While landlords and retailers had started moving towards turnover rent leases over the past few years, a recent report has found that, as a result of Covid-19, 82% of UK retailers have sought to incorporate turnover rent provisions – where a landlord will take a percentage of their tenant’s gross turnover instead of a more conventional fixed amount of rent – into their leases.
Ben Cox, associate and commercial property solicitor at Nelsons, explains: “The coronavirus pandemic has affected the UK in unprecedented ways and the retail sector, as we know, is no exception. It is, therefore, not surprising that the landlord-tenant relationship and various lease obligations have been placed in the spotlight.
“When it comes to turnover rent leases, it is argued that a shared pain/shared gain approach to business occupation in such a challenging economic climate is the way forward.
“Back when demand for commercial property mirrored or bettered supply, landlords generally insisted on leases granted at market rent with ‘upward only rent reviews on the passing market rent – and tenants were happy to accept. However, as present demand for retail premises has been so badly hit following economic effects and pandemic-related usage restrictions, landlords are more willing to consider alternatives.
“That said, we suggest erring on the side of caution before taking the plunge. Turnover rents are seen as one way of achieving a rent level that more accurately reflects what can be earned from the premises and, therefore, achieves a fairer outcome for the landlord and the tenant alike.
“By linking the level of rent to the income of the premises, the deal can be beneficial to both parties. It all sounds great and makes us question why such arrangements haven’t always been more commonplace in retail leases. However, turnover rent arrangements are not without potential problems.”
Getting it right
“Types of tenants and their businesses can vary enormously. Some earn all their income from the turnover at the shop, while for others, the shop may only be a physical presence for most of the turnover being achieved elsewhere (i.e., online – mobile phone shops are a good example of this).
“With the rapid rise of internet shopping, many retailers use their premises for both – direct sales and an advert for online sales. At the time of a letting, the tenant’s entire turnover may be generated from the premises, resulting in a good turnover rent for the landlord. However, with the growth of online sales, soon after completing the lease, the tenant’s business may change and a substantial part of their income could arrive from online sales – causing a low turnover at the shop and low turnover rent for the landlord.
“When drafting leases, it’s important to seek legal advice to ensure that turnover rent arrangements are flexible to capture physical and online sales within the rental calculation so landlords are properly remunerated.”
Closing businesses
“A business can close for any reason – more typically, for repairs and alterations, but more recently, as we’re all aware, as a result of a lockdown. There must be a mechanism in place for determining the level of rent when the property is closed and, subsequently, not generating income. This must be considered by the parties when a turnover rent lease is negotiated and drafted.”
Avoiding rental income losses
“Even where the tenant’s business is known to be stable, the lease needs to strictly govern the landlord’s prompt collection and verification of turnover data. A landlord cannot simply relax and wait for a pre-agreed and definite amount of rent to arrive (knowing any rent can always be chased up later, plus interest for arrears). If the landlord is not adept in a turnover rent situation, it may be very difficult to collect and verify all the turnover data later, resulting in a loss of rental income.”
Covering all eventualities
“Should the tenant seek to assign the turnover rent lease to a new tenant, the landlord may find that the lease, which was suitable for the original tenant’s business, may be entirely unsuitable for the proposed assignee’s. The answer may be to insist on the landlord having the right to accept a surrender of the lease if the tenant wishes to assign.
“It is evident that, if drafted properly and competently, turnover rent leases are beneficial for both landlords and tenants. If a turnover rent lease is being considered, allow extra time and expense to fully explore if it is a good idea and how to do it correctly.”
