Performance based commercial leases
The ups and downs of the pandemic are still affecting many business sectors, with retail and hospitality again hit hard, especially over what should have been their busy Christmas period.
Some commercial landlords and their tenants have already agreed measures to help during these ongoing, difficult periods and performance based or turnover rents as they are better known is one option. Are turnover rents something we are likely to see more of in the future and what role do they have for commercial landlords and their portfolios?
The simple answer is yes we are likely to see more turnover rents in the future. They will encourage new businesses onto the high street and help to reduce risk for established, but struggling businesses, who would otherwise trade profitably with no covid restrictions in place and higher consumer confidence.
Turnover rents are calculated based on the turnover of the business, but this could be as a simple percentage of turnover, or a guaranteed base rent plus a premium if a certain turnover threshold is reached. Clearly the better the tenant’s business, the more rent is paid to the landlord.
Percentages of turnover can vary significantly with some agents reporting a rate of anywhere between 1%-15% and an average being 7%. If you are considering offering a tenant a turnover rent, what should you consider?
The first thing to consider is the business model, its viability and whether other costs payable under the lease should be kept separate from the turnover provision, how long the provision should last if temporary and what happens if the tenant wishes to assign the lease.
Secondly, the calculation of turnover itself. For example, if a customer is shopping online and having their goods delivered which could be from a separate distribution centre, should this type of turnover be excluded, especially if the customer doesn’t enter the physical premises at all? And for restaurant operators, how do they factor in takeaway sales not consumed on the premises and how can they make sure staff tips are not included in overall turnover calculations?
Whilst landlords might want a fixed income for the natural security that gives, the changing, post pandemic high street and the business models of the remaining businesses that occupy it will naturally alter overtime and therefore we are likely to see more turnover rents demanded in the future.
This element of shared risk also means there is more incentive for the commercial property owner to help ensure the property is in a safe, convenient, and welcoming area, a place where people want to visit and spend time. Improving footfall will help to increase turnover and landlords that work together will have greater success.
For turnover rents to work there needs to be full disclosure of financial information and landlords need to consider issues that lenders might have. The devil will be in the detail to ensure the success of these types of arrangement and having a well-drafted lease will go a long way to preventing issues in the future.