The value of freeholds in the sector can be an “illusion” and operators are restricting themselves if they avoid leaseholds, according to serial industry investor Luke Johnson.
He told the Association of Licensed Multiple Retailers (ALMR) Spring Conference that freehold assets “aren’t necessarily as solid as [banks] like to think”.
“Bricks and mortar can be an illusion sometimes, and if you look at some of the colossal value destruction on complicated securitisations… a lot of that is based on the ‘undeniable’ value of freehold property that isn’t always there.”
Johnson, who investments have included PizzaExpress, Giraffe and Patisserie Valerie, highlighted the “curious anomalies” that can you can get “value destruction” with a freehold pub.
He added; “The differential multiple of earnings on a freehold pub and the same premises [that is] leasehold doesn’t account for the full value of the freehold.
“You might get six times of EBITDA on a leasehold estate and 10 on a freehold. That doesn’t pay for the freehold. That’s one of the argument why I don’t necessarily like freeholds because I think to buy a commercial freehold might cost you 20 years’ earnings.”
The Risk Capital Partners chairman said operators are “restricting themselves” by only seeking freeholds, especially with the growth of shopping centres and retail parks that are “virtually never going to be freehold”.
Peter Hansen, founder of Sapient Corporate Finance, said: “There is much greater acceptance today of the role that leaseholds have to play in businesses than there would been even five years ago, 10 years ago, as long as the leases are not onerous and account for too much of the EBITDA.”
Crispin Tweddell of Piper Private Equity, which last year invested in café bar concept Loungers, which predominately operates leaseholds, supported their view.
“Why be a property company as well as an operator?” he said. “Just stick with operating. God knows that’s difficult enough!”
Loungers managing director Alex Reilley added: “Retail seems to have got its head around leasehold businesses. They are not fussed at all about owning the freeholds. We have to almost accept that the business needs to leech off the property.”
Mike Delay, head of licensed trade & leisure operators at Barclays Bank, also indicated that his company can look favourably on pub company leaseholds.
“We like the Punch assets and Enterprise assets in terms of the longevity of some of the leaseholds, and the not too onerous terms on those leases. So we are lending against those leases.”
He added: “Clearly it’s all about the fundamentals of the performance and the licensees within those units.”
In general, Delay said there’s been a “slow turning of appetite” for lending to the sector in recent times.
Views differed among the panel of investors and operators about the merits of discussing some kind of exit strategy prior to an investment being made.
Reilley said “pragmatic” discussions were held with Piper about who it may want to sell to prior to its investment in Loungers.
But Johnson said: “I never ever talk about exit when I go in.
“I take a quite different view, I take the view that if you’re talking to the founders who have put their life and soul into the business, if you are talking in your early meetings about how I’m going to get out of this, how am I going to get this cash out, I think it’s insulting.
“I focus on is this a good business we can grow and can we add value on the way.”
“I do not focus obsessively on four or five year plan, or whatever.”
He gave the example of Giraffe; Tesco bought Risk Capital’s stake in the business earlier this year when it acquired the company for £48.6m. It worked out as an eight-times return on investment after a nine-year investment.
“Wait until they come knocking and you’ll probably get a good price,” Johnson added.
He was also critical of the principle of operators taking cash out of a business when it’s sold to investors, unless there are particular circumstances, such as a big mortgage.
Johnson said he wanted to work with operators who “have their balls on the line, or the female equivalent”.
“I don’t want people who want an ideal world, a work life balance.
“Forget that. I want people who are going to put their heart and soul in this business and make real sacrifices to create incredible value.”
