Scottish Pubs Code and related regulations: business and regulatory impact assessment

Annex C

Rent Reviews

Background

The rent review process is a mechanism by which the ‘dry rent’ paid by the tied pub tenant to the pub-owning business is re-evaluated and potentially adjusted. The purpose of the process is to ensure that the rent paid by the tied pub is fair and reflects market conditions. The rent review can be influenced by various factors such as changes in market conditions, the pub’s performance, and any investment made by either party.

It is proposed that the tenant can request a rent review, in certain conditions, which then initiates the rent review process. The first step of the process is the rent assessment statement provided by the landlord to the tied pub tenant. The tenant and pub-owning business must mutually agree the new rent, after a rent assessment statement is provided, after a period of 6 months or failing which, the rent review process comes to an end.

Insights from stakeholder engagements show that there is a level of information asymmetry in the industry, with tenants calling for increased transparency around the process of determining rent. Obligating the pub-owning business to provide the tenant with a rent assessment statement is expected to close some of this information gap and support greater transparency around the process as the statement is to disclose all the matters that have been relied upon to determine the rent. This increased level of information is expected to increase a tenant’s bargaining power in negotiating a mutually agreed rent.

Estimating costs of rent reviews

The cost of each rent review will depend on the amount of work involved and who is employed to complete it. Our understanding is that rent reviews can be conducted by the pub-owning business’s staff. While tenants may face some time-related costs in preparing for a rent review, these are expected to be fairly nominal, and it is expected that the pub-owning business will bear most of the associated costs. Based on insights shared by the SBPA, the average cost of rent reviews carried out by responding members in 2022 was £1,750 – although responses varied, presenting a range of £1,500 to £2,500 per rent review. The costs calculated below will be 5-yearly costs.

For the purpose of an illustrative analysis of the possible costs of the rent review process arising from these regulations, we assume that 15-25% of tied pubs in Scotland could request a rent review under the code. This is an estimate but in engaging with stakeholders, we think it to be a realistic one. This is because, some of the pub-owning businesses have tied pub leases that are shorter than 5 years and will therefore have a rent assessment as part of a new lease agreement at a frequency of less than 5 years. In this circumstance, tenants will not be in a position to request a rent review provision under the code. Another pub-owning business has stated that their tied pubs leases already have a rent review clause. Therefore, the proportion of tied pub tenants that could request a rent review under the code will be less than 50% but more than 0%. Furthermore, in engaging with stakeholders it appears that most tied pub tenancies in other pub-owning businesses in Scotland are 5 years or less and, therefore, the 15% to 25% range is likely to be a reasonable estimate of the proportion of tied pubs that could request a rent review under the code (although we recognise the numbers requesting a rent review could feasibly lie out with this range).

Taking the above assumptions, it is assumed that out of the estimated total 700 tied pubs in Scotland, 105 to 175 tied pubs will be eligible to seek a rent review, as described.

An upper bound for this cost can be established by supposing a scenario in which all eligible tied pubs request a rent review. In such a scenario, the estimated number of rent reviews to take place is between 105 and 175. A total cost of internal rent reviews faced by the pub-owning businesses can be estimated by taking the number of eligible pubs and multiplying this by the average cost of a rent review. This gives an estimated total cost of between £183,750 and £306,250. The costs are likely to be closer to the upper bound estimate for Option 4 as more tenants will be able to request a rent review.

These costs are expected to be realised over a 5 year period because not all tied pubs will be at the 5 year mark of their tenancy at the same time. To determine an annual cost, we can assume a scenario in which all tied pub tenancies are 5 years in length and that the distribution of tenancies at their 5-year mark is evenly distributed over the 5 years i.e., a 5th of all tied pub tenancies reach 5 years in the first year, a fifth in the second year and so on. Therefore, we can assume that out of the 105 to 175 eligible tenancies, 21 to 35 pubs would request a rent review each year. Thus, multiplying the average cost of a rent review with this number of tied pubs, an annual cost of between £36,750 and £61,250 is arrived at.

Conversely, a lower bound for the cost of internal assessments can be established by assuming a scenario in which, annually, only 1% of eligible tenants exercise their new right to request a rent review. In such a scenario, the 1% of eligible tied pubs (one to two tied pubs per year) is multiplied by the average cost of internal rent reviews which gives a total cost range of £1,750-£3,500.

The above looks to demonstrate the perceived two extremes of the cost of rent reviews. The true cost will likely be somewhere in between these estimates. However, due to a lack of evidence and the effect of individual circumstances, it is not possible to be more specific.

Costs/benefits which cannot be quantified

Increased bargaining power for the tenants – It is expected that a statutory right to a rent review will increase the bargaining power of the tied pub tenants and that this will result in them gaining more favourable terms in the leases, even in circumstances where a tenant chooses not to utilise this clause.

Increased transparency – It is proposed that the code will require pub-owning businesses to provide tenants with a rent assessment statement as part of the rent review process. The rent assessment statement is a statement which declares the rent to be paid by the tenant, and any information that was used to determine the rent. The rent assessment statement is expected to result in increased transparency in the market with tenants expected to receive better understanding of how their rents are determined. This may then result in better relationships between the businesses as tenants hold a better understanding of the pub-owning business decision processes.

Costs and benefits of the rent review outcome – Although there is a possibility that the outcome of the rent reviews is that the rent remains the same, the rent may also decrease or increase. In such a case that the rent decreases, we would expect that the tenant gets a benefit in terms of decreased rent mirrored by a cost to the pub-owning business in terms of decreased rent. And, in a case that the rent increases, the pub-owning business will receive a benefit in terms of increased revenue while the tenant sees a cost of increased rent. However, these outcomes have not been quantified as there is too much uncertainty around them.

Uncertainty/risk in the analysis

Change in material circumstances – Understanding how many tenants may need to request a rent review as a result of a change in their material circumstances is a challenge. It is nonetheless expected that the inclusion of such a clause presents a particular risk that the cost of the rent review provision will be higher. This is because it provides additional grounds on which a rent review can be requested and additional grounds to challenge a rent assessment statement. However, it does not increase the eligibility of rent review requests as the condition of a minimum 5 year tenancy remains.

This added uncertainty in the tied pub industry might impact pub-owning businesses desire to invest as they are less certain on what the rent will be and how large their costs will be as a result of the rent reviews. This might incentivise pub-owning businesses to turn their pubs into management agreements as opposed to tied leases.

Having such a provision will, however, benefit tied tenants by giving them increased certainty if they feel that the rent is not representing the market conditions. Additionally, in relation to Option 4, if a tied pub is worse off as a result of a change in circumstances, it will be beneficial to both the tenant and the pub-owning business to review the rent.

Increase in short term leases – Stakeholders in the industry, especially tenants and their representative organisations have voiced concern over pub-owning businesses continually renewing only short-term tied agreements as a way of preventing tenants attaining the right to request a MRO lease. With the right to a rent review only being exercisable at the end of a 5-year period of a lease that has not had a rent review within that period, it is possible that pub-owning businesses would decrease the length of tied tenancies to under 5 years. However, the extent to which this may happen is uncertain.

Cost of rent review – The total cost of an internal rent review is uncertain. Although there are some figures suggesting the cost of a rent review, these are based on the current market circumstances. It is possible that the cost of rent reviews increase with the introduction of the code as pub-owning businesses are expected to provide additional information. However, it is also possible that the costs of rent reviews decrease as a result of the code in the long run. This may occur if pub-owning businesses look to establish rent reviews as a default part of tenancy agreements.

The frequency of rent review requests – There is uncertainty around the frequency of rent review requests by tenants. Although, we would expect them to rise as a result of the code, this will undoubtedly vary depending on circumstances. The state of the market can influence the frequency of requests. For example, if the code results in a decrease of tied pub tenancies, then we would ultimately expect the costs resulting from rent reviews to decrease as well.