UK & Europe
Historically, the real estate industry in the UK has not embraced turnover leases to the same degree as many other countries. Investors and their lenders typically prefer a fixed income which is not subject to the vagaries of consumer trends. Meanwhile many tenants prefer not to "share" their profits or indeed the commercially sensitive data required to calculate turnover rents. A year of lockdowns may have changed all that.
Back in March 2020, non-essential retailers and hospitality operators found themselves closed for business overnight and essential retailers had to adapt their operations to ensure the health of staff and customers. All of that had a catastrophic effect on the market, which was already battling BREXIT uncertainty as well as increases in business rates and minimum wages. The third lockdown has continued to knock the beleaguered industry. According to the ONS, retail sales volumes decreased by 8.2% in January 2021 when compared with the previous month and online retail accounted for a record 35.2% of sales.
Recognising that an inability to trade meant that many businesses would also be unable to pay their rent, the government legislated to prevent landlords from taking forfeiture action for rent arrears. That legislation has been extended and extended again. However, the underlying rent remains due - the problem has just been postponed. A number of businesses have attempted to head it off by asking landlords to convert their leases to turnover rents. Others are making use of break options and lease expiries to force through re-gears and make the switch.
The logic of turnover leases is attractive. In theory they provide a means by which landlords and tenants can share the profits and the pain of the business which is trading from a property. At their most basic, tenants pay a fixed percentage of any profits that exceed an agreed threshold - usually in addition to a fixed rent which is less than the open market rent. So if the turnover of the property does not exceed the threshold, the tenant will only pay the fixed rent or (more unusually in the UK) no rent at all. The turnover percentage will depend on the tenant's margin. A low turnover and a high margin will dictate a higher percentage than a high turnover and a low margin. Whether businesses feel comfortable sharing their margins with prospective landlords can be the first impediment to turnover leases.
Turnover leases are relatively common in shopping centres and outlet villages where landlords have a degree of control over footfall and a vested interest in the success of the wider property in which the retailer operates. The retail sector has also developed broadly accepted principles to govern what should and shouldn't count towards the turnover for an individual store.
The hospitality sector has been slower to make use of turnover rents, but the tide may be turning. Lockdown has prompted many landlords to convert leases to turnover rents for their restaurant, bar and café tenants.
The face of retail and hospitality is changing and lockdown has forced the issue of rents to the fore. When the facemasks come off, landlords may well find that the market has shifted away from fixed open market rents. That will sit uncomfortably with many investment models, but in a difficult market an uncertain rent is better than no rent at all. Of course, the added threat of the much reviled CVA means that landlords may not have much choice anyway.