simple, an hotel or a restaurant. Fortunately, the difference between the three will soon become largely academic when public houses come within the protection of the Landlord and Tenant Act 1954.
Public houses were normally valued in England and Wales by reference to barrelage, and a rate per “converted barrel” was applied to the reasonably maintainable sales, three gallons of wines and spirits being regarded as equivalent, in terms of the proportion of profit that a tenant would pay by way of rent, to that on a barrel of beer. More recently, as in Scotland, a percentage of the turnover, which also reflects soft drinks and other takings behind the bar, has been considered to be an equally, or more, appropriate method of assessing the rental value of a public house.
There is now frequently some debate as to whether amounts should be allowed for food, fruit machines, juke boxes and other money-making operations on the premises. Normally, such an allowance is made, but tenants, not surprisingly, argue that such features should be ignored, since they are an attraction that reflects on the amount of liquor sold.
One also has to consider the possible, or likely, overbids of breweries who can create for themselves an element of wholesale trade by taking a new public house. I, personally, do not consider the so-called “overbid” as being of particular significance, since, if companies are prepared to bid high rents in the market, for whatever reason, then those rents can be reflected in assessing market rental value. This aspect has been drastically diminished by The Supply of Beer (Tied Estates) Order 1989 whereby brewers with more than 2,000 pubs must free the excess, or half the excess, from any tie by selling, or letting on full repairing leases. Tenants of these brewers are generally no longer tied for purchases of wines and spirits, cider, low or non-alcoholic beer or soft drinks. Even tied tenants of these breweries can now buy-in a guest real ale from another brewery.
Although it may seem only too obvious, one has to consider and differentiate between the rental bids for free houses and tied rents or other situations where a letting is not completely at “arms’ length”. One also needs to consider the sales in trendy pubs of lager and premium beers, on which there are very good profits, in relation to what is the reasonably maintainable level of profit. This trade can vanish overnight, with competition, changes in fashion, or trouble with the so-called “lager louts” being the most newsworthy. In terms of trendy pubs and fashion, it is surprising, or perhaps not, how many public houses are refurbished, or the theme changed, shortly after a rent review has been settled.
In the case of restaurants occupying retail-type premises in shopping thoroughfares, the valuation will normally be made by reference to comparables, using other retail premises, since, in most cases, the restaurateur is competing with the retailer. In this context, there is frequently some debate as to whether it is appropriate to value using the zoning method, normally applied to shops, or on an overall basis, since the shape and layout of what may be considered to be a difficult shop do not necessarily affect the profitability of a restaurant. One also has to consider the scarcity, or otherwise, of the availability of suitable premises. Consideration must, therefore, be given to the planning situation and the reluctance of some landlords, particularly where they own adjoining premises, to permit a catering use. In non-retail areas one might consider the premises in relation to their suitability for some other use, eg offices. There has recently been an increasing number of catering outlets, mainly of the fast-food type, developed in the vicinity of retail warehouse parks or major leisure developments. Here rents are calculated normally at a rate per square foot on the gross internal area. In many cases, however, particularly in rural or residential areas, a profits method of valuation is usually the most appropriate.
Hotels
The rents of hotels are normally calculated by reference to the number of rooms, the rate per room and the occupancy rate. As an aside, central London rental figures thus produced are often impossible to reconcile with the capital values that are sometimes mentioned in connection with freehold hotels. There are, however, significant tax considerations to be taken into account in hotel developments. In any event, one needs to be particularly careful when considering the room rate as to whether it is the published rate or, as frequently happens, there is a much lower rate for tour operators or airlines in order to keep up the occupancy rate. Of course, the figures will reflect the other amenities of the hotel, in particular conference and banqueting facilities, restaurants, shops and so on.
In many cases, particularly outside the larger cities, the profits method is more appropriate. Even if one does see the accounts, it is important to ensure that there are no other significant cost centres which are not shown, or reflected, eg a public bar.
Theatres and cinemas
While many cinemas are let, the increasingly popular “multiplex” developments are almost always held by the operators. Some other reasonably modern cinema developments, in premises forming part of larger development schemes such as shopping centres, are frequently let. Quite often these lettings are on turnover rents, but where one has to get to rental value it is often possible to rely upon a rate per seat and to value by reference to comparables. One must, of course, take into account the arrangement of the auditoria and, although in theory it should not happen, whether the cinema is a “first run” operation, as it probably will be. One will need to reflect the advertising or revenue that accrues from it and whether the cinema is available for late-night use.
Theatres and cinemas in London are nearly always valued by reference to a rate per seat. On theatres these rates, rather like hotels, do not seem to relate to the very high capital prices that are paid by some people who wish, for whatever reason, to own their own theatre. The rates per seat vary considerably with the higher prices tending to be paid for those theatres with optimum sizes, which are about 750 seats, or a little less, for the straight play as against 2,000 seats for the musical which will incur very high costs of production but which, if it is a “hit”, is likely to lead to a very high profit. Obviously, the dimensions of the stage can be a significant feature in relation to the latter.
For some time now profits-based valuations for London theatres have been treated with considerable caution. So much is dependent upon whether, in the period up to the date of the assessment of the rent, the theatre produced a “hit” or a run of “flops”. One small feature of a number of theatres which needs to be taken into account is the “PP seats”. These are seats held by someone other than the occupational tenant as a result of the lease or, more likely, some other earlier transaction.
Clubs, nightclubs, dance halls and discotheques
This, I think, is an extremely difficult area; a minefield for the unwary. In terms of profitability such businesses can be very volatile. Much depends on the personality of the operator; in many cases the local management installed by major leisure groups does not have the commitment of an individual proprietor. In terms of commitment, if that is the right word, these types of operation tend to attract individuals with an inclination to “manipulate” the takings. As regards volatility, so much is dependent upon fashion, and a change of theme at a rival operation may drastically affect another operator’s profitability.
Within this field, there seems to be considerable risk with licences, and clearly a dance hall or nightclub that cannot sell liquor is a disaster. In this connection, be careful also of looking at the business of an establishment which may be benefiting, at the time, from a rival’s misfortune or stupidity. As a result of these quirks, in many cases where one sees accounts, the figures do not justify the rent or the price paid.
In terms of a dance hall or discotheque, it is becoming increasingly common to rely on comparables, using a rate per square foot of floor area or the number of persons licensed to be on the premises. The latter is, of course, to some extent dependent upon the floor area. A note of caution here. As with other types of property, using the rate per square foot method on premises which are often not purpose built may produce an inflated figure, as they may be larger than is required to satisfy demand.
Bingo halls
Bingo halls are frequently old cinemas and, notwithstanding the licence under the provisions of the Gaming Act, they are usually valued on a rate per seat basis although I know a rate per square foot has been used. Again, as with so many other types of properties, many are larger than they need to be, but in some cases they are too small.
In terms of profitability, much depends upon prize money that the operators can pay and thus the major operators like to have and be able to fill regularly 1,000 seats or more. A difficulty with bingo is that an assessment of the number of admissions alone may give little indication of profitability.
Casinos
At the end of the year 1988-89, of the 104 casinos in England and Wales the 21 in London had a “drop” of more than £1,000m. The drop is the amount of money changed into chips. On the rule-of-thumb basis for assessing the win of the operation by taking 20% of the drop, these 21 casinos had a win of £200m in what was considered by casino operators in the West End to be a very bad time.
Licences are extremely difficult to obtain and apart from the questions of suitability of the applicant and the premises in question, the applicant, in order to obtain a new licence, must be able to demonstrate that a further licence is required “to satisfy unstimulated demand”.
Nor surprisingly, there have been several cases in the courts, as well as some hard-fought arbitrations on the few leasehold casinos in central London. Here, perhaps, there really is a case for the profits valuation, but Cardgrange has made this rather difficult.
It will be readily apparent that there are vast sums of money involved in hard gaming, even in a bad year, and in the past an element of greed has resulted in some licences being lost. Some ex-operators have let, or sublet, their premises to people who were able to obtain a certificate of consent from the Gaming Board. Those leases were drafted in such a manner that the rent would, to some extent, reflect the licence value. This was with the intention of recovering some of their lost potential. In those cases a valuation by reference to profits is clearly the only appropriate method, but one does have the difficulties created by Cardgrange.
An example of a less fortunate tenant was that in the case of Daejan Investments Ltd v Cornwall Coast Country Club mentioned earlier. The defendant tenant was a subsidiary of a company that had lost its licences, having just fitted out Crockfords at very considerable expense. The lease, in the usual manner, provided that one was to disregard the tenant’s goodwill, occupation, improvements and the addition to the value attributable to the licence, so long as it belonged to the tenant. The tenant had assigned to an associate company who, in turn, had sublet. The subtenant, or associate of the subtenant, in occupation was not the tenant as defined by the lease and it was held that as the licence-holder he had a special interest in securing a letting, as he was in the nature of a “special purchaser” with a special interest in obtaining the lease. Clearly, the hypothetical tenant did not hold a licence but would have to match, or exceed, the bid of the subtenant, who had been in occupation and had a valuable business to maintain. In the subsequent arbitration, which was before the Cardgrange case, the landlord, Daejan, obtained a subpoena requiring the company secretary of the occupational subtenant to appear with the accounts. Not surprisingly, there was a significant shortfall between the rent determined under the sublease, following Cardgrange, and that under the headlease since, in the sublease, all the disregards, particularly the effect of the licence, were applicable and the actual accounts could not be used as evidence.
Provincial casinos are, in most cases, in, or close to, city and town centres and accommodated in buildings which have previously been used, or were designed, for some other use, eg offices, restaurants and multi-storey warehouses. As a result, unless there is a provision whereby the licence is somehow to be taken into account, most of these buildings are let at rents reflecting the rental value for the accommodation in question or the rental value for the appropriate alternative use of the space. Indeed, many leases on provincial casinos provided for the rent to be assessed on the basis of the higher of casino or other appropriate use.
Bowling alleys and snooker halls
Both these types of premises tend to be assessed by reference to a rate per square foot, but in some cases they are assessed by reference to rate per lane and table respectively. Again, since many snooker halls occupy space over shops the rents on open market lettings and consequently reviews have tended, in many cases, to reflect the value of the accommodation as ancillary space to the ground-floor retail use, but this is not always the case. There does, however, seem to be an upper limit.
Conclusions
Where do we go from here?
Perhaps Cardgrange is the most important case in this whole area. Even in those situations, such as public houses, where landlords and tenants have happily continued to use accounts or sales figures to arrive at rental values, there seems likely to be a change in the near future: particularly as it seems many public houses will soon be on the market and, in the case of the national breweries, they themselves may, or will, not know what precise non-beer, or even total beer, sales are taking place.
Paul Morgan suggests a turnover rent as a way of dealing with the difficulties of assessing or fixing rent. While clearly this would reduce the problems of arriving at an accurate estimate of profitability, which, from a landlord’s point of view, can only be beneficial, what happens if the tenant allows the business to decline or is foolish, or unlucky, enough to lose his licence; where does this leave the landlord?
There are many examples of artificialities that are considered by some to be an appropriate method of dealing with leisure and other slightly unusual properties. It often saves a lot of trouble to have the rent assessed by reference to something else, but it can lead to considerable difficulties.
One West End casino has its rent fixed by reference to an office rental value to which a multiplier is then applied. When originally agreed, the rent, as a casino, was quite reasonable and the landlord was happy, as he received a great deal more than he would if he had let the building as offices.
Between the last two reviews, however, office rents more than trebled, with the result that, with the multiplier on top, the rent was appreciably higher than the tenant would have expected to have had to pay for the premises as a casino. Not surprisingly, perhaps, the tenants have recently sold the operation.
A final thought. Probably the easiest way of resolving the profits-based valuation is to incorporate a clause whereby the tenant is specifically required to disclose, in confidence, the accounts which may be taken into consideration in assessing the rental value. Just such a clause was the subject of the dispute in Electricity Supply Nominees Ltd v London Clubs Ltd [8] 2 EGLR 152 mentioned by Paul Morgan.
