Why petrol stations often fuel landlord and tenant disputes

The design and function of petrol stations have changed dramatically during the last 30 years. Adrian Camps explains how landlord and tenant disputes arise

CHANGES IN THE NEEDS of oil companies, in vehicle design, and in consumers preference have radically altered petrol station design. Often the terms of a standard lease create difficulties at rent review or on renewal. Obsolescence in petrol-filling stations has been high, with fewer stations now pumping more litres per site. Many medium to high volume petrol sites, with throughputs of 3.6-9m litres have been redeveloped or refurbished by oil companies or private occupiers. Many sites in the late 1960s had attended service, with no canopies and small tankage. The shops were often little more than kiosks and rarely offered the range of goods available in today's forecourt shops, where one can buy anything from clothes to pizza.

Rent review disregards

Most rent review clauses direct valuers to disregard tenant's improvements. Section 34 of part 2 of the Landlord and Tenant Act 1954, as amended by the Law of Property Act 1969, directs that similar disregards apply to lease renewals.
Unlike conventional properties, where tenant's improvements such as an increase in floor area or the provision of heating are easy to define, it is difficult to quantify the increase in sales volume attributable to improvements to a filling station.
Some alterations are not improvements for these purposes but obligations on the tenant. There is normally a tenant's covenant to comply with all statutory requirements, which would cover improvements to the site such as the fitting of petrol interceptors or vapour recovery, without which the petroleum licence for the site would not be renewed.
The replacement of defective petrol storage tanks is a repair, but often when tanks are replaced the capacity is increased. It is beneficial to increase storage capacity to accommodate a full tanker load, as supplying oil companies often make a surcharge to deliver part loads. It can therefore be argued that the additional capacity is a tenant's improvement that helps to retain the profitability of the site.

Similarly the replacement of petrol pumps could be argued to be in compliance with the tenant's repairing covenant, but where these pumps are increased in number, or have additional capacity, the increased capacity must be ignored.
The situation is further complicated where the forecourt has been redeveloped. and the capacity increased by an improved layout. Thirty years ago most sites had pumps arranged in line on a single island. Modern forecourts are often set out as starter-gates': four or six square developments.
Where a site has been completely redeveloped, the lease often directs that this is assessed to a ground rent. In this case it is not always appropriate to disclose the throughput of the site, as one has to assess a rent that a hypothetical tenant would pay if the site were cleared of buildings, tanks and equipment. This is a complex matter and it is normal to assess the potential volume for the site from the 16-hour traffic flow along the road on which it is situated. One then assesses a 'turn-in rate' for the site, which will take into account the site accessibility, the price structure of the area and the competition in the area. Turn-in rates usually vary between 1.5% and 4% for normal sites, depending on location. One would normally assume an average purchase of 23 litres.
Petrol stations are expensive to develop, with high-specification oil company sites costing between £600,000 and £900,000. Where one has to disregard the existing development, it could sometimes be argued that while the operator can obtain an adequate return from the existing site, as the development cost has been partially written off, he could not obtain an adequate return by constructing a new site and would invest his capital elsewhere.The Landlord and Tenant Act directs that one should disregard the tenant's occupation and goodwill when assessing the rent at renewal and there are similar disregards in many rent review clauses. This is of increasing importance, with most oil companies

seeking to develop and maintain 'brand loyalty'. Many run nationwide promotions including air miles, electronic points stored on smart cards, videos and so on.

Many of the major oil companies have their own fuel cards, which further encourage brand loyalty. In some circumstances it is appropriate to make a deduction to reflect the costs of these promotions and customer accounts.

Price-cutting and rents

Price cutting has become very severe throughout the market over the last few months with the introduction of the Esso 'price watch' scheme, and most other operators have had to follow suit, or suffer a reduced throughput. In some areas of the country petrol has been retailing at a price lower than some independent dealers' wholesale purchase price.
In many cases volumes have dropped due to the presence of hypermarket operators but in some cases volumes have remained static, or have increased slightly. If an increase in volume is taken at face value, it could indicate a higher rent, but often an increased volume is 'bought' at the expense of the margin that the oil company and other tenants achieve on fuel sales.
In areas where there are hypermarket forecourts, oil company or dealer tenants often support the price by up to lp per litre, in order to remain competitive. Where such price-cutting leads to a reduction in gross profit, the ability of the site to pay rent is also reduced.
It is customary to make a deduction from the gross throughput to reflect 24-hour operation, usually 10%, and a further deduction to reflect price-cutting, usually up to 25% in severe cases. Oil companies are now arguing that the price-cutting deduction does not adequately reflect the loss they are suffering. This may suggest a return to the profitability approach to rental valuation. But this approach also has its problems as oil companies have traditionally been secretive about their profits on petrol sales.

There is also the question as to whether the site is achieving its full potential. Many sites are tied to oil companies, either by the operator entering into a supply agreement, or by being tenanted or licensed. In these cases the supply price of the product is dictated by the oil company and in the event of price competition, operators suffer a reduced income, unless the supplying oil company grants price support.

Valuation methods

The value of the petrol station is directly linked to the profit which a competent operator can generate. General price-cutting has resulted in oil companies and other operators taking a reduced margin on their sites. In these cases both capital and rental values should have decreased. The presence of upwards-only review clauses and the use of comparables from non-price-sensitive areas has distorted the market in some cases. When using comparable evidence, it is important to ensure that the 'price profiles' of the areas in which the comparables and the subject property are located are similar, otherwise adjustments must be made to the throughput, to reflect price-cutting.

The rental and capital values of petrol-filling stations increase on a sliding scale according to volume, as the fixed costs of running a site vary little whether it is pumping im or lOin litres. Some approximate guidelines for sites free of tie are shown in the table. These values must always be applied to core volumes.
In cases where sites are tied on favourable terms with full price support, this will increase the value for the length of the tie. Where sites are tied below market terms, this decreases the value for the period of the tie and in such cases it is normal to value the term and reversion using different rates. The above figures

exclude a value attributable to the forecourt shop and other buildings, which are normally valued on a square footage basis to a rent and then capitalised at an appropriate rate. Where forecourts have throughputs of im litres per annum or less, the profitability is usually marginal and the value for an alternate use is often greater.
This may be for car display, redevelopment or other uses, assuming planning consent would be forthcoming.

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