Turnover rents – sharing pain and gain in commercial tenancies during COVID-19
Turnover rents have become the new talking point for commercial landlords and tenants in the past few months. The idea of sharing pain and gain is popular with tenants, but in the new world of constantly changing rules for retail and restaurant opening restrictions, landlords are also initiating them more often.
In the past, turnover rents were usually granted in larger shopping centres or to attract tenants to less attractive neighbourhoods. They have now gained popularity in all areas of commercial property. They tend to involve a low regular guaranteed base rent and a further rent, payable in arrears, and in accordance with the turnover achieved from the unit. The rates agreed vary and as most arrangements are confidential, available data is rare. What seems to be clear, is that base rates tend to range between 50% to 80% of the market rent with the turnover rent topping this up, if applicable.
Landlords mainly agree these rents, as they are hopeful that once the restrictions are lifted altogether, the tenants’ businesses will flourish again and on this basis, they are prepared to suffer a temporary fall in rental income.
Turnover rent provisions need to be carefully drafted to avoid situations where the landlords are short changed in the future, despite the tenant’s business improving. The main pitfalls are related to the definition of turnover and the exclusions from that definition. If, for example, the tenant sublets part of the premises – will the rent be part of the tenant’s turnover? Should the undertenant’s rent be turnover based as well? The same applies to concession arrangements (shop in shop), where third parties trade from the premises.
If buyers of products agree stage payments – will the turnover rent apply to the staged payment or the original purchase price? What about returns of items, staff discounts, use of vouchers and incentives? For restaurants, online sales via third parties, such as Uber Eats or Deliveroo and takeaways should always be included in the turnover definition, as these could make up the entire turnover during lockdown periods.
One of the most frequent points of negotiation has been whether online sales should form part of the tenant’s turnover rent. The difficulty can be, that the tenant provides advice and displays stock on the premises but actually sells them via a website, especially during the lockdown periods when the shop is closed. If the relevant business tenant only trades from one unit, the answer is probably that online sales should be included. But if the tenant’s business is part of a chain, it becomes more difficult to establish the actual turnover of the individual shop, as the tenant could refer customers to online stock or nearby branches if it cannot immediately serve the customer’s needs.
A lot of issues may arise around the lack of sharing of turnover information. The tenant needs to be prepared to operate on an open book basis, which the tenant may be hesitant to do, for many reasons. Landlords will insist on seeing quarterly accounts, which have to be provided by accountants or auditors. On a practical level, not all tenants have separate accounts for each of their units and the turnover rent provisions can result in the need to prepare separate accounts just for the purpose of the rent calculation and including the relevant defined income streams in the accounts.
The traditional turnover rents were usually paired with ‘keep open’ provisions, which dictated the times during which the unit had to be open for trading and when closure was permitted. In the current situation these provisions are less common as the ability to trade is not only restricted by COVID-19 regulations and restrictions to opening hours. Shops could be obliged to trade at a loss if located in tourist hotspots and offering tourism related supplies , for example. It may also simply not be possible to open if staff are self-isolating or, in fact, unwell with the virus.
A considerable number of turnover rent arrangements are of a temporary nature and landlords have agreed them with a view to having certainty of base rent receipts with the expectation that they are not losing out if businesses recover. It is uncertain, whether the turnover rent surge has a longer lasting effect. This will probably largely depend on whether, as an end result, tenant businesses are saved from collapse and landlords are eventually rewarded for their patience with a sizeable turnover return.
If you need help or advice concerning any of the issues raised in this article please contact either myself or a member of the Real Estate team.