Turnover Rent in the Retail Sector: A Flexible Leasing Solution for Challenging Times

There are two forms of turnover rent leases:

• Turnover top-up lease, where the tenant pays a minimum base rate plus turnover rent.
• Pure turnover lease, where the whole rent is calculated as a percentage of the tenant’s annual turnover.

The traditional turnover-based leases have provided for the tenant to pay a base rent plus a top-up element calculated upon turnover. 

However, the growth of shorter, more flexible leases has seen an increasing use of pure turnover lease arrangements, i.e., where there is no base rent.

For the tenant, this provides flexibility, whereas landlords may regard the risk as acceptable for short, low-value lettings, where the tenant’s business model is simple. 

Where a turnover rent is being negotiated, the landlord may also seek to limit the risk by incorporating flexible landlord breaks so that the arrangement can be terminated if it is not working out.

Those in the retail industry may generate turnover in an increasing number of ways, for example:

• Traditional at-till purchases.
• ‘Click and collect’ where customers purchase online but the goods are collected in-store.
• Customers may purchase gift vouchers online or in a store and then use those vouchers at a different store.

The underlying principle is that the calculation of turnover should reflect sales from the premises and be properly attributable to the premises,  but this can pose problems. 

For example, some tenants operate regional stores, which serve as cost and profit centres for a number of local stores. 

Depending on a tenant’s arrangement, there may be resistance to applying this principle in the broadest sense.

The traditional model of a rack rent lease is well-established and familiar. 

A rate is negotiated, usually on an annual basis, and is paid in equal quarterly instalments in advance. If the lease is of a sufficient length, rent review provisions allow for a reassessment of the rent at regular intervals, by reference to the then open market rent.

Usually, the review process will be on the basis that the rent can only go up, never down. Other than that, the rent as negotiated does not change.

Regardless of whether the tenant is trading profitably, and regardless of what use the tenant actually makes of the property, the rent is a known figure.

That model has the merit of predictability and allows the landlord to make a straightforward calculation of the return on investment, but it is inflexible.

Flexibility means having a fluctuating level of rent, and the mechanism for achieving that which has found some market acceptance is for the amount of rent to be calculated in part by reference to the turnover which the tenant achieves from the premises.

The pros and cons for the landlord and tenant may vary.  The attractions from the tenant’s side are not hard to see: in poor trading periods, there is a degree of downward adjustment of property costs to insulate the tenant from the impact.

Moreover, the landlord is incentivised to promote the property and keep it well-managed, well-maintained and fully let, with a view to maximising its rental income. That is always true, but the relationship is more direct, where rents are payable on a turnover basis.

The attraction to the landlord is less obvious since the arrangement involves assuming a part of the tenant’s risk, but there is also the potential to participate in profits and achieve a better rental income than would otherwise be the case.

More importantly, by offering the tenant something of a helping hand in difficult circumstances, a turnover rent promotes the sustainability of the tenant’s business and so reduces the risk of tenant insolvency and rental voids.

Given the significance of void property costs now, this is an increasingly important consideration for landlords.

Landlords may try to build in terms to protect their position, such as:

1. A landlord’s break option.
2. A ‘success payment’ for the landlord, if turnover exceeds a specified threshold (in the form of a one-off payment or an uplift in the rent); or
3. A ‘look back’ period is when a balancing rent is due if the turnover-based element of rent has failed to reach certain levels.

The idea of turnover rent is a simple one, but providing the details of it in lease drafting in a way that is fair to either party requires careful thought and negotiation. 

The draft has to take into account a variety of practical implications of the shift away from a fixed rent, as well as anticipate changes in trading circumstances.

Operators in the retail sector continue to demonstrate ingenuity in devising new methods of generating custom: shops may enter into home delivery arrangements with operators, which can also create challenges in assessing rent on a store’s turnover and how to capture it as part of the turnover calculation.