Most commercial leases are structured in a way where tenants pay a fixed amount of rent throughout the term, subject to periodic upward only rent reviews, either by reference to open market rent or to an index such as RPI or CPI. With the recent lockdown measures and a shift towards social distancing, retail operators are increasingly looking to mitigate the risks associated with fixed rents.
Opting for a turnover rent lease is one method of spreading the risk between landlord and tenant. There is a greater perception of fairness in having a proportion of the rent tied to the tenant’s trading performance at the premises. The landlord takes a smaller slice of the rent during times of hardship and takes a larger slice during times of success.
Use of turnover rents can encourage and facilitate data sharing and collaboration as landlords work with tenants to promote the overall shopping experience in a shopping centre or parade. An existing collaborative relationship between landlord and tenant can help both sides during difficult trading periods like the one we have at the moment with rising numbers of CVAs and legislative changes restricting landlords’ ability to recover unpaid rent.
The most common form of turnover rent lease has two main sums that constitute the rent – base rent and turnover rent. The relative split between the two will usually hinge on the bargaining position of the parties and the general market conditions.
- The base rent is a guaranteed sum that is paid periodically to the landlord, in the same way as rent is paid in most standard commercial leases. The base rent might be subject to review – perhaps to a percentage of open market rent at the review date or subject to fixed increases or to a percentage of average turnover rent achieved over the review period.
- The turnover rent portion operates as a performance based top-up to the base rent. It constitutes an agreed percentage of the tenant’s turnover from that particular premises. The agreed percentage might be fixed or it might increase as pre-determined turnover thresholds are reached.
As margins in the retail sector in the UK becomes ever more challenging, turnover rent leases will be increasingly common. We are also likely to see them shift from being base rent heavy towards more of an equal distribution between base rent and turnover rent sums. With this in mind, there are a number of important factors for parties to consider during negotiations:
- Keep open provisions: tenants are required to keep the premises open for trade during pre-determined hours. This ensures that the premises continue to trade and generate turnover, protecting the landlord’s income stream. There are usually exceptions to the keep open obligation, including where the premises cannot open due to damage or destruction, or where the tenant needs to carry out alterations or comply with legal obligations. Well advised tenants are also seeking carve outs to the keep open obligation for force majeure events and, specifically, epidemics and pandemics such as COVID-19.
- Deemed turnover provisions: where the tenant is in breach of the keep open provisions, turnover will reduce or possibly cease, which damages the landlord’s income. The deemed turnover clause will assume a deemed turnover based on historic trading if the premises are not open for trade in accordance with the lease.
- Defining turnover: historically, this would ordinarily constitute cash through the tills; physical sales made at or fulfilled from a retailer’s premises from customers making purchases at those premises. Landlords now seek to incorporate as wide a definition as possible, including online orders placed in store and click-and-collect orders placed remotely but collected in Tenants are often keen to exclude anything which does not have sufficient nexus to the store in question. The treatment of gift vouchers, returns, partial payments and staff discounts can also be problematic. Multiple retailers have firm policies on what they consider constitutes turnover and can rarely be persuaded to deviate from those policies.
- Alienation: parties should consider whether the payment provisions are to continue in the event of an assignment or sub-letting. Turnover rent leases are sometimes for shorter terms and prohibit alienation or they refer to the payment provisions as being personal to the named tenant. If the payment provisions are personal, the landlord should look to ensure that the full open market rent is paid on a lawful assignment or
- Confidentiality: for a turnover rent lease to operate effectively, landlords require access to a wide range of sales information to support the turnover certificate provided by a tenant. Tenants are keen for this information not to be shared and to be used solely to verify the turnover rent.
- Land Registry: turnover rent leases often include a number of commercially sensitive provisions (base rent, thresholds, percentages etc) that landlords may not wish the wider market to be aware of. If a lease is registrable, the agreement for lease or lease should include a mechanism for the landlord to provide the tenant with a redacted form of lease (an EID or Exempt Information Document lease) to register at the Land
If you are considering entering into a turnover rent lease, please do not hesitate to get in touch.
