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Traditionally, institutional landlords have favoured long-term, market rent leases with frequent upwards-only rent reviews, but in the current economic climate, retail tenants are seeking more flexibility in their leases.
The combined effect of Brexit, the pandemic and the cost-of-living crisis has created a tough market for retailers, who now favour leases with shorter terms or break options and rent linked to turnover.
What is a turnover rent lease?
A turnover rent lease is a lease where the tenant pays a rent geared to a fixed percentage of the gross turnover at the leased property, with a base rent.
Typically, the tenant will pay a discounted market rent as a base rent (for example, 80%).
Over and above that base rent, the tenant will pay the turnover rent, which is the amount by which the agreed fixed percentage of gross turnover exceeds the base rent.
Alternatively, some tenants may negotiate terms whereby they only pay a turnover rent, which means that the rent payable depends solely on the tenant's business turnover.
These pure turnover-based rents are less common than the hybrid model.
So, what are the pros and cons of a turnover rent lease for retail tenants?
Pros of turnover rent leases
- The tenant pays a lower base rent, easing pressure on cash flow during difficult trading periods or while working to establish a new business. Any turnover rent payable over and above the base rent is directly linked to the store's performance.
- Turnover provisions can be beneficial to both the landlord and the tenant. Both parties are invested in the business's success at the property; if the business does well, the tenant benefits from higher turnover, and the landlord benefits from higher rent.
- Although landlords prefer leases with a fixed rental income if the alternative is an empty property, a turnover rent model will mean that the landlord will avoid paying business rates on an empty store, and the tenant will keep the property in repair and pay insurance rent/service charge.
Cons of turnover rent leases
- In successful trading periods, you are likely to pay more rent than you would under a fixed market value rent lease.
- Landlords are likely to raise concerns about moving towards a turnover rent model, including the impact on the value of their property investments and their ability to secure funding due to the lack of predictability of rental yield.
- There will be an increased administrative burden on both parties as the tenant will have to report their turnover to the landlord, and the landlord will be responsible for calculating any turnover rent that is payable.
- It can be difficult to come to an agreement over what should be included in the turnover figure, particularly if the store incorporates an element of 'click and collect' sales.
- Landlords will likely want to restrict alienation of turnover rent leases since an incoming assignee or undertenant's business will have a different predicted turnover than the tenant's. Restrictive alienation provisions will make assignment or underletting more difficult for the tenant.
Key considerations for turnover rents
The following key points will need to be considered before attempting to agree heads of terms with your landlord:
- Will the rent be purely based on turnover, or will you pay a base rent plus a turnover top-up? The hybrid model can be preferable for a retailer compared to a fixed-rent lease but still provides the landlord with some income security.
- What percentage of your turnover will form the base rent figure? Analysis of rent negotiations in the UK by Savills shows that turnover rents requested by retailers range from 1–15%, with an average of 7%. Will there be a cap which limits the amount of turnover rent you have to pay during successful trading periods?
- Will you have a rolling break clause after a specified minimum term? Where no base rent is payable, will the landlord have a break option if the turnover rent is too low?
- How will you report to the landlord on your store figures? How frequently will you be required to present this information, and will you be required to employ external auditors? Whatever you agree needs to work for your business.
- Will the definition of turnover include online sales where the goods are collected in-store?
- How will discounted items, returns and gift voucher sales impact turnover? Should the cost of processing returns be deducted where goods were ordered online but returned to the store?
- How will the turnover of undertenants or concessionaires at the property be treated?
- Will there be a separate service charge payable, or will you agree to pay a higher percentage of turnover that includes the service charge? The advantage of the latter is that it gives tenants a clear view on the affordability of the property.
- Will assignment be permitted? The landlord may not want a turnover rent lease to be assigned to a third party or, if the lease is assigned, may want the rent to revert to open market rent.
- Will the lease contain a 'keep open' covenant? If it does, you should ensure that there is a carve-out for legitimate closures, for example, during store refits or periods when the store is closed for essential repairs or staff training.