2020/NO.31 - Section 34 of the Landlord and Tenant Act 1954 sets out the disregards that play a significant part in the rental valuation of public houses.
Items to be disregarded include:
A. Tenant’s occupation;
C. Improvements; and
Disregards A - C are standard in most leases with some slight change in their wording. A disregard of occupation prevents the tenant from having to pay more for their already established business than for an identical property close by. This then links to both the disregard of goodwill and any tenants' improvements.
Disregarding the tenant’s goodwill does not prevent a profits test method of valuation being undertaken. It simply aims to ensure that the rent assessment is based on the fair maintainable trade of the 'reasonably efficient operator', and not the actual accounts, avoiding any over or under performance related to the current tenant.
The Improvement Scam
A story all too familiar concerning tenant/lessee alteration works. As it has been told on many an occasion by the professionals that gather for the six o’clock swill - you can do your landlord a great favour by either altering it, or improving your pub. If you are doing the work yourself at your own expense, the lease often requires you to get permission or consent. Often your friendly Pub Co, or one of the few field staff from the estates department, will fail to tell you that the consent you require will need to be in writing.
Time after time, you will get the verbal approval of the business development manager (BDM), maybe even the area manager or regional director. You will have served the necessary planning notices, assuming you needed consent, and all is tickety boo.
Well, actually no.
What your so called partners have not told you, often claiming to be an oversight on their part, is that without a Licence to Alter the works will not be disregarded at rent review. Whilst there is no obligation for the landlord to have to tell the tenant/lessee, it is a pretty low trick to just allow the often expensive work to completed, and then include the benefit of the work and expense in the next rent review securing an increase in rent.
To add further salt to the wound, a second trick used against tenants/lessees is that many are not told that it is perfectly legal to seek a Retrospective Licence to Alter (RLTA), even if it is many years after the works have been done often by a predecessor in title, i.e not the current tenant.
Morgan & Clarke have knowledge of several RLTAs that referred to work done in the mid 90s under Inntrepreneur, Unique and Laurel leases that were only put back on track in recent years. With the very reluctant Pub Cos accepting an application for a RLTA. So, now you have the proper paperwork everybody should be on course to have a fair understanding of the rent review process in disregarding the previous works.
Wrong again! The ultimate Pub Co stitch is yet to have been explained in great detail –
Most modern rent review disregard clauses state -
“The effect of such works of a structural nature undertaken by the tenant at the tenants expense, and with landlord’s approval, shall be disregarded for the purposes of rent review”
Note that there is no mention of the word ‘cost’. So what does any devious and crafty landlord do, they tell you that it is “established industry practice” to have a vague guess at the cost of the works and allow for simple interest on their guesswork. So why should there be any great difference? Well our team has set out the maths which echo real case history. It’s quite the eye opener to be sure.
Picture this; a large brick surfaced hard standing area for five cars at the rear of a South London pub with dropped curb to the road. Tenant builds a new brick wall at the pavement edge, reroutes an internal corridor, opens up a new door from the corridor onto the now enclosed hard standing, creates new Gents and Ladies lavatories, rips up the hard standing surface and then creates a sizeable trade garden.
Result - the trade nearly doubles from £275k up to £510k. Two years later at rent review, the Pub Co attempts to rent the tenant on their vastly increased trade having made an allowance in the profits test valuation of just £1,800. This figure being their estimate assumption of the cost of the works at £20k and applying 9% interest. They sought an increased rent of £60k, up from the existing rent of £32k. Now obviously it would never suit the Pub Co to actually play with a straight bat and consider “The effect” of the works on the business being conducted in the property. If they did have a heavy medicinal dose of conscience, the rent would never ever reach their projection of £60k, and would probably not see much if any increase over the existing level of £32K.
Do not forget that the barrelage has also rocketed and seeing as the pub is fully tied, the Pub Co has already received a massive increase on wet rent. But this vital piece of data is often not mentioned. We wonder why…
So what is the legal position in all of this? There is a distinct preference in legal circles to disregard the effect on the business being carried out as the primary method. Only if that is not practical, can the cost route be taken but using todays costs, not when the work was actually carried out.
Any works of great expense should be costed by an expert with knowledge of the type of construction concerned, never an airy fairy guess given which is always far too low by the Pub Co surveyor. Finally, the cost allowance in the calculations must be on a capital and interest repayment basis, sort of like a term loan.
Section 34 of the Landlord & Tenant Act 1954 (L&TA 54) states at lease renewal the rent should be the rent that might reasonably be expected to be obtained in the open market but disregarding “any effect on rent of an improvement”.
Such improvement must have been carried out with consent from the landlord where necessary, it must not have been completed as an obligation to the landlord and it must have been some time during the current tenancy, or within the last 21 years. Rent review clauses can vary but more often than not reflect the wording of the L&TA 54.
Following strict interpretation of the L&TA 54, valuers can disregard improvements made by the tenant and value the premise as it was on the original layout before any works were carried out. This particular method is usually favourable to the tenant as it can result in a lower FMT and rent. Allowing the tenant to fully benefit from their own improvements, without the landlord attempting to receive an increase in their rental income.
Disregarding the tenant/lessee improvements can lead to disputes, so it is important to determine whether the alterations actually improved the property.
The Royal Institution of Chartered Surveyors (RICS) GN 67/2010 states -
“the valuer may decide that an incoming new operator would expect to improve the trading potential by undertaking alterations or improvements. This will be implicit within the valuer’s estimate of FMT.”
By example, the inbound operator might be expected to structurally adapt the lay out of the trading area and open up a section of a pub that has been used inefficiently, creating a further dining space, or function room for hire etc.
And there you have it, the truth.
If you have carried out any improvements to the structure of your pub, considering the effects of any planned improvements on any future rent review, or potentially you have already had your rent set on your improvements without any disregard, please do not hesitate to get in touch with us.