In the drink

According to the British Beer and Pub Association, pubs in the UK are closing at a rate of 52 per week. The typical English local pub, traditionally the 'wet-led' operations '“ establishments where people, mostly men, went for their regular pint of ale and a smoke '“ are disappearing.

The smoking ban, in force since July 2007, is undoubtedly a factor in the sharp decline of this type of pub, but it cannot be held solely accountable. 'We've had these successive bits of bad news in the economy,' says Peter Holden, partner and founding member of Milton Keynes-based firm Kimbells, which acts nationally for brewers, pub companies and the licensed trade.

He continues: 'People's discretionary spend has been hit as a result of the recession, at the same time as tax duties being put up '“ the government now reportedly makes £85,000 out of each pub in the UK '“ and with the smoking ban too, this has led to the perfect storm.'

Tied down

And now there are more clouds gathering, says Holden. The long-running debate over the beer ties is once again rearing its head. As a result of the Tied Estates Order in 1989, most pubs are now owned by large pub companies (pubcos), such as Enterprise and Punch, which let pubs to tenants subject to tie agreements with suppliers they have directly negotiated separate contracts with.

But many pub tenants aren't happy with this arrangement. They have been lobbying for an end to the beer tie arrangement, claiming that pubcos use their position to impose heavy rents and that they don't pass on the full benefit of discounts on liquor to tenants. One argument is that the supply agreements mean that prices are so tight often there is little profit to be made.

A House of Commons' Business & Enterprise Committee report, published on 13 May 2009, suggested that the trading tie is potentially anti-competitive. Holden points out that 'while these are suggestions only, they may be taken into account in future legislation and, particularly, in any new block exemption from article 81 of the Treaty of Rome'.

Article 81 prohibits agreements which affect trade between member states and have as their object or effect the prevention or distortion of competition in the common market. However, certain agreements with economic benefits can be immune from the ban under European Commission block exemptions '“ for example Regulation 2790/99 on vertical agreements. The trading ties for pubs in the UK is one such example, with the widely held assumption being that the tenant receives benefits equal to the cost of the tie.

The block exemption rule in its current form ends in May 2010. Holden thinks that although it may well be renewed on the same terms, 'in my view that's unlikely'. His firm is already seeing a lot of queries from brewer clients who want to know that their trading agreements will be compliant with the provisions of the block exemption, 'and we expect these to increase'.

Carmela Inguanta, a partner in the Leisure & Property Management Group at London firm Sprecher Grier Halberstam LLP, counts a number of pubcos among her clients. From her perspective a review of trading ties regulation is unnecessary. She points out that the block exemption debate has been around for many years, and she finds it interesting that the trading tie issue has been resurrected at a time of economic recession. 'It stems from the fact that pubs are finding it challenging because of the economic climate. It is not necessarily because pubcos are charging them too much. And those complaining do tend to disregard the other support services pubcos provide.'

A better offer

Rather than revisit the rules, Inguanta thinks that the key to trading success is in pubs being more versatile and offering better products. 'In a recession trade is difficult, but you can't get away from the fact that it's the better operators that will survive, if they adapt and change their offering.'

She also feels that the statistics we read in the media about pub closures do not reflect the true picture, 'as they do not take into account the ones that are re-opening'. Many, she says, even re-open on the same day as repossession takes effect, albeit under new tenancy.

The BBPA report said that new-style branded pubs and café bars were opening at a rate of two per week, showing that there is some growth in the market. Dominic Beeton, a partner at Beeton Edwards LLP, a niche property law practice that recently set up in Southampton, counts several such gastro or café-style bars among his clients. The success of these establishments, he says, is in them becoming friendlier, more welcoming places, that appeal to women as well as men, that are no longer full of smoke, that have a good food offering and that take advantage of the gaps in the market.

'One client in Southampton has eight luxury bedrooms above and a high-class restaurant below. There aren't that many good restaurants in Southampton itself, so he is filling a gap in the market and he will do well,' he comments.

Whatever your style, however, public houses, like many other types of commercial businesses, are facing the problem of trying to raise finance during a recession. But unlike other businesses, Beeton points out, 'because the leisure industry has traditionally been very highly leveraged, the banks regard it as particularly high risk. They are now looking to go as low at 50 per cent loan to value. So anyone doing refurbishment or building a new leisure unit has got to find 50 per cent of the funds out of their own resources.'

He has also seen how difficult it is to assign leaseholds at the moment. 'You've got all these requirements on securities, bank guarantees, references, often being asked for 12 months' rent in advance'¦ it's a lot of money. And you have to pay three months' rent upfront. Landlords are digging their heels in and being very unreasonable in granting consent.' And disposals are taking three or four times as long, 'as landlords are being so difficult'.

Room for improvement

In the wider leisure sector, it may be the pubs that have garnered the most public sympathy, but hotels too have their own set of problems '“ as well as many of the same ones. While people are choosing to eat and drink at home instead of going down the pub, they are also avoiding spending on hotel rooms. And corporate clients have had their budgets cut.

'A room is a fixed asset for a hotel business, but many also depend on trading profits from selling food and drink, or from hosting conferences and events,' says Dawn Stallwood, head of Thomas Eggar's hotel and leisure group in Gatwick. 'With corporates cutting back, the hotels are facing a reduction in revenue, and competition for customers is growing.'

And, like pubs, hotels are finding it hard to raise finance. 'Some hotels are trading in breach of their banking covenants so there's the risk of banks calling in the loan,' says Stallwood. A covenant might require the real estate to maintain its value, and in a downturn property might not be worth what it was. Or it could be that revenue or profit targets are not being met.

'Banks are becoming more interested in the performance of the business than before,' she says. 'Hotel owners have now got to be more aware of the day-to-day performance of the business and be acutely aware of their obligations to creditors. And they must keep their accountants and auditors close at hand, to be given strategic advice on how to present their accounts to the banks.'

According to Stallwood, any level of hotel 'is going to have to produce a compelling argument' to obtain finance. And it's finance that they now need more than ever. 'It would be interesting to see how many hotels are dipping into their overdraft facilities as compared with last year,' she says.

The recession is also shedding light on another issue: 'Typically, if you've got a branded hotel it is likely that the ownership is distinct from the operation,' explains Stallwood. 'If you've got the brand, you hopefully have the benefits of the brand: goodwill, reputation, intellectual property, economies of scale and marketing ability. But you have to give up some of your revenue as payment.'

That cost is often justifiable, but if the hotel goes into administration '“ much more likely in a recession '“ it is very much the owner's problem. 'The brand may well lose revenue, but it can extract itself and go somewhere else,' says Stallwood. With a lot of brand arrangements, she says, 'the brand will try and protect itself by insisting the bank doesn't terminate the management arrangements; but that it steps into the shoes of the owner allowing the brand to continue'. But if a bank steps in, she says, 'the owners will have a lot of issues'.

Survival of the fittest

Ultimately, to ride out the storm, hotels and pubs must consider how they can differentiate themselves from the competition.

As Stallwood points out, the larger establishments are naturally faring better than the smaller independently run ones which don't benefit from the same buying power or have the same economies of scale, and which have fewer links with the distribution channels.

'But many independent hotels are looking at making branding arrangements, franchising or marketing affiliations as a way of encouraging custom,' she says. And for those hotels who do not want to become part of a brand or chain, 'one tactic is to link up with independent providers who can help them boost their distribution channels, including their online presence, as a route to market'.

Pubs too are learning the benefits of versatility, with more and more becoming multi-channel establishments that sell food and coffee and that offer entertainment channels and family-friendly areas. This might explain why we are seeing large chains like Wetherspoons thriving. They are a far cry from the traditional smoky local pub on the street corner.

And it should not be overlooked, says Peter Holden, that the pubs have had a little help this year with the good-ish summer weather we have had, and the Ashes series. 'It's not all doom and gloom,' he concludes. So it seems not everyone is crying into their beer.