Tristan Wark, senior associate in the property team at London law firm Goodman Derrick LLP, explains the fundamentals of a turnover lease.
Since the start of the Covid-19 crisis and the country going into various states of lockdown, there has been a growing demand from retailers for turnover leases. New Look, Pret a Manger and Frasers Group (formerly Sports Direct International) have all publicly made the case for turnover rent-based leasing arrangements; joining earlier advocates of turnover leases, such as the H&M group.
We are potentiality on the verge of a widespread movement towards turnover based leases that would bring the UK in line with the United States and Italy. There, rents being linked to turnover and visitor traffic are more common. Retailers who agree with their landlord to move onto a turnover rent-based lease must be aware of how such leases differ from standard fixed rent leases. Plus, the key issues they should consider.
There are effectively two types of turnover lease:
- A “pure turnover” lease, where the only rent that the tenant pays is based on their turnover.
- A “turnover top-up” lease. Here, the tenant pays a reduced fixed base rent at a certain percentage of the open market value, with a turnover top-up paid in addition to the base rent where turnover exceeds the base rent.
A critical consideration of a retail tenant seeking to agree a turnover lease is what constitutes turnover. Some issues are not straightforward and landlords and retailers should properly explore these between them. For example, the treatment of click and collect operations.
Payment mechanics also need careful thought. The following can be important:
- Turnover leases typically involve paying an on account turnover rent estimate, which is then reconciled against actual turnover.
- Consider the effect of seasonal turnover variations. Most retailers prefer to pay a more even turnover rent throughout the year rather than receive one large turnover rent bill in the Christmas quarter.
- Consider tying the annual turnover reconciliation date with your financial year-end so that certificates of turnover can be more easily produced.
A turnover lease will almost certainly mean a more pro-active landlord and tenant relationship.
Your landlord will become interested in your trading success, seeking to maximise their rent with a high turnover occupier. This may result in very restrictive provisions to prevent you underletting or assigning the lease. A closer relationship also means your landlord will have more information about your business. You will need to ensure that there are suitable confidentiality obligations in place.
Turnover leases often include a keep open covenant, where if the shop doesn’t open, a turnover is assumed. Check carefully how this works and that an artificial turnover won’t be assumed where it would be unreasonable to do so. For example, if you can’t open as to do so would be unlawful. Or, if you close the shop to undertake refurbishment and decorating works.
Stamp Duty Land Tax in respect of the grant of the lease is also more complex for turnover leases and involves estimating what the turnover rent will be during the term of the lease and potentially making multiple SDLT returns.
Turnover rents can be beneficial and are undoubtedly growing in popularity with retailers.
However, they are not without their difficulties, both in terms of drafting and management. Failing to consider the detail of your new turnover lease could result in you paying more in the way of rent than you would otherwise have. Or, struggling under the administrative burden of calculating and auditing turnover rent levels too frequently.
To do checklist:
- Appoint a specialist solicitor and surveyor. They will support and advise you on negotiating and agreeing the terms of the turnover lease.
- Examine the definition of what the lease treats as turnover line by line.
- You will likely be asked to provide turnover certificates and detailed records. Ask yourself if you are happy with your new obligations. Also, be honest about the time that will be needed.
- Timing is crucial. When must you pay the rent and any top-ups? Do the new terms work with your typical cash flow?
Tristan Wark is a senior associate in the commercial real estate team at London law firm Goodman Derrick LLP.
