“There’s a lot of private investor money looking for a home in new assets” says Don Smith, who runs listed pub landlord HPI. “Pubs, with their quality tenants and long leases, have become an investable asset class like childcare.”
JLL Hotels’ Ben McDonald attributes the investor interest in pubs to the “strong and consistent cash flows” that their operating businesses generate, backed by “growing underlying property and gaming asset values”.
Key property terms you need to know
- Triple net lease is where the tenant pays for all the costs of the property they are leasing, such as utilities and maintenance upkeep, in addition to rent.
- Yield is a valuation measure to work out how the market is performing. It is calculated by dividing the annual rent by the purchase price. A more expensive property will have a lower yield and is considered less risky, and it is generating more income. If yields are “tightening”, or contracting, the market is getting stronger.
- Book value is the value of a property recorded on a company’s balance sheet at a particular time. For example, a valuation may be done every six months. It may differ from the “market value” of a property, which is the sale price.
- Sustainable earnings is the net income that you can expect to occur year-to-year.
Martin Scott, Australian boss of Swiss fund manager Partners Group, which swooped on the Lucky Hotel in the Newcastle CBD for about $20 million in December and has plans to build a portfolio of assets, calls pubs an “exciting sector”.
Scott, like many other investors, also believes the pandemic shone a positive light on the sector.
“The last few years has shown the importance of spending time together with friends in great hospitality venues,” he says.
“Disruption has hit many markets globally, but this sector is one that will always remain relevant and do well if the offering is right.”
Why have pubs gone up in value so much since the pandemic?
Andrew Jolliffe, a leading pub broker and managing director of HTL Property, estimates real estate values in the sector have doubled since the dark days of the global financial crisis, when banks called in loans on overleveraged owners, sending many to the wall.
“Back then you had pubs trading on yields of 7 per cent, which was the same as the cost of debt,” says Mr Jolliffe, who negotiated the Crossroads Hotel record sale.
“Now [even with yields tightening], you have a 300 to 500 basis point spread between yields and the cost of debt with the lower end of this range applying to metro pubs and the upper end to regional ones.”
Also seeing the surge in values first hand has been JLL’s Ben McDonald, whose sale successes this year include Cremorne’s popular Minskys Hotel, which sold for $39 million last month to the Karellas family and publican Mitchell Waugh.
McDonald attributes the rise in pub values since the onset of the pandemic to three main things. The first is the increasing weight of capital entering the sector, which has created more competition for a limited pool of assets. Then there is the heightened trading performance of the businesses themselves as people returned to their local hotels and clubs in droves, and there’s the historic-low cash rates and liquidity in debt markets (this trend may start to “shift” as interest rates start to rise).
“Significant cap rate compression [or lower yields] over the last two years has been the primary reason behind heightened asset prices,” he says.
As an example, ALE Property Group, before its delisting and sale to Charter Hall and Hostplus, sold six venues to private investors on a weighted average yield of 4.4 per cent and at an average 24 per cent above book value.
Selling agent Nathan Mufale, of CBRE, attributes this result to “the increased weight of capital competing for blue-chip assets in Melbourne’s commercial property market”.
How do they make money?
For investors, a metropolitan pub can typically generate a net return (based on rental income) of about 5 per cent a year. Yields are typically higher in regional towns, about 6 to 8 per cent, as asset values are lower.
Combined with gearing, investors typically seek high single-digit returns although double-digit returns are also very common, says Rick Woelms, national director at specialist finance broker HTL Capital.
“Metro-based pubs typically perform at a 200 to 300 basis points [yield] premium to their regional counterparts, albeit this gap with regional assets is, and has, closed considerably as regional populations and footfall grows,” he says.
As operating businesses, pubs make money from a variety of revenue sources, including food and beverage sales, gaming, retail sales (through onsite liquor stores) and accommodation.
“A typical pub will operate on a profit to sales ratio of between 20 and 40 per cent, dependent upon the revenue mix,” Woelms says.
As a good working example, the previously listed Redcape Hotel Group generated more than 60 per cent of its $335 million in annual revenue in the 2020-21 financial year from gaming, about 20 per cent from food and beverage sales and the rest from liquor sales.
Its operating earnings of $74 million were delivered on a profit margin of 22 per cent across its 34 venues worth about $1.3 billion.
Not all pubs are as reliant on gaming for their revenue and profits.
The Public Hospitality Group, which owns 14 venues in Sydney, Melbourne and regional NSW, derives only 7 per cent of its revenue from gaming, the prospectus for the group’s now-aborted float shows.
With a focus on appealing to trendy urban dwellers, about 70 per cent of the group’s $93.5 million in annual income comes from F&B sales and about a quarter from its 319 accommodation rooms. PHG forecast operating earnings (earnings before interest, taxes, depreciation, and amortisation) of $33.5 million, a profit margin of 35.8 per cent.
What makes a pub worth $10m or $100m?
It is important to distinguish between straight pub investments, where an investor acquires only the real estate and leases the venue to an operator, and “freehold going concern” sales, where an owner-operator (often a publican) acquires both the property and business.
As with other commercial real estate investments, freehold pub values are based on a combination of rental income (current and projected) and yield (or capitalisation rate), which is determined based on other comparable transactions.
Regarding freehold going concern assets, HTL Capital’s Rick Woelms says valuations are based on a multiple of sustainable earnings or EBITDA.
“We’ve seen numerous examples recently where material sales have illustrated a 5 per cent yield, or the equivalent of 20 times the sustainable annual earnings.”
In both investment and freehold going concern sales, a premium might be added to the valuation if the asset sits on a large landholding that provides scope for future expansion.
For example, the Strathfield Hotel in Sydney, which is being sold by the Whelan family for more than $90 million, includes approved plans for a mixed-use development comprising 60 apartments, 14 hotel rooms and commercial and retail space.
This has added as much as $30 million to the valuation given it generates consistent earnings of more than $3 million (equating to a $60 million asking price at a cap rate of 5 per cent).
Gaming machine entitlements – which can be held by either the asset owner or the tenant – can also significantly increase a pub’s value given their ability to boost revenue and earnings.
Figures published by Liquor and Gaming NSW show the state’s 22,500 gaming machines delivered net profits of $818 million in the six months to December 2021, or more than $36,000 a machine.
The record-breaking sale of the Crossroads Hotel included 30 gaming machines. It ranked eighth in NSW on a gaming machine net profit basis.
Similarly, liquor licences and late-trading permits can also put a premium on valuations.
Highlighting this, last year HPI paid $38.8 million for reversionary interests in liquor licences and gaming entitlements from its main tenant Queensland Venue Company, meaning they revert to the landlord when leases expire.