Rent Assessment Proposal and Shadow Profit & Loss Analysis Guide

The involvement of PAS during rent review has allowed us an unparalleled extended view and the opportunity to do analysis across multiple Rent Assessment Proposals over the past decade. PAS has put together a comprehensive guide for tenants and lessees to pick apart the inner workings of their Pub Co, or landlord when proposing new rents, and their assumptions of what trade they think you should be achieving.

A Rent Assessment Proposal (RAP) will include a shadow profit and loss account, the calculation of which your Pub Co or landlord will put together to support their justification of rent. Your landlord should take into account the conditions of the local market, the trading potential of the premises when operated by the Reasonably Efficient Operator (REO), and any historic barrelage records amongst other items of consideration.

The shadow profit and loss account details how your Pub Co has calculated their opinion of rent. It will outline their assumption of Fair Maintainable Trade (FMT), the gross profit, operating costs, and the expected future profitability that could be achieved by a REO. A line by line breakdown of each sales line will often accompany and set out the income streams for drink, food, and other sales such as accommodation etc, alongside the gross profit achievable for each.

As you can imagine, your Pub Co or landlord will be looking to obtain the maximum amount of rent that they can get away with, they will do this by inflating their assumption of profit so you will need to check their logic thoroughly. There are high chances your Pub Co or landlord are exercising a number of tricks within their calculations – we refer to them as the “Russian Dolls”

We have compiled a list of items often contained within a RAP shadow profit and loss employed to inflate the rent;

1. Inflate FMT
2. Underestimate Tenants Goodwill
3. Inflate Sales Mix
4. Underestimate Wastage & Sediment Allowance
5. Underestimate Expenditure
6. Regional Pricing & Gross Profit Margins

Inflate FMT

This should represent the trade that can be sensibly forecasted in the future for the Reasonably Efficient Operator (REO). Time and time again we see estimates of ‘future potential’ well in excess of the trade currently being achieved in the pub concerned. This is an area most are aware of and involves debate over the difference in opinion on what is considered reasonable, fair and maintainable.

This is tactic is fairly straightforward in that your Pub Co or landlord will look to suggest the REO would look to achieve an improved level of turnover or profitability than what the tenant in occupation is currently enjoying. This is a heavily debated argument in the trade, and can be argued in many different ways, but considering the annual BBPA beer barometer suggests on-trade beer volume has been in decline for the best part of a decade, coupled with the high number of pub closures year on year. It is difficult to justify why the hypothetical REO tenant would envisage an uplift on the actual level of turnover currently achieved. Unless of course the tenant in occupation is far below what is considered REO standard. If you are presented with this at rent review or renewal, ask why your supposedly below par REO status was not brought to your attention in previous meetings with your BDM? Chances are they will pick and choose when the REO status does and does not apply to suit their motive.

A further debate to be had on the inflation of FMT in shadow profit and loss accounts is the Pub Co opinion that a tenant exercising their right to go free of tie through the Pubs Code will see an uplift in their turnover/trade. Pub Cos will have you believe that when you go free of tie, you will release all of this hidden trade that somehow passed you by when you were tied – a different breed of drinkers will now frequent your premises, your pub was seemingly invisible to these drinkers when you were tied.

Now, the more likely reason, a tenant looking to sever their tie with their Pub Co threatens their wet rent income. The income they are set to make by selling tied drink products to their tenants and lessees at an above market rate premium. If the Pub Co loses this wet rent income, they will look to make up their loss by convincing you that your turnover will be above and beyond what it has ever reached before. This conveniently allows them to justify a higher level of FMT and profit, recovering as much of their loss of wet rental income in the form of dry rent.

A pub recently free of tie may experience a slight uplift in the overall turnover, if they can now attract and retain new custom by supplying products that were previously unattainable under their beer tie. But not to the level of turnover uplift that the Pub Co would have you believe!

Now, if for a second we were to believe the Pub Co assumption that free of tie FMT would be far in excess than that of the same pub but under the beer tie. Would that not suggest the tied pub model was in fact anti-competitive. We are sure the Competition and Markets Authority would be interested in this if it were true…

Underestimate Tenants Goodwill

Within the rent review provisions contained within a lease is the disregard of tenants’ goodwill. It is required that the rental calculation should be undertaken on the basis of vacant possession and the current tenant and his existence should be disregarded. Goodwill however is notoriously difficult to quantify and is almost completely ignored by many Pub Cos.

To define goodwill, it is either intrinsic or transient, as universally recognised by the Valuation Office Agency (VOA) in the assessment of fair maintainable trade for the purposes of business rates. The important element being;

Transient goodwill – the trade which is deemed to be not affixed to the premises, as with intrinsic goodwill, and which could be removed from the property if the trading operator imbued with that goodwill left the premises. Transient goodwill is the extra trade achieved over and above that which would normally be expected to be retained in the property following the guidelines of intrinsic goodwill.

Your Pub Co, or landlord, will not go out of their way at rent review to disregard or discount any of your trade in order to reach the FMT expected of the REO. If you are over-performing your Pub Co will often state that it is considered REO and that “anyone would do the same”. If there is an obvious failure to disregard the apparent goodwill and trade down to your good self, you are unfortunately being rented against yourself, which could be far in excess of what is considered Reasonable and Fair.

Inflate Sales Mix

A classic tactic that is often overlooked. It has been noted that many Pub Co and landlord calculations of rent have weighted the volume of drink sales towards the wine, spirits and minerals (WSM) category. This has a significant effect on the calculations, if a volume of drink sales is directed away from lager and ale, in to the WSM category, this will ultimately inflate the rent. Ale and lager has a lower gross profit margin (around say 45– 55%) than that of wine, spirits and minerals (say 60-75%).

If you accept a rent assessment proposal with a distorted sales mix, you will be rented on a drink sales profile that does not necessarily reflect your actual pub offer, or even your consumer drinking profile. If you then operate said pub, and you do not sell the required level of WSM in order to meet the required level of profit, and thus the rent too, there will be a shortfall in profit that will come out of your share. In effect, you could be rented on a pub offer totally different to yours.

For example, the product mix presented within a Pub Co RAP is as follows;

Wet Sales	Turnover ex VAT	% of Wet Sales	GP Margin %	Gross Profit
Bitter	£58,104.00	15.2%	52.3%	£30,385.73
Lager	£147,552.00	38.5%	52.1%	£76,923.50
Stout	£18,576.00	4.8%	46.7%	£8,674.99
Bottled Ale & Cider	£19,367.00	5.1%	65.0%	£12,579.24
Draught Cider	£13,105.00	3.4%	60.2%	£7,889.21
WSM	£126,436.00	33.0%	70.2%	£88,735.10
Total	£383,140.00	100%		£225,187.77

Now if you apply the actual product mix taken from the historic records – working from the same turnover and GP Margin % but applying the true product mix through the % of wet sales

Wet Sales	Turnover ex VAT	% of Wet Sales	GP Margin %	Gross Profit
Bitter	£76,628.00	20.0%	52.3%	£40,072.93
Lager	£176,244.40	46.0%	52.1%	£91,881.76
Stout	£15,325.60	4.0%	46.7%	£7,157.06
Bottled Ale & Cider	£22,988.40	6.0%	65.0%	£14,931.40
Draught Cider	£15,325.60	4.0%	60.2%	£9,226.01
WSM	£76,628.00	20.0%	70.2%	£53,778.93
Total	£383,140.00	100.0%		£217,048.09

If we are to take the above example, the difference between the Pub Co opinion and the historic is 13% of wet sales. The total gross profit has fallen approximately. £8,000. After working its way through the calculations and after deducting the same operational costs, it shows the rent to be out of line by £4,000. Over a five-year period, this equates to an incorrect assessment and overpaid rent of £20,000. You guessed it – this will come out of the tenants’ share of profits. Unless of course you work hard to over trade and make up the difference through an increased level of trade taking you above the FMT.

 

Wastage and Sediment allowance

Some tenants may be aware of the Pubs Code Adjudicator Guidance on Beer Waste and Duty. This guidance came into effect July 2019 in relation to pub owning business’ statutory obligations to account accurately in forecast profit and loss account statements as part of a rent proposal for:

1. The volume of alcohol on which duty has been paid; and
2. The volume of draught product waste which is unsaleable

Further information on this can be found here.

This is a particularly interesting area for consideration; if we are to take the above figures as an example, the difference between the historic data and Pub Cos assumption of sales volume that is WSM is 13%. If the rent is set with reference to the Pub Co estimation of 33% of WSM as wet sales volume. If the additional and incorrect assumption of volume for WSM actually returns to the ale or lager categories as we pointed out, there will need to be an increase in allowance required for wastage and sediment. The allowance for wastage and sediment provided within the rent model would be insufficient.

In fiddling with the sales mix and if incorrectly set, the allowances required should be greater and the total wet gross profit should be far lower due to the incorrect level of allowance. If not assessed correctly, this will ensure the total gross profit is now inflated and will lead to an artificially higher rent.

The muddling of the drink sales mix inflates the profit, and thus the rent. Weighting volume towards higher gross profit margin categories (WSM) will decrease the allowance on sediment and wastage (for ale and lager) as you have moved a significant percentage of the sales volume away from those categories. The actual operation of the pub will often see the volume of drink sales return to ale and lager, where a greater allowance for wastage and sediment would be required to remain profitable.

Underestimate Expenditure

A far simpler tactic and one many tenants and lessees are aware of. Your Pub Co, or landlord, will often vastly underestimate the operational costs of your business. They will assume you can run your pub on the tightest of operational cost budgets, thus ensuring the net profitability and their rental income in their calculations is inflated too.

The RAP will often reference one of the industry BBPA or ALMR annual cost benchmarking guides, this will often be the base of which the calculations will assess your operational costs on a hypothetical basis. An essential point to consider in that industry costs benchmarking is a backwards look at what costs were. Not a forward-looking take on the realistic expenses through the three or five years until the next rent review – you will have foreseeable increases in staff costs with annual wage increases, amongst other items etc. The rent when set, with all linked expenses, must be affordable until the next review not just for the current year looking backwards to out of date statistics.

For purely demonstrative reasons, the below example sets out the sensitivity analysis on cost figures. Even a 4% underestimation on costs could have a significant effect on the bottom line.

Pub Co RAP		Actual Pub Figures When Trading
Fair Maintainable Trade	£360,000.00	Actual Turnover	£360,000.00
Total Gross Profit at 55%	£198,000.00	Total Gross Profit at 55%	£198,000.00
Operational Costs at 35% of FMT	£126,000.00	Operational Costs at 39% of Turnover	£140,400.00
Net Profit (Divisible Balance)	£72,000.00	Net Profit (Divisible Balance)	£57,600.00
Rent Bid Split 50/50	£36,000.00	Rent Set as seen to the left	£36,000.00
Tenants Share	£36,000.00	Tenants Share	£21,600.00
		Tenants Loss of Profit	-(£14,400.00)

 

Regional Sales Price & Gross Profit Margins

This issue is rather pertinent to those looking to go free of tie in exercising their rights under the Pubs Code.

It was noted the recent (2019) SIBA Craft Beer Report includes the following observation:

‘Restricted routes to market

 

The pub sector has been shrinking for some years now, with a fall of almost 5,500 pub sites in the last six years alone.  Add to that the growing number of breweries in the UK and it means competition for every available beer font on the bar is extreme.  Craft beer has yet to really make its mark in the wider hotel, restaurant and catering arena and so small craft brewers are currently fighting over a small slice of a diminishing market. The post–Pubs Code retail landscape is also proving a continuing challenge for small brewers, as the promised ‘freeing up’ of bar space for craft beers has largely failed to materialise despite the Code in theory allowing licensees to more easily opt to go free–of–tie.  With pubs still under pressure financially, large brewers have been able to incentivise licensees with investment and marketing spend and in effect ‘tied’ bar space to their products even in a free–of–tie site.’

We read this with interest and whilst we agree that larger brewers have been able to incentivise licensees with various deals to ‘re-tie’ them to their products in effect, despite the publican breaking their tie under the code, even more damaging is that tied pubs exercising their right to Market Rent Only option have a blanket gross profit margin applied across the country at around 70% on their wet trade/drink sales during the rent setting process.

It is accepted that gross profit margins will rise when a tied premises goes free of tie due the availability of open market discounts and pricing. However, it is unfair for many parties, for a fixed gross profit margin to be applied with no regional variation allowed. Gross profit variations have been accepted at a tied level by a few Pub Cos in past training manuals; the variation exists regionally for new lettings and at rent assessment for many tied pubs remaining tied. Seemingly this variation is not transferred for those wanting to go free of tie when the free of tie rent is determined. Convenient for the Pub Co or landlord of course!

The point here is that, if the rent is set on a blanket GP margin of 70%, it effectively prices out all small and local brewers gaining the much-needed access to previously tied bar spaces. The deals and discounts offered by the national brewers cannot be replicated by the smaller brewers if priced correctly and fairly. If the now free of tie tenant decides to stock the local/small brewers’ products anyway, despite the lack of discount, they will not be able to achieve the gross profit required in order to meet the rent.

If we take an example pub, with figures set out below. Notice how vital it is in setting the correct gross profit margin. The Pub Co will have you believe you can achieve at least 70% gross profit, whereas in reality, going free of tie will see an uplift in your gross profit compared to the previous tied margins, but maybe not quite as high as they would have you believe. Especially if you are going free of tie for the purposes of stocking local ale and other drink products.

	Tied	Pub Co Free of Tie	Actual Free of Tie
Wet Turnover	£300,000.00	£300,000.00	£300,000.00
Wet Gross Profit at	£162,000.00 (55%)	£210,000.00 (70%)	£198,000.00 (66%)
Operational Costs at 37% of Turnover	£111,000.00	£111,000.00	£111,000.00
Net Profit (Divisible Balance)	£51,000.00	£99,000.00	£87,000.00
Rent Bid Split 50/50	£25,500.00	£49,500.00	£43,500.00

Therefore, any loss or shortfall will come out of the tenants’ share of the profits. In effect, the blanket gross profit margin protects the national brewers’ access to bar space even once the tied tenant has exercised their rights to MRO by ensuring the pub is less profitable or potentially unviable if the tenant does not stock nationally branded products. See below;

	Pub Co Free of Tie RAP	Actual Pub Figures Free of Tie
Wet Turnover	£300,000.00	£300,000.00
Wet Gross Profit	£210,000.00 (70%)	£198,000.00 (66%)
Operational Costs at 37% of Turnover	£111,000.00	£111,000.00
Net Profit (Divisible Balance)	£99,000.00	£87,000.00
Rent Bid Split 50/50	£49,500.00	£49,500.00 (Rent Set as seen to the left)
Tenants Share	£49,500.00	£37,500.00
		(£12,000.00) Tenants Loss of Profit

Pricing is an area most tenants and lessees are able to pick up and challenge. When checking the RAP shadow profit and loss account, is the pricing structure suggested above and beyond the prices you are actually able to charge in your area? If this is not correct, you will be faced with either passing a large price increase on to your customers, or selling under the suggested price structure and face a lower share of the profits yourself due to a reduced gross and net profitability, unfortunately the rent when set will have no regard to this and will be rentalised on the higher level of hypothetical profit that you would not be achieving if left uncorrected.

If you would like to re-trigger your rent use the link below.