Turnover rents: A new commercial partnership post-COVID?
Even before the current economic crisis there was increasing concern in commercial property spheres that the current retail leasing model was no longer fit for purpose.
Rigid, often lengthy durations, inflexible terms and reliance on infrequent open market rent review made it a blunt instrument, discouraging innovation and unable to adapt to the speed of change in a modern marketplace.
While this is not a new concern (we have discussed this before here in the context of increasing numbers of CVAs) as with many things, the sudden impact of coronavirus has accelerated the discussion. The question is, where is this likely to take us in the future?
One recent trend is the increased use of turnover rent provisions – especially in retail leases. The belief is that this allows both parties to share both the downside and the upside of changes in trading conditions on a more immediate basis.
Turnover rents are being promoted now by a number of major landlords – such as Hammerson (which has recently announced scrapping upwards-only rent reviews) and L&G (touting new forms of turnover leases). Big-name tenants such as JD Sports and Zara are also reportedly looking to scrap upwards-only reviews in future negotiations, and New Look has demanded turnover rents as part of their second restructuring in three years.
This is seen as an opportunity to improve the landlord/tenant relationship, by giving both parties an increased investment in improving market conditions and ensuring harmony in the long-term.
So what are turnover rent provisions?
A traditional rent payment clause provides for a fixed sum to be paid either quarterly or monthly, revised upwards every three or five years to keep pace with the then open market. The key differences with a turnover rent is that rent levels change more frequently and can go down as well as up – adapting rapidly to local market conditions.
There are many shapes and sizes of turnover rents and this flexibility is one of the main attractions. The classic form provides for a fixed base level of rent, usually based on some percentage of the open market rental value, with the addition of a fixed percentage of the tenant’s turnover. But the rent can be based entirely on turnover, or even rely on turnover hitting a trigger point, with any number of combinations in between.
How a rental payment is structured will also determine how flexible the arrangement is. The bigger the base rent, the more attractive this might be for a landlord (and their funders) favouring security, but this will be less attractive for a tenant looking to share the risk.
How willing a landlord is to share that risk will depend on how big a risk the individual tenant is deemed to be. Bigger name, perhaps less ‘risky’ tenants are already benefiting from this model with the likes of H&M now insisting on turnover rents for all new leases (notably a pre-Covid policy). However implementing this may be less feasible for smaller tenants, due to the increased level of administration a turnover model demands.
Defining terms for turnover rents
While there is a well defined set of parameters for how open market rents are determined, turnover rents are less well defined. Despite there being an established methodology for some shopping centre leases, there is still a much larger degree of flexibility as to what can, or can’t, be included in the necessary turnover calculations.
This can have a huge impact on the level of rent and must be very carefully considered from the outset. For instance how are online sales treated, should these be distinguished from click and collect? How should the calculation treat sales, returns, vouchers, staff discounts and returns?
The answers to these, and other, questions will vary between tenants and locations e.g. the leases for those tenants with no on-line sales, such as Primark, will look very different to others with a huge on-line presence, such as Next. A tenant must also be wary of issues of confidentiality, with Scottish leases almost always being registered in a public register. There is no one size that fits all.
From a landlord’s perspective, careful consideration must also be given to ensuring the premises are actually kept open and trading to ensure there is a turnover (an insurmountable problem during recent months), that a minimum level of trading hours are adhered to and there is potential for liquidated damages on breaches. Greater control over alienation provisions (pre-emption rights or reintroduction of open market rentals) and tenant mix in general are advisable, to maximise relevant footfall and ensure maximum return on any capital spend.
A landlord must also be willing to be more involved with their tenant’s business – something not all landlords will be interested in exploring. Turnover rents, and the resulting uncertainty over income stream, can also have a downward effect on valuations.
Are turnover rents the answer?
Many operators on both sides of the fence including Land Securities and British Land now recognise the need for a more supportive, symbiotic relationship between landlord and tenant - and a properly considered turnover rent can undoubtedly be part of that conversation.
That’s why in my view turnover rents at least have the potential to help repair, if not fully mend, the marriage between a modern landlord and tenant.
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