For years, the standard institutional 25 year lease, with 5 yearly upwards only rent reviews, dominated the real estate sector in the UK. Those days are gone. Risk exposure has gradually, but firmly, shifted from tenants to landlords and, in the retail sector, shopping malls and High Street units have seen lease lengths steadily drop to 15 years, then 10 years, and now 5 and 3 years are relatively common. Indeed, the retail sector now has the shortest average (unweighted) lease length in its history and of any sector.[1] Larger retailers, in a strong market, are seen to prefer 10-year terms, to offset costly fit-outs, but with break clauses, again effectively transferring the risk to the landlord.
Our research is finding that tenants are driving a further change. Turnover rent clauses are expanding across the sector, from transport hubs such as airports and railway stations, via single-ownership retail parks and shopping malls, now into the High Street. The findings show that some national fashion and sports retailers insist on turnover rent clauses in lease negotiations, and have done so for a few years. Indeed, The Sunday Times reported in November 2019 that Sports Direct demands turnover-based rents for lease renewals and new lets.[2]
These leases mean that, instead of paying a fixed rent determined by reference to the market, retailers are paying a proportion of that market rent, topped up by an amount that varies depending on sales turnover, often only when turnover exceeds a pre-agreed threshold. The way the rent is set can vary across leases and our findings reveal growth in turnover clauses prior to the current pandemic, including where the rent is based wholly on the tenant’s turnover. As reported in The Sunday Times, Sports Direct is paying turnover rents of up to 15 percent of store sales to secure full turnover-linked rents. Landlords cannot bear the entirety of risk, however. And nor can tenants. Additional clauses include break clauses for the landlord if tenants fail to reach a set turnover, and rental ceilings for tenants. Overall, a turnover rent clause can, should, and is, often used by both landlord and tenant, for mutual benefit, a motivator to increase both turnover and rental flows. For landlords of single-ownership centres, this can motivate optimising tenant mix, events, marketing and maintenance, for example. For owners of single units, this may include greater participation in TCM and similar schemes, in pursuit of the same – partnerships working. Not the ‘them and us’ of what must now be, surely, a bygone era. Instead, mutual gain. A sharing of risk. But, ultimately, far more risk for landlords than with the traditional institutional lease and less stable income stream than previously characterised in the market. This is a significant shift. A shift that requires landlords to be better informed about the operational needs and business planning of their tenants.
There are challenges with turnover leases. Some known and others emerging. The sharing of data does not sit well with all retailers and the expansion in turnover leases to High Street units will not be smooth. While automated systems are used within some single-owner shopping malls to record sales, estimates and periodic audit certificates are relied upon in others, meaning that trust between parties can be key. Furthermore, and emerging from interviews conducted in February and March by the REPAIR team, the issue of online sales is rising up the ladder of challenges. Some online sales will have their origins in a visit to a physical store but are not counted as sales from that unit, a leakage in the data. Click and Collect, and viewing and trying on inside a shop but purchasing online, are other examples where sales leak from a store’s turnover figures. Deductions from a store’s turnover due to the physical return of items bought online can represent double the leakage.
As yet, there is no standard way to deal with this issue, with a sizeable proportion of all online sales estimated to have touched a physical store at some point. Lease terms are up for negotiation. Negotiation depends, to an extent, on bargaining power. Landlords, faced with rising vacancies, are having to be flexible to accommodate the demands of tenants. Yet this is not without cost, as asset values are tumbling. The subsequent problems this causes were highlighted recently by the warning that Intu may go bust as it is now in breach of its covenant terms on its debt obligations.[3] Hammerson, another high profile landlord, reported sustained losses that triggered a significant slump in its share price.[4]
In the wake of COVID-19 the pressures on landlords to accept turnover leases will only intensify. Perhaps value retailers will remain ambivalent to the turnover model – a variation in the data collected before the pandemic took hold in the UK – but already there have been calls from key figures in comparison retailing to widen their use[5]. The growing momentum behind the adoption of turnover rents needs the property industry to further adapt, however, the need for change does not preclude retailers. At the very least greater transparency is needed from both parties. A compromise, perhaps even standardisation, on accounting for online sales must also be found. Only then will a more even and fairer playing field be achievable.
[1] See the MSCI and BNP Paribas Real Estate ‘UK Lease Events Review 2019’.
[2] See the article ‘Mike Ashley pushes landlords to link rents to sales’, 17 November 2019, at https://www.thetimes.co.uk/article/mike-ashley-pushes-landlords-to-link-rents-to-sales-fs5r56cg8
[3] See the article ‘Shopping centre giant Intu warns it could go bust’, 12 March 2020, at https://www.bbc.co.uk/news/business-51851791
[4] See Reuters, at https://uk.reuters.com/companies/HMSO.L
[5] See the articles ‘Landlords told to face a new reality on rents’, 3 May 2020, at https://www.thetimes.co.uk/article/landlords-told-to-face-a-new-reality-on-rents-3zqc0csph