A third of the U.K.’s pubs have the opportunity to break supply agreements that force them to buy beer from their landlords and renegotiate contracts to potentially lower their rents, all as a direct result of the government’s handling of the COVID-19 pandemic.
Industry experts say the U.K.’s tiered lockdown system—designed to restrict trade and freedoms in targeted areas where COVID-19 rates are high—could trigger a clause in over 12,000 leases that allows publicans to renegotiate terms if they can prove their income is directly impacted.
In the U.K., all pub rents are determined by the estimated revenue that a pub can earn. But with COVID-19 likely to reduce business for at least another year, those rents are now overestimated. That problem is compounded by the fact that tied pubs are obligated to buy their stock from their landlords at inflated prices. The ability to renegotiate their leases could save thousands of pubs from closure, while the opportunity for pubs to break their ties—known as going “market rent only” or MRO—might help breweries find vital new taplines and stockists in their own bid for survival.
This scenario applies to all tied tenants of pub companies with over 500 sites in England and Wales, allowing tenants to negotiate if their ability to do business changes significantly during the timeline of the lease. Those with leases need to present an event or circumstance that has arisen as a result of the tier system—such as the closure of a local attraction or large local employer—that will cause a drop in sales for at least a year. They also need to show that the event in question was unforeseeable; not related to or controllable by the tenant; and affects other local pubs but not all U.K. venues.
That final condition meant that a nationwide lockdown such as those in March and November did not trigger the clause. That changed when the government’s localized tier system was set out on Nov. 26, giving pubs in each region different rules, restrictions, and levels of financial support.
Publicans will have a fight on their hands, however. The clause is largely untested given the remarkable circumstances required to enact it, and large pub companies have been criticized in the past for refusing and stalling MRO applications. Claimants also have to show proof within eight weeks of the change in their circumstances, and in many cases that means the clock is already ticking.
The beer tie is a highly controversial part of the U.K. pub industry. Campaigners believe it is used to exploit and extract undue profit from publicans, and this rare moment represents the widest collective opportunity ever for the industry to break the system down. But for individual publicans it’s also a chance for pubs to readjust their rent and profit margins for the tough economic times ahead.
Despite a vaccine being rolled out across the U.K., the pandemic-induced drop in sales is expected to harm on-trade businesses beyond 2021—across the globe, analysts believe business won’t return to 2019 levels until 2022. Tier restrictions are not expected to be lifted until April 2021 at the earliest. Continued economic damage means that without further support or lower costs, over 70% of hospitality businesses fear they will go under.
Tied pubs are uniquely vulnerable because their flexibility and profit margins are restricted by the obligation to buy their stock from their landlord. Chris Wright, whose Pubs Advisory Service helps tenants negotiate with landlords, says this could be some businesses’ last chance.
“If they don’t renegotiate, many of these pubs will go bankrupt,” he says. “They [publicans] may not know it yet, but at their current rent these businesses will be unviable next summer.”
Pub companies will disagree. Tied rents are typically lower than free-of-tie rents, and pub companies have all offered some level of rent discount during the pandemic—although many were slow to offer it during the early days. However, pub companies routinely charge 35%-45% above the market price for their products, and in some cases have even misrepresented how much beer is in the casks they provide, causing thousands of pubs to pay for beer that never existed.
In 2016 the government introduced the Pubs Code, a piece of legislation that regulates the largest pub companies. Most notably it gives tenants the option to negotiate going “free of tie” at the point of contract renewal or agreed moments during the lease. Pub companies such as Heineken’s Star Pubs & Bars have been fined for purposefully making the process long-winded and costly, but stalling the process will be harder with the tier-based trigger. By negotiating mid-contract, publicans can use a “deed of variation” to adapt their lease, rather than having to bear the costs of a new legal agreement.
As the country heads into 2021, the first few cases of MRO negotiations have given an indication of the real opportunity for tenants. Typically rents will go up when a pub goes MRO as pub companies look to claw back profit lost on beer sales, but since COVID-19 some have actually gone down.
David Morgan, a partner at Morgan & Clarke Chartered Surveyors, has 40 years of experience in valuing pub rentals. Since the pandemic began, he’s worked on more than 10 MRO negotiations with four different pub companies. Despite those businesses asking for an average 74% rent increase to go MRO—in one case a jump from £38,000 ($50,600) a year to £90,000 ($120,000)— he says independent valuers increased the rents by an average of just 4%, with half of them going down. Even a small increase would result in significant extra profit for a publican, as they gain access to significantly cheaper market prices for beer, wine and spirits.
Wright adds that while there has never been a more “fertile” chance to break the tie, this moment is more about the long-term survival for many in the U.K. pub industry. Pubs are currently being propped up by a combination of government support, tax holidays, and small business grants, as well as rent support from their landlords. Government support is unlikely to continue once restrictions are lifted—regardless of whether business returns to normal levels—and while the major pub companies have all pledged to continue to discount rents, they have no contractual obligation to do so. Wright says that publicans need more certainty than that.
“If the pub companies really want to show they support tenants during this time, they should bake that support into the contracts now,” he says.
While Wright claims the opportunity is clear and the moment pivotal, it may be harder to enact in reality. Because the tier system itself is not the trigger, the difficulty will be in demonstrating a provable “event” has changed trading conditions for a given pub. He has, however, seen compelling examples of businesses that have made the case for changing their leases. These include pubs located near transit hubs to London, where commuter numbers have dropped as people work from home; pubs located near closed sports and music stadiums; and pubs in areas reliant on tourism, such as Cornwall.
There may also be some reticence to take on the risk of going it alone. Pubs that went MRO before the pandemic have not received any rent support from their pub companies, and experts say this could put off businesses from applying. A spokesperson for Star Pubs & Bars, which owns 2,900 pubs in the U.K., said they had had “zero demand” for MRO negotiations and that their tenants were “delighted with the level of support we have offered.” Marston’s said they had tenants going through the MRO process but that many were “understandably stalling” to ensure they received rental support during the pandemic.
The pub companies will also do all they can to persuade publicans to stay tied. While Star Pubs & Bars isn’t alone in attempting to make the process onerous, it could also present an opportunity for publicans to simply negotiate a rent decrease in return for staying tied.
Some, however, will be determined to escape. Phil Eades, who runs the Globe Inn in Swanage, tried to go MRO two years ago during a rent renewal phase, but couldn’t afford it due to what he says was financial “bullying” by Punch Pubs & Co, which demanded quarterly rent in advance and a three-month rent deposit at the start—potentially totalling more than £14,000 ($18,800) at the start of the contract. In the end Eades accepted a 30% drop in his tied rent instead, but he now plans to use the lockdown tier system as a trigger for a second MRO attempt.
Eades submitted his trigger letter in early December but is yet to hear back from Punch, which has 28 days to respond. Eades understands the company is “not making any predictions” about future trading conditions, but says it has granted Eades a 75% reduction in rent while he is closed and restrictions remain, which he says shows Punch’s belief that making profit in these conditions isn’t possible.
“If they accept the MRO and we negotiate, then we’ll see what they think trading will look like over the next year,” he says.
Where negotiations do start, there is likely to be a disagreement about new rental values. Both the pub company and the publican will estimate how much the rent should be, as well as enlisting an independent chartered surveyor. These figures typically vary widely, as pub companies attempt to address the loss of profit from supplying the pub with stock, and publicans seek to get the best deal they can.
Morgan says at the moment, pub companies are “blinded to the financial viability” of most of their pubs and that, when it comes to valuing pubs going forward, the only “rock solid” certainty is that 2021 sales will not reach 2019 levels.
“In our view the effect of COVID will flow right through to 2022,” he says. “[Landlords] have to take that into consideration.”
While these pub companies continue to push for 2019-level rental values—around 70% higher than independent valuers suggest—many have urged caution when talking to their investors. Marston’s’ half-year results in June 2020 said it was clear there would be a “contraction,” and that there is “uncertainty as to the long-term impact” of COVID-19.
Wright is bullish about the chances of success with this trigger in both reducing rent burdens and achieving MRO for publicans who want to break free, and says he is already working with over 50 pubs on proposals. Ultimately his goal is the abolition of the tied model, and both he and Morgan see this as a chance to accelerate the process. If rental values are suppressed and pub companies lose much of their wholesale profits through MRO, it could stop these large landlords being able to service their mortgage debts—resulting in either going out of business or offloading huge numbers of pubs.
“It’s a slippery slope,” says Morgan. “They know it, so they will fight tooth and nail to keep people tied.”
That will mean a fierce legal battle for any publican but—after decades of declining profits and the toughest year for the industry in living memory—there is a feeling that this is also a simple fight for survival.
Words by Jonny Garrett