SA Pubs: Rent revision looms for local landlords

HOSPITALITY

The days of sustained incremental rises on pub rents (and values) in South Australia appears over. Hotel landlords (and their financiers) should be mindful that the goalposts are changing and the effect the adjustment may have on their future leasing negotiations and possibly financial position. Ferrier Hodgson’s David Kidman looks at the recent decline in the underlying business performance of hotel operators in the local sector and what impact this is having (or will have) on the income streams and hotel values to their landlords.

Background

For many years, South Australian pub landlords have dictated rental terms and seen their wealth exponentially grow thanks to increasing rent from strong demand from operators, CPI increases, high barriers to entry and underlying growth following the introduction of the lucrative gaming revenues from the mid 1990’s. The general increase in the State’s real estate values has also been a positive for the sector with some hotels also gaining an additional developmental value.

The current state of play

In the past 12 months we have seen many of the State’s leaseholds closing and/or entering insolvency. These include CBD venues such as the Office, the Stag (again), Jack Ruby, the Colonel Light (again) and the Ambassadors and iconic suburban venues including the Semaphore and the Archer. Whilst in the country areas the Lucindale, the Kincraig, the Woodside, the Tintinara and the Traveller’s Rest have all recently fallen on hard times.

Obviously each of these hotels will have its own specific story but it is no secret that many operators in the industry are seeing their bottom line deteriorate due to a number of factors, including :

  • Increased Competition (now approx. 90 small bars licences now in the CBD)
  • Declining Gaming Revenues (Statewide down by circa 6% in past 3 years)
  • Increased Costs (e.g. Electricity/ Wages/Compliance etc)
  • Ageing Venues (no reinvestment, tired looking)
  • Stagnant State Population and Declining Population in Certain Rural Areas

Current rents in many hotels are just too high. In some cases, the net income generated is insufficient to meet all operating costs (including rent) and therefore there is no capacity for improvements or interest and principal repayments.

We are aware from recent pub lease negotiations that the landlords are having to adjust their rent down by up to 35% and/or no upfront capital payment. We are also aware that contributions for fit out improvements or incentives (similar to an office or shop lease) are being offered to attract the right operator.

There are also some landlords selling some of their gaming entitlements as a trade-off for reduced rent under a variation of the lease. However, given that gaming entitlements are now trading at only $12,750 or less than a quarter of their value from six years ago such action provides a twofold blow to the landlord.

Alternatively, several hotels are closing forever (particularly in the country areas) and selling all their gaming entitlements and buildings for alternate use. Previously, a 'sum of the parts' realisation for alternate use was at a significant discount to a valuation based on a solid income stream. With pub rental income decreasing (or likely to decrease) this gap may be marginal or even negative in some cases.

Minimising the Ratchet Clause Effect

In April 2011, the rental threshold under the Retail and Commercial Leases Act 1995 (SA) (the Act), which amongst other things prohibits a landlord from (1) not decreasing rent after a market review and (2) charging land tax to a tenant, was increased from $250,000 to $400,000. This variation was a win for tenants. However this increase has led to judicial and possible parliamentary clarification. This includes seeking to clarify whether this new threshold applies to leases commenced prior to April 2011 and whether a lease can move ‘into’ and 'out of' the jurisdiction of the Act during the term of that lease.

A recent test case involving an Adelaide city hotel with a pre April 2011 lease (with a ratchet clause) with rent payable at commencement at above the old $250,000 threshold, ultimately found in favour of the tenant with the new rent payable at $215,000 (and no land tax payable) from the rent review in 2016. That matter was subject to an appeal by the landlord to the Full Bench of the Supreme Court, but we understand that appeal may have since been recently withdrawn. Therefore, a lease can move ‘into’ and 'out’ of' the jurisdiction of the Act during the term of the lease and there is a possibility that parliament may again increase this threshold in the near future.

To this end, landlords with older leases may be at risk of significant rental reductions from existing favourable lease terms (see hypothetical example).

Hypothetical Example

In November 2008 Landlord Larry entered into a 25 year lease (which included a ratchet clause) with Tenant Terry at $380,000 pa. In November 2018, the lease then was subject to a 10 year market review (in accordance with the lease) which resulted in rent being reassessed at $280,000 pa. Despite Landlord Larry previously having protection from rental reduction at the commencement of the lease in light of the ratchet clause, given the increased threshold, the lease would now fall within the provisions of the Act with lower rent applicable (by $100,000) and no land tax being payable by Tenant Terry.

What will likely happen?

  • Some Hotel operators will be in a position to command a fairer and lower rent (and possibly no land tax due to threshold changes) which should improve their bottom line.
  • Hotel freehold values will reduce for those leases which are affected by rent reductions. This could have adverse consequences if the landlord is heavily geared.
  • Some landlords may need to redevelop or sell their hotel assets at lease expiry or termination.  
  • Larger venues may look to reduce floor space (subject to approval) and re-let for alternative use such as retail or commercial.
  • Those struggling operators that aren’t in a position to have rent reviewed will continue to remain vulnerable to business failure.

How can we help?

Our hospitality team has worked in partnership with financiers and operators in the industry for more than 25 years. We are the market leader in this field having reviewed more than 200 venues and managed over 100 venues nationally in the past 5 years alone.  We provide an unrivalled level of industry experience and intelligence, operational knowledge and industry contacts to deliver our clients commercial and cost-effective solutions. 

 

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