There is no doubt that the retail, leisure and wider property sectors have undergone huge change over the last two years; forcing businesses to become more agile and to reconsider their physical presence, whether that be in relation to flagship stores, warehouses for e-commerce or flexible office spaces.
Difficulties posed by the pandemic, increasing business rates, the impact of Brexit on supply chains and a general movement towards experiential retail have increased uncertainty around footfall and the need for a physical space to showcase products. The inherent flexibility of the turnover rent model has therefore proved an attractive option for some classes of occupier.
So what is turnover rent?
In contrast to the typical fixed-rent model, where rent remains certain and unchanging throughout the term of the lease (perhaps increasing upon a fixed rent review or after an initial rent-free period), for “turnover” rents, the amount of rent payable changes depending on the income (turnover) received by a tenant at the premises. For many retailers who are locked into long-term leases, annual income may change year upon year. This means that in a profitable year, the rent will increase proportionately; however, when sales are down, retailers can find some comfort in that the rent will be reduced, or frozen, accordingly. Essentially, the model shares risk during harder times and benefit during periods of stronger trading. As you will see below however, landlords still want to isolate themselves from this risk to greater or lesser extents.
There are various types of turnover rent, though they fit broadly into the following two categories:
- Pure turnover rent: where the entirety of the rent payable is calculated as a percentage of a tenant’s turnover. This is a riskier approach for a landlord, as there is greater exposure to a tenant’s downturn in trading; and
- Top-up turnover rent (also known as base plus): where a tenant pays a base figure in addition to turnover rent calculated by deducting the base rent from a fixed percentage of the tenant’s turnover. This is the more common model in the market, as landlords get the certainty of a base rent, and share in some of turnover element.
Inevitably, there are variations within these categories (such as the ‘80/20’ or ‘ratchet’ turnover rent) and one must drill down into the granular detail for each specific lease. For retailers, it is key to consider which model best fits your business, reflects the current market and, crucially, what your landlord will accept.
What are the issues?
Despite the attraction of the model, some of the historic issues of turnover rents remain, including:
- Valuation concerns and uncertainty about yield performance, both of which can see some funders being put off;
- Difficulties, or at least more investment time, in managing them. This is from both a practical as well as a drafting perspective. As turnover rents have evolved, they have become more comprehensive, as landlords seek to extract as much value out of the occupation whilst minimising exposure to the inherent uncertainties surrounding the turnover element of the model (as outlined above). This has meant, however, that the provisions have necessarily become lengthier and thus more unwieldy and problematic to manage and run correctly. The reliance on cooperation and information flow from tenant to landlord and the analysis of that information took time;
- Higher risk for landlords, particularly in pure turnover situations, where low turnover means low rent.
PropTech to the rescue?
Thankfully though, PropTech solutions are increasingly being used to streamline some of these processes and to resolve, or at least mitigate against, some of these historic issues.
Whilst the data input still needs to be carefully considered, there are tools which increasingly automate the analysis and produce not only the final figures but, crucially, also offer analyses of various data sets and metrics. As there is more reliance on the quality and accuracy of the data itself, this has, in turn, lead to companies turning to data-analyst third parties that specialise in this aspect.
For example, as experiential retail continues to expand, with retailers using certain stores to showcase and demonstrate their brand and products, turnover for those individual stores naturally drops. But landlords are able to capture important metrics like footfall, dwell time (the time spent in the store and/or centre by each customer), in store turnover and, more contentiously, in store collections of online purchases (i.e. click and collect).
Accordingly, there is an emerging trend of valuing rents to include such metrics. Whilst arguably a less tangible measure of value, this is nevertheless likely to become increasingly central. The proposition is a simple one: landlords can command a higher rent off the back of a tenant’s successful trading. If both landlord and tenant can draw customers to their centres and stores respectively, then both should benefit. The analysis of real-time datasets should, in theory, equip the parties with the tools to try, adapt, change and, hopefully, thrive. This then provides a genuine onus on collaboration and openness – buzzwords throughout real estate since, and prior to, the emergence of Covid-19 in 2020.
An article involving collection of personal data would not be complete without a mention of GDPR. It is, of course, crucial to anonymise any personal data collected by either party and be compliant with the regulations, but beyond these, the positives are clear to see.
How will all this impact turnover rents themselves though?
The expectation is that the base rent element of most turnover rent provisions (typically around 80% of market rent) will drop, with these other metrics plugging the gap. There will continue to be tension between certain elements – credit card costs (see Amazon and Visa’s current spat on high charges from Visa), staff discounts, gift cards and click and collect being obvious examples – but the hope is that, by being better informed, parties can work in partnership and produce a better outcome for themselves and their customers.
If the parties do cooperate and proactively monitor what is and is not working in their spaces, the sector could not only recover, but thrive. Whilst this would not all be down to turnover rents of course, it could be a significant contributor to the regeneration and evolution of the high street market.
By Patrick Brown, Real Estate – Lewis Silkin
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