The leasing market is changing and turnover rents will become more common. In this article we look at how they work.
The traditional rental structure for a commercial lease sees the tenant pay a fixed annual rent. This rent is usually subject to a period “review” although rather frustratingly for tenants the rent review process is a one-way system: rents can only go up.
The various challenges of 2020 have put immense pressure on some tenants, particularly in the retail, leisure and hospitality sectors and the fixed rents in traditional commercial leases may no longer be a viable proposition for some of them. Turnover rents can help to mitigate the risks associated with fixed rents and ultimately lead to an element of risk sharing between landlord and tenant in a way that is seen as fairer. In tougher times the landlord receives less rent but in the good times it gets the upside of strong trading.
Turnover rents may help landlords and tenants to work together in order to promote overall success. Sharing information about trading trends and challenges could, for example, lead to shopping centres making changes to improve footfall to their occupiers’ offerings.
Turnover rent leases typically have two elements to them: a base rent and a turnover rent. As with any commercial lease, the amount of base rent and percentage of turnover are commercial terms upon which many factors will come into play, including the relative bargaining power of the parties.
The base rent is a minimum sum which will be paid by the tenant to the landlord on a regular basis: monthly or quarterly. Base rents are often subject to periodic review, as they would be in a traditional commercial lease, typically in line with a price index (RPI for example) or by taking a percentage of open market rental values.
The turnover element tops up the base rent and is linked to the financial performance of the tenant. An agreed percentage of the tenant’s turnover from their premises will be paid over on a regular basis. The percentage might increase as turnover thresholds are exceeded. Turnover data (essentially till receipt information) must be regularly provided to the landlord.
Turnover rent leases can be a little more complicated than traditional leases as there are a number of additional issues that need to be considered, not least the question of what constitutes “turnover”; do online sales count? Landlords will want tenants to trade their premises and it is often the case that minimum trading hours must be kept. There are also challenges around what happens if the tenant wants to dispose of its lease; turnover rent leases usually limit the opportunities for tenants to assign or underlet. Another matter for tenants to consider is confidentiality; sharing trading data with third parties is not something that every tenant will be comfortable doing.
Commercial real estate must keep up with the quickly-changing world and turnover rents are part of that. It wasn’t long ago that the standard lease term was 21 years….