The Turnover Rent Condurum: Tips For Retailers

Protections provided to commercial tenants under CIGA and the Coronavirus Act 2020 are due to end on 31 March 2021 and now, more than ever, landlords are having to explore the possibility of entering into non-standard leasing arrangements.

Whilst moving to a turnover lease or a hybrid turnover lease may help to address the sales volatility in retail at the moment, which has only been exacerbated by the pandemic, this approach is not without its difficulties and retailers may wish to consider the following when negotiating with landlords:

A standard lease cannot simply be ‘converted’ to a turnover lease; significant redrafting is usually required. Landlords may want to add a break option where the rent does not hit a given threshold, and “keep open” requirements become important where a landlord is relying on turnover for its income (perhaps coupled with a fixed rent on any days when a property is not open for trade). For retailers, ensuring that obligations can be complied with in all hypothetical circumstances is important. For instance, the effect of seasonal turnover should be considered to ensure there is no disproportionally high rent payment after Christmas, Black Friday or other ‘shopping-heavy’ times of the year.

Tip: it is important that a specialist solicitor advises on the terms of the new arrangements.

Most landlords are likely to be keen to capture all sales generated from a set of premises, even those online, while we expect that tenants would typically want to exclude VAT and items with no margin such as stamps or lottery tickets.

Landlords who do not have the infrastructure in place to capture and analyse their tenants’ sales data in real time (electronic point of sale or “EPOS” systems) will be reliant upon the turnover data provided by their tenants, including any returns made by their customers. Historically, there has been a reluctance between landlords and tenants to share data. The landlords may insist on including reporting clauses, such as in-store turnover and footfall.

Tip: Retailers should be cautious when accepting any reporting obligations and limit shared data to that strictly required for the rent calculation.

Moreover, any shared information about a retailer’s sales and business finances should be subject to suitable confidentiality obligations.

The lack of rent certainty can also have a significant impact on portfolio valuation and the pricing of debt. Valuing turnover leases requires an analysis of previous years’ sales evidence rather than a guaranteed rental income over the life of the lease, meaning the debt is typically more expensive. With the retail market changing, we expect that valuers will inevitably be forced to change the traditional yield based valuation methods and find alternative approaches.

Tip: Minimum rent thresholds and priority receipt of landlord success fees for good performance can assist in making turnover rents more palatable for lenders.

In the multi-channel age another hot topic is which sales should be attributed to a store, and this will depend very much on the specific store and the types of goods being sold. The true value of a specific store often goes beyond the physical sales from that one leased property as often it will also be used for brand building, showrooming, click-and-collect, or returns.

In any event, the direction of travel is clear – turnover rents are the new normal in retail.