Turnover Rents – a fairer approach?

As a start, it is worth understanding the structure and reasons behind the use of this somewhat a-typical rent structure. The landlord is usually paid a base rent equivalent to a percentage of the market level, perhaps 30% or so and will then also be entitled to a percentage of the turnover generated by the tenant from the property. The base rent is payable quarterly, or monthly (as is usual) and the turnover part will be calculated annually and paid within a short period, perhaps 10 working days, of that sum being confirmed. The turnover rent is calculated on the sum which gross turnover from that property exceeds the base rent, so that there is no double counting. Annually the tenant is to deliver a certificate confirming the turnover for the year and paying the relevant turnover rent sum to the landlord.

This structure creates a natural type of contractual joint venture, where both parties share the upside and risks associated with trading from that specific location. The logic for a retail unit in a shopping centre is easy to understand – the centre creates the footfall through reputation, collective marketing, anchor tenant attraction etc. and therefore the retailer is in part beholden to and benefits from the overall performance of the centre and the efforts of the landlord, rather than relying solely on its own goodwill and product attraction. Many consider this fair and it means that a landlord will be incentivised to maintain the centre and its amenities. It also means that it need to undertake enhanced due diligence of its tenants, their trading projections and fit and location within the relevant centre. At Memery Crystal we have advised numerous tenants in relation to these types of arrangements over many years.

The landlord will have the benefit of the fixed sum part of the rent, meaning that their costs, or a significant part of them, should always be covered and the remainder of the rent generated by the turnover can result in a surplus, if the tenant has a robust trading year.

A more traditional commercial lease will usually has a fixed rent only, possibly with an upwards only rent review at five year intervals and which provides a “copper-bottomed” income stream, making it attractive to investors, particularly when compared to other European leasing structures, which can result in fluctuating rents. Turnover rents are usually upwards only in relation to the base rent element only and naturally subject to fluctuation in the turnover segment.

The Times reported on the 19th of July:

“The Crown Estate, dubbed the Queen’s property group because its income supports the royal family, has offered to share the pain of plunging footfall with its tenants.

As retailers and restaurateurs struggle, the Crown Estate, which owns swathes of London’s West End, has written to some tenants offering to link rents to turnover — meaning it will accept lower payments while they trade below usual levels.”

This will no doubt be seen by many of their stricken tenants as providing some respite, depending on the level of the base sum required and the percentage of the turnover demanded as part of the quid pro quo. It will also be seen by many as a fairer approach to the current rent discussions, rather than simply loading all of the hurt onto one side or the other, by requiring full payment of tenants, or full rent holidays from landlords. For many of these tenants, this may represent their best hope of business survival. We are also likely to see them shift from being base rent heavy towards more of an equal distribution between base rent and turnover rent sums.

There is a possibility that if tenants on the Crown Estate and beyond benefit from a fillip of pent up retail spending post lockdown, this will be seen as astute asset management that worked for both parties.

The question has also been raised as to whether this structure can be utilised in the office market, given the uncertainty circulating that sector and future tenant requirements. Some of the larger office developments operating their own flexible office operations will have felt that they are already engaging in a similar risk / reward structure for their income, with British Land launching ‘Storey’ a few years ago to offer additional space to its occupiers on flexible terms and CBRE operating its ‘Hana’ platform. The new 22 Bishopsgate also offers 100,000 sq. ft. of “integrated social spaces and services for its occupiers”, including an innovation hub for small businesses and start-ups.

To introduce turnover rents in scale to office use requires a different mind-set and contains structural issues around tenants’ confidential financial information, as well as a re-assessment as to how integral their property is to the turnover of the business. Something easier to assess in a contained environment like a shopping centre. The recent switch to majority home working for many suggests that this may not be anything like as significant as landlords would like it to be believed. It is also more difficult to differentiate turnover that may have been generated at the property and that which should not be included – such as internet sales, which rarely count for turnover rent calculations.

That said, there may an attraction for some businesses to know that the level of their rent is unlikely to breach an acceptable percentage of their turnover and that they can fix what is often on of their largest overheads, after staff costs.

Lease lengths and structures have undergone significant reimagining in the past 10 years or so and as the real estate world and the world at large begins the task of emerging from the lockdown, it is easy to foresee new risk-sharing models coming forward and the continuing retreat of the 15 year FRI lease with five yearly reviews. The landscape is increasingly one of collaboration between landlords and tenants, and fairness and flexibility will be key to recovery and the ability to withstand any future shocks, although hopefully anything like we have seen in 2020 is many years away…

The real estate team at Memery Crystal has extensive experience of all types of commercial leasing, acting for both landlords and tenants.