“Profits method” of rental valuation does not breach s.37 of Retail Leases Act 2003

The question of whether the “profits method” of determining rentals for hotel premises contravenes s.37(2) of the Retail Leases Act 2003 (Vic) has finally been determined by the Supreme Court of Victoria.

Under the “profits method” the valuer estimates the income and expenses of the business with the difference between the two estimates being the net profit. The method entails the cost of fitting out and similar work being brought into the calculation since it is a cost which will be born by the lessee in order to make a profit. The usual means of doing this is to estimate the capital cost involved and “rentalise” it over the period of the expected life of the equipment with the “rentalised” sum being an item of expenditure to be put into the notional accounts. See: Hill and Redman’s Law of Landlord and Tenant.

Uncertainty has surrounded the use of the “profits method” because s.37(2) directs the valuer to determine the current market rent as the rent that would be reasonably be expected to be paid for the premises if they were unoccupied and also directs the valuer “not to take into account the value of goodwill created by the tenant’s occupation or the value of the tenant’s fixtures and fittings”.

In the important decision of Epping Hotels Pty Ltd v Serene Hotels Pty Ltd [2015] VSC 104 (which was an appeal from VCAT) Croft J decided that the valuer’s use of the “profits method” in determining the rent of a hotel and gaming venue did not infringe s.37(2).

His Honour agreed with the Tribunal that the critical question was whether the valuer had taken into account the value of the sitting tenant’s fixtures and fittings contrary to s.37(2).

The valuer had excluded the acquisition costs of the sitting tenant’s gaming machines and gaming entitlements from the rent determination but had taken into account the fittings and fixtures that the hypothetical future tenant owned.

His Honour held that while the valuer had not followed strictly the methodology referred to above, the valuer had not taken the sitting tenant’s fixtures and fittings into account and had properly assumed that the premises were unoccupied. Therefore the valuation did not breach s.37(2).

The decision will be a great relief for valuers of hotels and similar premises.

His Honour also decided that the Tribunal had erred because it had not taken into account a supplementary report by the valuer: the supplementary report formed part of the valuer’s reasoning in the rental determination.

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