Turning over a new leaf: are turnover rents the answer for retail?

With the arrival of Covid-19, retail has become even more stricken and retailers are now waking up to the fact that change cannot come too soon. The effects of the pandemic have hit the sector hard, particularly with Government recommendations and restrictions turning many high streets and all shopping centres into ghost towns. While some retailers are making ends meet through e-commerce, the majority are burdened by crippling rent and overhead costs on empty outlets. In order to have a fighting chance once the restrictions are lifted, the retail sector must flex and adapt by changing the way landlords and tenants operate.

The perfect storm to hit the retail sector means that turnover rents leases are, once again, coming into their own. It is likely that they will firmly embed themselves into ‘the new normal’ for both the high street and shopping centres alike. But first, these helpful lease agreements for retailers need to improve their reputation with landlords; something which may be easier said than done.

Allowing both parties to share in the good and bad times, turnover rent agreements typically work by dividing the payment into a fixed term base rent, which is determined by current market conditions, and a turnover element, which is determined by the financial performance of the tenant. The typical minimum base rent is around 75-80 percent of the total. The turnover payment element represents a percentage of the total turnover, usually between 5 and 12 percent; however, the mix can be tailored to suit both parties by negotiation. Typically, a retailer will want to increase the turnover rent element. A landlord will invariably try to negotiate a higher turnover percentage the greater the turnover element.

The flexibility of these agreements makes them particularly popular with multi-faceted businesses, such as H&M Group, which operates several different independent brands and stores: COS, Monki, Weekday, & Other Stories, and Arket. However, what works for one does not work for all; retailers large and small must be aware of their current position and carefully assess whether turnover rent will benefit them in the long-term. For example, having three or four units, each with a turnover rent agreement, can quickly become more of a burden than an opportunity.

While turnover leases can be effective in shifting some power back into the tenant’s court, before entering into an agreement, it is essential that they consider the weight of responsibility they carry. It may seem like a compliance exercise as under every turnover lease, retailers are required to keep careful and detailed records of all items sold and to provide their landlord with regular ‘turnover certificates’. In circumstances where trust has broken down, landlords can require a full audit to be undertaken, including a right to inspect and query any business’ records. Retailers must therefore ensure all files and accounts are fully up to date, including cash receipts, vouchers, computer data, VAT returns, and online sales.

Disputes around turnover rents can be time consuming and expensive so, for retailers, prior agreement with a landlord is key. Retailers will want to exclude online sales from the turnover calculation as well as VAT and bad debts. What if the retailer allows staff and family to purchase its goods at cost? Most landlords will insist that those goods appear in the turnover figures at full price. The retailer may want a tailored turnover calculation for each brand it sells, however, they should be aware that this will substantially increase the administrative burden. Both parties should ensure that the agreement contains a disputes provision, in the case that the turnover rent element cannot be agreed.

To ensure that retailers with turnover agreements have maximum control in light of Covid-19, keeping revenue locked in is essential. While terms and conditions should be continually reviewed, now may be the time to tighten up delivery and returns policies. Whilst such policies differ widely (unless an item is faulty where the customer can expect a full refund), in the current climate, retailers should now be offering exchanges or credit notes within a strict timescale from the date of purchase to help to protect future revenue.

Advice when negotiating a turnover lease agreement is essential, and a surveyor experienced in such matters can help to deal with any inconsistencies which may arise around how much of a unit is ‘retail space’ and how much is purely for display purposes. Expert advice will also be required when negotiating the turnover rent percentages. Most concerns can be dealt with during the lease negotiations and it is important that landlords and tenants properly address any issues at an early stage to mitigate against unnecessary cost and time delays.

If the going gets tough, communication is key. A two-way dialogue between landlords and tenants is essential in negotiating a solution that benefits all parties in the long-term. While the current climate is altering the landscape, landlords may express some hesitancy around signing a turnover rent agreement in the first place. Retailers should therefore revert to their business plan and assess what they are going to offer a landlord in return. For example, agreeing a slightly longer lease would give the landlord more security. Alternatively, the retailer could promise a re-fit at its own expense. Depending on the market and the state of the economy, tenants may find they have more leverage when forming these types of agreements.

For retailers considering entering into or renewing a turnover agreement, it is also essential to check the contract for a confidentiality agreement beforehand. In a highly competitive market, this agreement is key to ensuring that any sensitive information or trading figures stay between the parties. For retailers with an existing lease, any amendments they wish to make must be done via negotiation with the landlord – in this case, the support of a third-party expert is advised.

With the effects of the pandemic taking a toll on the retail sector, fluidity in the marketplace is essential. If retail is to survive the effects of Covid-19, drastic change is needed, starting with negotiations between landlords and tenants and the reintroduction of turnover rents on a larger scale.

This article was written for FashionUnited by Julian Joseph, real estate partner and retail specialist at law firm, Shakespeare Martineau. Shakespeare Martineau delivers a broad range of specialist legal services. The firm believes that legal counsel is only one piece of the jigsaw and bespoke business solutions are designed firmly around clients’ needs.

Image: David Visnjik (Andoly Agancy) via AFP