Thursday 23 October 2008

The Tied Pub - for and against

The beer tie and pub companies (pubco's) are being blamed for much of the trouble that pubs are suffering. I'm not altogether convinced that this is true. I am however against the beer tie as I believe it restricts the potential of the craft brewed market, limits customer choice and is a monopoly which exploits the aspirations of up and coming licensees often dashing all their dreams of running a good pub. Conversely it has also provided many people with the ability to gain a foothold on the ladder of pub management, one that they might otherwise have been unable to attain.

In this piece, I intend to explore some of the advantages and disadvantages in a constructive way. I hope, that if nothing else, it might provide an insight for the prospective pub entrepreneur into the various methods of starting out with your own pub business. Careful shopping around at this time, if you can finance the right project, could be very lucrative. Although the pub market is in a bad way, there is the possibility that it will turn around some time soon. As they say, invest when the market is at the bottom, it's judging when the bottom is. It could be a very exciting market to be getting into for those who are brave enough.

The models of ownership

There are 4 basic models of ownership: managed, tenanted, leased and freehold. All these can have a tie associated with them. Freehold is much less likely to have a tie and is only very subtle in the form of a loan with strings, it only requires alternative financing to enable the removal of tie. All other forms normally, although not always, have a tie of some form or another. There is however normally only a tie on the wet trade so the pub that does food or even better has rooms will have various areas of the business with better freedom.

Before I proceed though, I have to point out that whatever model of ownership is in force the thing that will effect success more than anything else is location of the property. I will look at this in more detail later but a pub that is located near centers of permanent population will always do better. Where there is the ability for several pubs to survive in a close proximity, they can often feed off each other, provide a pub "circuit" or an area known for diversity. For location, I would argue that where one pub has a population of less than 500 within a 1 mile radius there is doubt about it's viability. There are special cases in tourist locations, but weather and seasonal effects can make it difficult to make a pub viable where the vast majority of the trade is from visitor numbers.

I am not going to discuss in any details the managed or tenanted model more than to say these properties normally offer the licensee the ability to run a pub without any risk of his own capital. Handing back the keys and walking away is often an option without loosing out. The risk is low but the gains are also likely to be low.

The tied lease

The vast majority of tied pubs after this are leased. There are free of tie leases available but they are not as common. When you "buy" a lease, you are paying for the right to operate the business that runs the operation in the pub building. This lease has a value and the value of the lease is influenced by how well the business runs: a combination of turnover and profit. The building is owned by somebody else, often a pubco or brewery. The responsibility of the owner of the building and the owner of the lease will have been defined when the lease was drawn up by the property owner, although with a new lease there is sometimes a chance to negotiate the terms.

The terms of the lease will determine such things as who is responsible for maintenance of various aspects. Some leases will require the lessee to carry out all necessary work. Often though the property owners will ensure the fabric of the building is maintained and internal decor, fixtures and fittings becomes the responsibility of the lease.

Most importantly the lease will state where the lessee may purchase various product from. In a tied lease much of the "wet" product, i.e. beer, wine and spirits will need to be bought through the property owner, sometimes this can also extend to soft drinks and occasionally food. Sometimes though there is an agreement where flexibility of the tie is permitted.

The cost of buying a lease is a fraction of what it would cost to buy the freehold of the same property. Sometimes it can be a significant portion and sometimes less so. It is though, a significantly less expensive option than a freehold in most cases. There is a bias to this as leased properties tend to be better located for reasons I will come on to. Better location results in a better trade which results in the business being worth more.

Pros and cons of the tie

A significant advantage of the tied lease model is the great support that the pubco or brewery gives to the licensee. They will normally look after such things as the building infrastructure and significantly invest where this is required. If the pub needs a new roof, then it will get one. If the electrics are not to regulations then they will be upgraded. Wet rot, dry rot, rising damp and subsidence should never be a problem for long to the leased pub licensee.

A further advantage is that there is often significant support to deal with legislate issues such as employment law, health and safety and accessibility. Training is often provided and support for cellar management are all provided at either reduced prices or without cost. In short the leased model has inherent built in support. It was recently estimated that current legislative overheads now accounts for £30,000 on average per property.

The leased model has it's disadvantages. For a start the whole of the licensees investment is into the pub business. His only assets are often a few tables and chairs and maybe the kitchen equipment, most of which will have very little second hand value. The majority of the capital he puts into the project is to buy a viable business. If this business turns out to not be viable and folds, he looses everything he has put in.

Free of tie

The free house does have huge advantages. The initial investment costs are normally significantly more but the licensee will have full ownership of the property. A bank may have first call in the event of bankruptcy, but by and large this is a technicality. The property itself would normally have intrinsic value in the bricks and mortar. Even if the pub business were to fail then the owner may still sell the property, although it's value may be reduced due to there being no viable business at a commercial property and the problems associated with applying for a change of use.

It is then, somewhat easier to purchase the lease on a pub than the freehold. But I'd like to explore that a little. As the lease on the pub only has intrinsic value while the business is viable, it can be harder to get a loan. Any loan would have to be an unsecured loan with higher interest rates and the proportion put up by the prospective licensee would have to be greater. For this reason it is often the case that the new lessee will be putting all he has into the business. This can often be the equity in any property he might currently own. Conversely it is perfectly possible to put the equity of many houses owned by 40ish year olds into the deposit for a reasonable freehold property and get a mortgage for the rest. In my limited experience of looking at purchasing freehold against lessee hold the deposit is not that much different.

The current credit situation does make this rather more difficult just now, but then everything is a bit difficult right now. It is important to remember though, and I can't stress this enough, with the leased model, if the licensee fails he will loose everything, but the pubco or brewery will still have the freehold title to the property, the property owner, the pubco or brewery, is putting up very little risk. The leasehold model is there to pass the risk on to licensees and away from pub companies and breweries.

Forming a monopoly

It has become apparent to me that very successful free houses tend to be the properties that get bought up by the pubco's and breweries. They are prepared to pay just that little bit more for the ownership of a very successful pub as it is guaranteed to provide a significant outlet for their own product. This has resulted in a bias in the trade. As mentioned above the location of the pub is going to provide success over and above the type of beer sold, quality or style of food or the friendliness of the staff. Not that I'm diminishing the value of these pub features, but it still remains a fact that some pubs are much harder to run due to location and some will be much easier. The pubco's and breweries avoid like mad the more difficult to run establishments, the ones that rely on food and accommodation for the majority of the revenue, basically, the ones where the location results in low beer volume. The remainder that are in the free trade are more marginal, as a rule or are not true pubs but diverse pubs that might be simply a public bar in a hotel or similar.

Where the tied pub is really a problem is in the removal of customer choice. There will always be a restriction on what the landlord is permitted to sell. A tied pub will almost never sell micro brewed ale. The economics of it will not permit this to happen. Pubco's and breweries own pubs so that they can sell their beer into these tied estates and make money out of the pseudo monopoly it creates. Without this commercial advantage of owning tied pub estates they would not be investing in pubs. In short, it's a double edged sword that cuts at the pub industry.

It's down to choice

The reason that the tied houses work is because both licensees and customers alike choose to get involved. Without customers who patronise these establishments they would not work. People who are looking to run their own pub find the leased property as a perceived lower risk and lower cost option. I don't believe this is the case, but perceived like that it is.

If every person who was looking at investing into the pub trade thought very carefully about what they're taking on there would probably be less successful leases taken out. If every customer looked twice at the beer range and realised that they had chosen a tied house then the free house model would do better.

The most disgracefully action of pubco's is the act of putting a failed tied house on the free market with a covenant on it to prevent it ever being used again as a pub. I am all for free houses that have failed being allowed to be sold and converted to dwellings if the alternative is for a licensee, who has put his life's worth and more into a pub, to loose everything. But it must be tested on the free market first. There are examples of tied houses, where the pub company has competing property close by,  are being sold with a legal covenant that prevents it being opened as a pub.

We do have to remember that there are some good tied houses out there. Generally the vast majority of the general public like the product that is delivered by the tied houses as it represents a consistent and reliable product. This is the same reason of course that keg beers still take up the majority of the market. Bland and predictable is what the majority of consumers want.

Disclaimer - I am not an expert on the legal issues surrounding leasehold's and it is possible I have some details wrong. Please seek independent  expert advise if you are thinking of taking on a leasehold. This independent advise will not come from a brewery, pubco or estate agent. I would recommend the BII in the first instance.
As this is an important issue, please comment on any inaccuracies as I believe we need the issues into the open, as I've said, if for no other reason than to advise new licensees.


Alistair Reece said...

This is a very complex issue, and while the romantic in me would prefer to see only free houses, I can see the value of the tie for getting a foothold within the industry.

Stonch said...

Followed a link here from the Tandleman blog...

Lots of leases are on a "fully repairing" basis - if so, the pubco won't pay for your new roof.

It's not true to say that your "real" investment in a leasehold is merely in the value of items like tables and chairs. A leasehold interest is a real asset - it's a registrable property right, something that can be assigned for value. True, if you go completely bust and the lease reverts to the superior landlord, you've lost everything. However, in most cases you'd simply assign first and you'd be able to extract some value. You might even make a profit, although that's less likely if you've reduced the value of goodwill in the business.

The Woolpack Inn said...

Hi Jeff, Stonch, good to see you!

I don't think that lots of leases are fully repairing in terms of the total, but I admit that I don't know the proportions.

Yes you're right though they do exist and I know of at least one significant one close by me. However this one I know to be free of tie. I wonder if there is a correlation there.

I agree that the goodwill is a significant part of the lease value. I didn't intend to say that it wasn't. Thanks for the clarification.

My main point would be that in most cases the lease is frankly over valued. But it is also true that it is possible for a lease value to be increased by running the pub well, in this case a profit can be made on the value of the lease.

If a pub fails then the lease does become very low in value because the goodwill aspect is reduced or non-existent. Every individual case is different and we could discuss this all day. Without some statistics it would be hard to prove the likelihood of a lessee making a return on his money.