Reflecting The Market - Part I

Updated: Mar 16

2020/NO.36 - The task facing a professional rent review Chartered Surveyor is enshrined in “reflecting the market” and to replicate the mindset of the hypothetical tenant. Sounds fairly straightforward but is it?

First let’s start with the concept of the Hypothetical Tenant at rent review. The lease is bound to require that there is (a) vacant possession, (b) that there is no personal goodwill to be taken into account and (c) to disregard the tenant in occupation. Brought together it means that the current tenants do not exist. Simple. What is assumed is that of hypothetical tenant for the chosen establishment. 

Those are the base rules or assumptions for the hypothetical tenant. More often than not glibly glossed over by any amount of landlord’s representatives (more of that another time). This amorphous being arrives on the day of change, buys the stock and consumables and the trade inventory at in-situ asset value and is deemed to have adequate working capital to cover all of the start-up costs. That person is supposed to “reflect the market” in the decision to pay an ‘open market’ rent. Now begins the conflict in the mind of the valuers doing the decision making. There are two ways of looking at the problem, either focusing on the profitability or viability of the business or considering comparable rent transactions.

In the current Covid-19 market new rental agreements are as rare as hen’s teeth. Currently the market for new rents is all but dead. Even if there was ‘market evidence’ the details will be unavailable for scrutiny “to the other side” due to the Data Protection Act (see previous News Letters). Comperables are in our view highly misleading. You do not know how the deal was struck. Were there any structural works disregards, what was the barrelage, did the accounts have an influence, was there a slug of special or personal goodwill to be disregarded, any special discounts given, cash incentives for external decoration, trade off against another pub in the same tenant’s name? The list is long and totally hidden from view. Generally you will only be told of the comparable rent agreed, nothing else, even if it inevitably was pre Covid-19. We hope you are getting the picture of how misleading comperables can be in the current real world.

But rent assessment valuers do have to make a fist of the Covid-19 situation. That being the case the RICS guidance note GN67/2010 does require in paragraph 6.5 that …

”often direct comperables will not be available and the valuer needs to research a wider market”.

The comperables method is the RICS primary route of rent assessment as confirmed in the following paragraph 6.6….

”Therefore the valuer should, as a second stage, consider the profits method of valuation. Where comparing comperables with reference to size or capacity is not realistic or is highly subjective, the assessment of the property on a profits method should be chosen”.

So only if all else fails try and put together a profits test valuation. This is defined as a future profits appraisal known as Fair Maintainable Operating Profit. But how different it was in previous RICS Guidance Notes. Then the profits method was the prime route and comperables had a different tone . GN7 (3/96 revised) stated…

A secondary basis of comparison (that is after the profits test) may be on physical factors. However when resorting to such a method it is essential that any comparable is very closely relevant, as regards style, location and trading circumstances.The accounting information on which other transactions were based is likely to have been strictly confidential and, unless all these factors are known, any comparison of physical aspects alone can be misleading and unreliable”.

That was in 1996 and was quietly erased from subsequent Guidance Notes. As if by chance the post 1996 RICS Trade Related Valuation Group, who regularly revised and updated the Guidance notes, was chaired by a senior employee of a major pubco. Perish the thought that rent only Pubco cherry picked comperables (no trade and no barrelage) could ever be thought of as “misleading and unreliable”.

Back to the current market. We know of not one single client either past or present who gives a fig about comperables. Their entire focus is on only two things. The level of direct competition and how they can profitably run their chosen business. Comperable rental evidence is of no relevance and is looked upon with great suspicion as being cherry picked by Pubcos valuers and their chosen independent experts to prove or justify an exorbitant rent proposal. Clients regularly tell us that they can’t see any point in the hard focus on a sketchy reference to other rental evidence. In their view comperables are seen as purely a valuers tool to perhaps try and justify a stab at the genuine reflection of what the Hypothetical Tenant might pay by way of rent. Tenants are the prime reflection of the market, not valuers. Right now those potential tenants are waiting to see what happens over the next three to six months minimum and only then will be seen to pay realistic rents. 

Food for thought as to who genuinely reflects the market…