Why are turnover rents becoming popular again?
The COVID-19 pandemic and accompanying lockdown have undoubtedly changed many aspects of life in the UK, but few sectors have been impacted as dramatically as retail, hospitality and leisure. The damage to these sectors is only just starting to become distressingly clear.
According to the Centre for Retail Research, 3607 stores have closed during 2020, resulting in 49,790 job losses. These figures run up to the end of June this year and don’t include the 25% of stores which, at that point, had yet to reopen following lockdown.
In the leisure and hospitality sector the picture appears even worse, with reports of 200,000 people laid off from the sector between February and the beginning of March, while the sector was one of the hardest hit by the introduction of lockdown, with 92% of the workforce being furloughed.
Measures like the furlough scheme and bounce back loans have helped many businesses stay afloat during the crisis, but as these props are gradually withdrawn, new business models will have to be created. One sign of the changes is the rising demand for a switch to turnover rents.
What is a turnover rent and how does it differ?
The demand is being led by retailers such as New Look which, at the end of June, was reported to have hired real estate consultancy CBRE to facilitate a shift to turnover rents against a backdrop of warnings to landlords that a refusal to do so could lead to a pre-pack administration deal.
The widespread switch to e–commerce has helped some retailers maintain a level of income, but the need to keep paying rents on empty premises has proved too much and it now seems likely that turnover rents will become a permanent feature of the retail and leisure sectors.
The appeal of turnover rents to tenants is clear, since they ensure at least a portion of the rent varies in relation to the performance of the business. However, it may prove slightly trickier for those tenants to persuade landlords that switching to this leasing model benefits both parties.
Key to a tenant’s argument will be convincing their landlord that agreeing to switch to a turnover rent is the only way the business can maintain its current activities, survive the economic slowdown and continue to pay some rent to the landlord.
The experience of the lockdown itself, with some landlords being more flexible than others when it comes to measures such as temporary rent reductions or rent holidays, should offer a good guide as to how difficult the negotiations over leasing arrangement are likely to be.
Turnover rent creates a closer relationship than the standard tenant-landlord model, with both parties sharing good times and bad. While the tenant benefits from the reduction in rent during tough trading conditions, the landlord will benefit when a recovery occurs and revenues rise.
Leases where the entire rent is based on turnover are rare, as they expose landlords to greater risk should market conditions worsen. But the actual split between a base rent and the turnover element can be negotiated between both parties, with no regulated limits.
Typically, the fixed term base rent covers around 75-80% of the total and is agreed on the basis of current market conditions. The remainder of the rent will be based on a percentage of the turnover, generally falling within the 5-12% range.
Naturally, a retailer will be keen to increase the turnover element of the arrangement and in return for conceding this, the landlord may want the percentage of the turnover being paid to rise in line with this increase.
Turnover rents need careful consideration
Anyone considering a turnover rent agreement should understand it will only be viable if there is complete openness between tenant and landlord in terms of the business operation. Each must trust the other implicitly, if it is to work.
The tenant will normally be expected to provide the landlord or their agent, with turnover certificates and make all accounting records freely available. The landlord will often insist on the right to audit the tenant’s figures to ensure the correct proportion of turnover rent is being paid.
Given all of this, tenants must ask themselves whether they will be comfortable with this level of compliance and if so, they need to insert a confidentiality agreement into any contract, to protect the wealth of commercially sensitive information they will have to share with their landlord.
From the landlord’s point of view, any turnover lease must be based on a detailed understanding of the business plans of the tenant and the likelihood of any recovery being sufficient to cover the loss of guaranteed income which switching inevitably involves.
The ongoing uncertainty in many markets means landlords may seek a longer lease to provide more security to counterbalance the increased risk profile, whilst questioning what strategy the tenant is planning to drive their recovery forward.
It is critical that both parties understand the commitment required and the need for due diligence before entering into any turnover lease. Expert advice from an experienced specialist real estate lawyer would also be a positive step in ensuring everything runs smoothly, as there are many points to consider.
If you have any interest in exploring the possibility of agreeing a turnover rent with either your tenant or your landlord, please get in touch for a preliminary discussion with Karen Mason, our experienced specialist real estate lawyer, here at Newmanor Law.