The Return of Turnover Rent Leases: can market risk be shared between landlords and tenants?
The landlord and tenant relationship is under immense pressure. They both face a rapidly changing economy and a cultural earthquake of how commercial property is utilised. The risk of vacant spaces and falling returns on investments is a concern to landlords. Many tenants are fighting to remain solvent. Can landlords and tenants form a partnership to share and mitigate these risks together? We discuss how turnover rent leases may save many businesses as well as their landlords.
The retail sector is battling the rise of online shopping, high business rates and COVID and the hospitality sector has suffered badly as a result of the pandemic. Many high profile retail and restaurant properties remain vacant following waves of administrations. COVID has reduced the likelihood of many vacant properties being relet.
Tradition is for a landlord to charge a rack rent. This is where a fixed rent is paid. Although this fixed rent may be stepped or reviewed upwards in line with the market, it can be inflexible and place a financial burden on struggling tenants.
Turnover rent is an alternative. It has been common in major UK shopping centres for many years. Turnover rent is based on the income generated by the property. It can be a straight percentage of turnover figures or net profit. Alternatively, it can form of a top up element to a base rent.
It gives landlords a vested interest in the success of the business operated from the property. The landlord gains during good times. During difficult periods, the pressure on the tenant’s cash flow will be reduced.
How does the landlord mitigate the risk of lower rent if the tenant is not performing? The lease negotiations and provisions are critical. Landlords must consider:
- how the turnover rent is calculated. The definition of turnover is critical and it must reflect the tenant’s full income stream e.g. online orders, click and collect services, gift vouchers and discounts offered via loyalty schemes. This proves more difficult if the tenant use is service based, or storage;
- reconcilliations will be needed to balance up turnover rent payments. Mechanisms for these and any balancing payments must be included in the lease;
- lenders may require additional security to address the risk of fluctuations to income. This is most likely to be by way of guarantees and rent deposits; and
- the lease needs additional provisions including:
- i. keep open covenants to encourage the tenant to maximize the turnover generated at the property;
- ii. mechanisms to enable the landlord to recover rent if the tenant fails to open for trade; and
- iii. prohibiting or additional restrictions on assignment. The incoming assignee’s business will have a different predicted turnover. Landlords can protect themselves by, on assignment, having the ability to convert the lease to a rack rent lease, vary the turnover percentage, including a right of pre-emption (under which the tenant has to offer a surrender before making an assignment) or suspend the turnover rent temporarily until a new turnover percentage is agreed.
Turnover rent leases are an interesting consideration for both parties. Market conditions are setting the scene for them to become more common. Due to the complexities of defining turnover and additional mechanisms required in the lease, detailed legal advice should be sought at the early stages of negotiations.
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Please note the contents of this article are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.