What if the CEO asks me about... moving to a turnover rent model?

On 10 March 2021 the Government announced that existing protections for tenants on non-payment of rent and against landlords' use of forfeiture and CRAR (the ability to sell a tenant's goods where rent is not paid) were to be extended until the end of June 2021.

As a retail tenant, this gives you extra breathing space in the short-term, but the Covid-19 pandemic has only exacerbated pre-existing difficulties with retail property, caused by the outdated business rates model, rapidly-changing consumer habits and the growing proportion of retail sales now taking place online.

For decades institutional landlords and their lenders have favoured fixed-rent leases with five-yearly, upwards-only rent reviews and terms of 10 years or more, but the model is outdated in today's fast-moving retail environment.

How are your competitors responding?

Tenant retailers are increasingly calling for flexible leases to allow them to react more quickly to changes and proactively manage lease portfolios to minimise exposure to risk. They are seeking:

• Shorter lease terms (Savills predicts that 90% of leases granted over the next 2 years will have terms of less than 5 years).
• Options to break leases during their terms.
• "Turnover rents" - a fluctuating rental model which depends on each particular store's turnover.

A turnover rent arrangement can be introduced as an amendment to an existing lease with the agreement of landlords, from the outset for a new lease, or by force via company voluntary arrangements (CVAs).

How can moving to a turnover rent help you?

The benefit to you of moving to a turnover rent is clear – the amount of rent you pay fluctuates depending on the particular store's performance, easing pressures on cash-flow and allowing you to weather particularly difficult periods. The idea is that landlords take a share of the risk during harder times but benefit during periods of stronger trading. Of course, in periods of stronger trading you could end up paying more rent than you would do under a more traditional lease arrangement.

Are landlords likely to resist and, if so, why?

Landlords are likely to raise various concerns about moving towards a turnover rent model, including:

• The potential impact such arrangements could have on the value of their property investments.
• Their ability to secure funding.
• The lack of predictability of rental yield.
• The difficulties in accurately capturing a store's financial performance in light of retail's rapidly changing omnichannel sales environment - for example, one of your stores may have a low turnover if it operates as a showroom for marketing purposes or as a click and collect hub, but is still critical to the success of your business.

Negotiating with your landlord

While there may be challenges for landlords in moving to a turnover rent model, there are also opportunities, which you can highlight in your discussions.

For example:

• Your landlord can benefit by gaining access to your data (such as footfall and financial performance) that will be invaluable in tailoring their future strategy (with both you and others).
• When the model is right, it can improve long-term occupancy rates and income security.
• It aligns the landlord's business with yours – they are incentivised to invest in upgrading their buildings, facilities and the services they provide to you as those investment are likely to lead to greater profits in future, particularly with the pre-pandemic focus on 'placemaking' and customer experience.

The key questions you need to consider

Before engaging with your landlords, we would suggest considering the following key questions:

1. What percentage of your turnover will form the base rent figure? The average requested by retailers in the UK is 7% (with a range between 1% and 15%) (Savills).
2. Will you pay a baseline minimum guaranteed rent with a ratchet top-up based on turnover?
3. Will there be a cap on the rent you can pay? This would protect the profitability of your high-performing stores.
4. Should service charges, insurance rents and any other costs classed as 'rent' be included in the calculation? More often that not, they are not, and are payable in addition, but it is a point which can be negotiated.
5. What will your financial reporting requirements be? How and when will you present this information? What information will you keep confidential?
6. Should revenue from your online sales be included where the goods are collected in-store? Increasingly, we are seeing that this revenue is included in the calculation.
7. Should the cost of processing returns ordered online but returned to your stores be deducted?
8. Is turnover an accurate reflection of the value of your store or should other matters be monetised, such as showroom value?
9. Should a break option be included after a certain period of time if the turnover rent is not what it was expected to be.
10. Will assignment be permitted? If so, will the turnover rent provisions be suitable for a potential assignee or could it deter them?

Conclusions

It is in both yours and your landlords' interests to find a workable path forward, and one silver-lining of the Covid-19 pandemic has been the promotion of dialogue between landlords and retail tenants.

Turnover rents, when properly drafted, can protect both parties' interests and provide the basis for a flexible and collaborative relationship - the key to success in today's challenging and ever-changing retail environment.

Disclaimer: The information in this publication is for guidance purposes only and does not constitute legal advice. We attempt to ensure that the content is current as at the date of publication, but we do not guarantee that it remains up to date. You should seek legal or other professional advice before acting or relying on any of the content.