John Sedgwick
Dr Samuel Johnson, or rather James Boswell, his famous biographer, tells us of the man who always got indigestion after eating muffins. His remorse — for he loved muffins — was such that he decided to shoot himself and half an hour beforehand he consumed six of those items, toasted and well-buttered, in the knowledge that no discomfort would follow. It is in something of this mood that the author embarks on this article and, having spoken of Dr Johnson, he is prompted to commence with a definition of terms.
The expression “key-money” used in relation to the assignment of shop leases, or indeed of any leases, is clearly a misnomer. The proper word may be “premium” or, to be more literal, “price”. The expression “key-money”, now in common use, seems to have been plucked from pre-war residential security of tenure situations, when it implied an illegal payment of money for the key to a flat or house, a payment prompted by the fact that the giving and taking of any sum of money for the grant or continuance of a tenancy of a controlled house was prohibited. Undoubtedly the transfer of such a tenancy was of value but the value could not be realised legally: hence the surreptitious payment of key-money to get hold of the metal instrument in question.
Speaking in terms of Sloane Street — that evocative thoroughfare — it would be absurb to think of Dunhill, Yves Saint Laurent, Gordon Lowes or such like paying an illegal premium to get hold of a key. We were told by Charles Boston in the issue of October 3 (“Making sense of key-money”) that Bond Street, Sloane Street and Brompton Road shops are now commonly assigned for premiums of more than £250,000, but to call this key-money is to use the wrong phrase. A premium is paid for an assignment of a shop lease for the simple reason that the assignee thinks it is worth it, and thinks this because the rent level under the lease is lower, to a greater or lesser extent, than he would be prepared to pay were the property available to let on the market with vacant possession. If such premiums are thought to be paid without reference to the rent passing then it follows that rents in general in these prime positions are ludicrously low — although ludicrous would not be the word the landlord would employ.
We must stop to admit that there are other factors, such as goodwill in the sense of a privilege granted by an assignor of trading as a successor, that attract a premium, but this is rarely, if ever, the case when High Street shop leases are assigned, particularly since mergers would be more to the point.
Indian rope trick
Mr Boston in his interesting article says, with reference to key-money, so-called, that some agents would be anxious to indicate that they could not justify the level of premium in a particular case “by reference to traditional valuation criteria”. A criterion is simply a standard of judgment and in the case of valuation the standard of judgment should be absolute, or within 10% of it if the judges are to be believed. The point of reference is the balance of supply and demand, so if a valuer cannot justify something by reference to “traditional valuation criteria” he is up the pole, although this is no aspersion on the logo of the institution to which the writer belongs, which shows the king of the jungle — presumably the one in which the leading institution operates — idiotically enough climbing up a levelling rod, probably because he took it for a rope.
It must surely be the case that a premium paid on the assignment of a lease is the measure of the profit rent; unless, that is, there is evidence to the contrary. The only question worth consideration is whether the premium is to be regarded as having been paid for the profit rent likely to be enjoyed for ever and a day, or simply to the end of the lease, or merely to the next rent review, or whether the payer of the premium can be deemed to have in his mind the fact that most rent reviews are settled at less than the going rate and that most new leases granted under the Landlord and Tenant Act 1954 are at lower than open market rents. The only true evidence of rental values is that derived from the letting of vacant premises or, to the point, from an analysis of premiums paid on assignment.
The trader who pays £300,000 for a lease with 24 years to run, but subject to a rent review to market value in four years’ time, is either paying a premium for four years’ profit rent, 24 years’ profit rent or, effectively, a perpetual profit rent. If the premium were to be regarded in practice as a premium paid for four years’ profit rent and if this happened to be based on a misconception then, given a nice prolonged arbitration or two with references to the court and then to the Court of Appeal, premiums would either tend to drop — or not to drop — depending on the eternal verities. £300,000 decapitalised over four years at 4% on the single rate tables would produce an annual equivalent of £83,000 pa, more or less, whereas a decapitalisation on a perpetual basis would produce a rental equivalent of £12,000 pa; therefore, a true understanding of the motivation behind the payment is of more than slight importance.
A leading case
In all probability the typical well-informed multiple retailer is perfectly well aware of the fact that the case of Ratners (Jewellers) Ltd v Lemnoll Ltd (1980) 255 EG 987 settled the matter fairly decisively, at least as far as the courts are concerned. In that case Dillon J had to consider an application for a new lease, or more specifically for the determination of an interim rent as part of an application for a new lease, where a substantial premium had been paid on assignment seven years before.
For once the traders were in the same line of business which makes the case even more to the point. Collingwoods had assigned their lease to Ratners, who paid a premium of £22,500 and then spent a good deal of money on shop-fitting. In due course the landlords served notice under the Landlord and Tenant Act 1984 to determine Ratners’ tenancy and after the usual rituals had taken place Ratners started proceedings, claiming a new tenancy.
The landlords asked the court to determine the interim rent, then Ratners decided that they did not wish to have a new tenancy but because of the passage of time the interim rent question remained, the interim rent needing to be fixed for a period of about three years. We all know that an interim rent is not a market rent, but that is not the point at issue here.
It was agreed that calculations from comparables should be on the basis of a rent for a term of years with five-yearly reviews, since that was the normal term of a shop letting. An important comparable involved the assignment of a lease by Salisburys to Kemvend in 1977. The rent payable under the lease of the property concerned was £10,000 pa, but Kemvend also agreed to pay Salisburys a premium at the rate of £2,000 per quarter until the next review date. The judge said that if this premium was to be treated as rent so as to produce a rental value of £18,000 pa that was that, to paraphrase somewhat, but the surveyor for Ratners said that the premium could not fairly be taken into account because it included an element of what, as the judge said, “he calls key-money”.
The judge did not accept this. He said: “The decapitalisation of a premium paid on an assignment of a leasehold term into a rental equivalent is a commonplace of valuation which is normally reliable.” He did add: “There may be extreme cases where the premium is so large that it would be misleading to convert the whole of it into rent; so large that there must be an inference that it is in part attributable to some other factor.” In context this remark is puzzling because it is not the size of a premium that indicates the existence of other factors but the lack of a profit rent — which begs the question.
Modern Methods of Valuation tells us that a premium is a sum of money paid by a lessee to a lessor for the grant or renewal of a lease on favourable terms or for some other benefit, and criticises the use of the term by agents to describe the price required for a lease which is being sold. We are told that what is sought is a price, not a premium, which brings me back to the beginning of this article. Let us from now on call a premium a price or perhaps, to invent a term of art, a “supplement”, such a word being better than surcharge since the latter has a sense of an excessive charge or a penalty.
In the Salisburys case the premium was paid quarterly rather than as a capital sum by agreement, because of the possibility of the lease being determined under a special break clause, so the judge simply added it up: of course £2,000 per quarter might add up to a capital sum but it is not equivalent to a capital sum payable at the beginning of a period of years. So much for the judge’s valuation expertise.
How to treat it
It seems clear to the author, a consumer of muffins, that a premium paid on assignment — he begs your pardon — a “supplement”, clearly falls to be decapitalised to produce evidence of rental value. No doubt the trader looks to the future and to some extent regards the payment as something to be written off out of profits over a period of years longer than that to the next rent review, or possibly to the end of the lease. That is the argument, not the question of whether it is proper to disregard the payment. By parallel with discounts on yearly rents as opposed to term rents it might be reasonable to take 10% of the premium and decapitalise it in perpetuity, 20% and decapitalise it for the whole term of the lease and then decapitalise the remaining 70% up to the next rent review. In suggesting this formula the author raises his right arm to shield his head and ears.
Patrick Cooke-Priest made a valuable contribution to the debate in his letter in the issue of October 17 (p304) and he looked forward to the time when a trader would find a premium paid for a lease taken fully into account. So do all the landlords in England, and it is surprising that Ratners v Lemnoll has not yet made its considerable weight felt. It cannot be money for jam.