As the UK adjusts to life with Covid-19 and the impact this and government closures have had on the retail sector, we are seeing an increased use of turnover rental structures. historical business (i.e. where the rent payable by a tenant is not determined by a fixed sum but by reference to a percentage of their turnover).
Are we witnessing a resurgence in turnover rents?
The recent increase in the use of turnover-based rent models is the result of the uncertainty that still surrounds the UK trading landscape and the ability to trade without varying degrees of restriction or lockdown and reflects concerns landlords and tenants regarding retail sustainability and the impact the pandemic has had on demand for high street retail rentals.
The difficulty with the traditional free market fixed rental model is that, while predictable, it is quite rigid and often – in a bear market – unsustainable for many businesses. Thus, and to avoid moving to short-term leases (which do not offer either party, but in particular landlords, much security), many traders are now looking to secure rotational rent obligations to benefit from the extra flexibility this provides. Essentially, both parties effectively share the risks (and rewards), ensuring, at least in theory, that tenants have a better chance of negotiating during a pandemic and that landlords avoid vacant premises/rental investment voids.
What are the options?
While the idea of moving to a revenue-based rent model may seem reasonably simple, the reality is never that simple, not least because there are a number of different revenue models. available without “one size fits all” option. While the calculation methods involve considering a wide range of permutations (often tailored to reflect a tenant’s specific business model), there are essentially two general models:
- “Pure” turnover – whereby the annual rent to be paid will simply be the calculation of an agreed percentage of the tenant’s gross turnover; and
- Turnover “at the threshold”r – whereby the annual rent will be set at a fixed percentage of gross turnover but only if this exceeds a base rent payable independently of turnover; in other words, the turnover element effectively supplements the base rent.
Key Considerations
A first consideration is the model to adopt. The most commonly adopted model is the threshold turnover model, with the base rent usually set at around 70-80% of the open market value. This base rent level guarantees the landlord a reasonable “guaranteed” minimum rent. However, as the percentage set for the turnover element will obviously be dictated by the level of the base rent (i.e. the lower the base rent, the higher the percentage of turnover is high and vice versa), this is clearly negotiable depending on individual circumstances.
Interestingly, the return to popularity of turnover-based rents can arguably be attributed, at least in part, to the agreements recently imposed under various Voluntary Distribution Company Agreements (CVAs) – including, for example, New Look and House of Fraser. There also appears to have been a broader easing from landlords willing to agree a rotational rent arrangement, perhaps to seek control of the exit from the pandemic and to avoid forced CVA action or insolvency of tenants.
The second consideration with turnover annuities is how the turnover is actually “captured”, which can lead to quite complicated workings and formulas. As this will obviously be the basis from which the turnover rent is calculated, it is obviously important to consider both the general terms and structure under which the model will operate and whether the percentage is fixed or flexible depending future market developments, economic events and/or market trends. From a legal point of view, the agreement between the parties should reflect how the chosen model should be implemented and how the rent should be calculated. These arrangements may well result in increased administrative and accounting burdens in terms of bookkeeping and approval of financial records/calculations.
In summary, although not without complications, it would appear that the turnover rent is once again experiencing, and will likely continue to experience, a revival in the retail sector as the economy continues to navigate through the pandemic. Only time will tell if this is adopted more widely or just used as a short-term solution to the immediate bite of the pandemic.
