[2023] UKUT 217 (LC)

Mr Hunter offered no justification for valuing more than half of the site at 10% of the value of the remainder other than he considered that it had greater potential for development than the surrounding agricultural land. He adduced no planning evidence to support this view but thought that a developer would consider the site as a whole rather than just the northern end which now has planning permission for development (although it did not at the valuation date).

Mr Hunter referred in a number of places to the fact that the site had not been offered in the open market. This seemed to imply that the deal struck between the claimant and DT did not achieve market value and that the purchase price would have been higher if there had been increased competition. Notwithstanding this impression Mr Hunter valued the site at only £7,500 more than the price agreed in principle in 2015 (although the price was renegotiated to account for the risk that a basement might be required). As the price paid by the claimant was agreed in principle within six months of the valuation date, and it was not suggested that the market had moved significantly by the time contracts were exchanged, this might appear to cast some doubt on the suggestion that market value was not achieved.

Mr Hunter also considered whether the development envisaged by the claimant would be viable, presumably as a sense check on his valuation, although he did not explain why this step was required.  He considered the question of viability from two perspectives: first, assuming the intended operation of the claimant, and then as a food-led pub operation.

Having looked at other Albert’s restaurants Mr Hunter estimated that the development would provide 200 internal covers and 230 external covers. He made assumptions about cover turns, spend per head and function income to arrive at a food turnover of £2,820,000 per annum. Food sales would represent about 60% of turnover, so he anticipated that wet trade would be approximately £1,900,000, resulting in a total annual turnover of £4,720,000. He expected gross profit margins on the wet trade of about 71% and 64% on food. Taken together he calculated a gross profit of £3,150,000 per annum. He estimated costs at £2,150,000 per annum but gave no indication of how he arrived at this figure other than mentioning that labour costs would be £1,670,000 per annum. The Albert’s operation relied on excellent service and standards which would result in a lower fair maintainable operating profit (FMOP) to turnover ratio than most corporate operators. The profit (FMOP) in this particular instance was put by Mr Hunter at £1 million per annum.

Mr Hunter then considered the venue in the hands of a food-led national operator. Such an enterprise would be based on a smaller footprint of 150–180 covers and would be aimed at a more price conscious consumer resulting in a lower turnover. He assumed 180 internal covers and 120 external covers and arrived at an annual turnover of £650,000 for the wet trade and £950,000 for food. In this relatively affluent part of the country he would expect gross profit margins of 72% on wet turnover and 68% on food producing a gross profit of £1,120,000 per annum. The operation would be less labour-intensive than Albert’s and Mr Hunter allowed £460,000 for wages and total costs of £625,000. The annual FMOP would be £495,000. Assuming a multiplier of 8 times the FMOP, once established the business would be worth £3,960,000.

We assume that costs excluding labour were estimated to be £480,000 for the Albert’s scenario and £165,000 for the food-led pub. Mr Hunter did not explain how property costs had been accounted for and made no reference to the assumed tenure. We assume he envisaged that the operator in both scenarios would have the benefit of the freehold, but we would have been assisted by an explanation how the purchase and development would have been funded, and how such costs would have been reflected in the annual operating cost. Such lack of detail was a recurring theme in Mr Hunter’s evidence which left the Tribunal less than confident in the conclusions that he had reached.

Mr Hunter also considered the costs of development, and looked at the build costs of 14 projects that he had been involved in. The buildings ranged in size from 641.7m² to 793.3m² and the costs were in the range of £2,569 per m² to £4,029 per m². He took the average of the costs at £3,195 per m² and applied it to a unit of 660m² suitable for a branded pub operator. There is an obvious flaw in using an average build cost derived from a sample where there is a 23.6% difference in size between the smallest and largest and a 56.9% difference in costs and applying it to a building at the lower end of the size range. Additionally, once again, too little detail was provided to make this exercise worthwhile. The sites were not identified and there was no information on ground conditions, building types, or fitting out. It was unclear whether the costs included the external areas and whether such areas were proportionately similar in all cases. The most we could discern was that there appeared to be a broad, inverse relationship between size and cost, but beyond that we found the information of no assistance.

In June 2021, in a report for the claimant, Mr Hunter calculated that the building costs for their proposed restaurant would be £5,380,000 including £230,000 (5%) for site clearance and £580,000 (12%) for professional fees. The same report included his opinion of the rental value of the proposed restaurant and of a smaller food-led pub. He thought the property would not be let on the open market as a managed pub. If a letting was assumed, he considered that the tenant’s rental bid would lie between 45% and 55% of the FMOP at the valuation date. He arrived at a figure of £250,000 per annum as the headline rent (50.5% of FMOP) with a six month rent free and a stepped rent until year three.

He also assessed the rent for the proposed restaurant at £300,000 per annum with the same incentives. This equated to 30% of FMOP for a restaurant that would be more than twice the size of the food-led pub operation. He explained this disparity by commenting that there is a limit to the rent that an operator would be prepared to pay irrespective of the size of the restaurant. Putting it another way, there is a quantum effect with larger restaurants although we note that the estimated FMOP for the larger operation is greater in absolute terms but lower on a unit basis in comparison to the food-led pub. The former is £680 per m² and the latter £750 per m².

Mr Hunter’s conclusion from his viability exercise was that the value of the completed, trading operation exceeded the costs of creating it, including the site acquisition and building costs. However, this conclusion applies solely to the food-led pub operation, since he did not test the viability of a local or regional operator with a bespoke offering, beyond noting that such an operator would expect an EBITDA of 25 to 28% of turnover.

Mr Owens explained that unlike other generic classes such as office, industrial or retail the value of leisure property depended on trading potential. To undertake a profit based valuation the valuer needs to consider the business in detail and assess the level of trade that a reasonably efficient operator would expect to achieve assuming that the property is fully equipped, properly maintained and decorated (the fair maintainable trade, or FMT).

The next stage in the valuation process is to ascertain the FMOP (Fair Maintainable Operating Profit) which is the profit excluding depreciation and finance costs that the reasonably efficient operator would expect to derive from the FMT. This should take account of all costs and outgoings as well as an appropriate annual allowance for periodic expenditure such as decoration, refurbishment and renewal of the trade inventory. These costs and allowances should reflect those of the type of operator who would be most likely to acquire the property were it to be offered on the market.

The final step in the valuation is to capitalise the FMOP at an appropriate rate of return reflecting the risk and reward profile of the property and its trading potential. This is usually achieved by reference to evidence of relevant market transactions.

Having described how one would usually value a leisure business, Mr Owens noted that the Cheshire Lounge had closed before the valuation date. We assume (though he did not say so) that he had in mind the difficulty there would be in assessing the FMT for the site without any evidence of the trade which had been achieved from it. But, for whatever reason, Mr Owens said that he had agreed with Mr Hunter that the Cheshire Lounge should be valued as a development site. He considered that the hypothetical purchaser would use a residual valuation approach but in place of the gross development value of the completed site, a figure derived from the application of an appropriate multiplier to the FMOP would be used. The site value could then be arrived at by deducting the cost of development and making an allowance for risk and return.

Mr Owens also reflected that trading premises can be owned as investments and let on a tied or free of tie basis. In most cases where that situation arose the landlord was a pub operating company. In such circumstances it was appropriate to arrive at a value for the premises by utilising a traditional investment approach, capitalising the rent, having regard to the fact that the property is a trading entity.

Despite apparently having agreed that the property should be valued as a development site and stating in his evidence that a residual valuation would be appropriate, Mr Owens valuation with the original access arrangements was based on a capitalisation of the last passing rent of the 2014 Cheshire Lounge building. No explanation was given for this departure from what was said to have been agreed.

Mr Owens placed particular weight on a letting of Worsley Old Hall to Brunning and Price in mid-2013 (ironically, Brunning and Price were one of the operators Mr Owens thought would not have been in the market for the Cheshire Lounge). The initial rent was £81,000 per annum with a 9 month rent free and a contribution towards dilapidations. Mr Owens regarded Worsley Old Hall as a superior site to the Cheshire Lounge, and a photograph in his report showed it to be an imposing building set in sizable grounds, adjacent to a large hotel and a golf course.

Mr Owens pointed out that the rent agreed for Worsley Old Hall was not dissimilar to the passing rent at the Cheshire Lounge before its closure (understood to have been £84,000). His valuation was based on the assumption that the Cheshire Lounge could have been relet at the rent of £84,000 passing before its closure without any further adjustment. He offered us no detail about the terms on which this rent was assumed to be achievable or even the date on which it was expected to take effect. In selecting that rent, Mr Owens said he had used his market knowledge, but he had no access to trading information and the Cheshire Lounge was not let on the valuation date. It had also changed hands several times over a relatively short period of years while it transitioned from a managed operation to a tenanted pub. This direction of travel was said by Mr Owens to suggest that its trading fortunes had diminished over time but he did not comment on the liquidation of the last business to trade there or consider whether the level of rent might have been a contributory factor in its demise. Without information about when, and based on what level of trade, the last rent was agreed and given the differences in style and location between the pubs, it can only be assumed to be a coincidence that the rents for the Cheshire Lounge and Worsley Old Hall were so close.

Mr Owens considered that the covenant strength of a tenant likely to take a tenancy of the Cheshire Lounge would be weak and that was reflected in the gross yield of 8% he used to arrive at his valuation. This yield was again based on his market knowledge, and we were provided with no transactional evidence to support it. The result was a valuation as follows:

We were surprised by the lack of detail in this valuation and although the Tribunal is more than capable of deducing the years purchase deployed it would have been helpful if the valuation could have been set out in a more conventional format. No account was taken of purchase costs, letting costs to achieve the assumed letting which did not yet exist, nor any void or rent free period, contribution to refurbishment or other inducement.

Having valued the Cheshire Lounge by means of an income based approach Mr Owens made the curious observation that ‘as a potential development site there is a wider range than normal in the valuation’.

Unlike Mr Hunter, Mr Owens considered that the change in access arrangements had resulted in a diminution in the value of the Cheshire Lounge. He did not think the maintenance costs of the new access would be taken into account by a prospective purchaser, and he had been instructed to assume the benefit of a completed deed of easement, but he did consider that the longer and narrower route would have a limited depressing effect on value. Most operators anticipating a significant investment in such a redevelopment project would prefer a shorter access with lighting, lined carriageways and kerb edging. He acknowledged that evidence to support a discount would be hard to come by and therefore relied on his ‘extensive experience’ to arrive at a figure of 10%. His valuation with the new access in place was therefore £945,000.