This article was first published in Estates Gazette, September 2017
The explosion of online sales in retail and restaurants has prompted landlords to reassess the definition of turnover rent. Ewan Viney and Giles Davy look at how key lease clauses could be modernised
Turnover rent mechanisms aim to apportion risk between a landlord and a tenant, providing opportunity for landlords by offering them a chance to share in the success of an occupier's business while providing a degree of flexibility to cautious tenants to counter the risk of stagnant or declining markets. An average turnover base rent has historically amounted to around 75-80% of the open market value with an associated "top up" payment, usually a percentage of the tenants gross turnover at the premises.
The definition of gross turnover has traditionally included all sums earned from the tenants business at the property. Given the seismic shift in consumer behaviour in both the retail and restaurant sectors over the past 10 years, it has become clear that (certainly from a landlord's perspective) this definition requires modernising to ensure the tenants sales are fully captured.
What counts as turnover?
Today, shoppers frequently take a "try before you buy" approach, using stores to view products before buying them online. Similarly, in the restaurant sector, companies such as Deliveroo and UberEATS have exponentially increased the amount of online food sales, which has denied landlords a slice of the turnover rent they would traditionally have enjoyed.
Of course in any commercial transaction, much will turn on the relative bargaining positions of the parties. Obtaining an enhanced understanding of the tenant's business from the very outset can facilitate the tailored and considered drafting of the turnover rent provisions that is necessary to ensure that a fair and workable solution is reached.
Landlords should pursue a turnover rent clause that is as "all inclusive" as possible, whereas properly represented tenants should not shy away from trying to negotiate express exclusions for those elements of their turnover that they do not believe should be included. Revenues that are "receivable" - as opposed to those actually received at the premises - should be included by landlords, so as to protect them from the tenant's bad debtors or instalment payments that have not yet been made by a tenants customers.
Prudent landlords will also want to ensure that refunds processed in store for items purchased online are not deducted from gross turnover. Landlords should additionally aim to require the tenant to provide their sales data from across all its platforms on a quarterly (or even monthly) basis, if possible, to allow them to closely scrutinise the income. In contrast, it is in the tenant's interests to resist these provisions.
A tenant may have to covenant to submit audited accounts at regular intervals to enable the landlord to verify its turnover. Alternatively, a landlord could install its own electronic data feed system to directly monitor the tenants turnover transacting through sales equipment at the premises.
What about orders that are made at a store, but delivered to the customer direct from a tenants distribution centre located elsewhere? For example, a furniture purchase. Both parties will no doubt feel differently about where this turnover should lie for the purposes of the rent calculation. It may be possible to negotiate a solution that allocates a proportion of the revenue to the retail premises and a proportion to the distribution centre for the purposes of the rental calculation.
Tenants can resist a landlord's interpretation of revenue in the context of turnover rent, but fundamental issues still arise when considering online orders that are placed through a variety of channels - for instance, point-of-sale devices such as smartphones located within a unit or shopping centre but outside the tenant's premises.
Transparency and flexibility
To ensure transparency, parties should come to a clear agreement as to the kind of data capture the tenant has to undertake, and the accounting information that it should disclose to support its turnover calculations. Where there are disputes, resolution procedures should allow for independent negotiation - and if this fails, a binding third-party audit process by an independent expert should take place.
Notwithstanding the current trend for short-term lettings, in longer leases it would be both sensible and pragmatic for landlords to draft turnover rent clauses that can be revised periodically to reflect current market practice or include an option for the lease to revert to a standard market rent at the landlord's option (if turnover rent ceases to be appropriate). For example, a landlord may find that an anchor tenant with a flagship store is more focused on offering a brand experience to customers than on obtaining actual product sales, which at least in the short term will affect the landlord's income stream.
The end of turnover rents?
With new methods of shopping including click and collect, mobile payments and OR code purchasing, it is clear that a traditional "cash through the till" approach to calculating turnover rent is not practicable. Retailers account for payments in different ways, often through a central system and not solely through the sales apparatus at the premises.
In light of the growing online presence of many outlets and the substantial changes in consumer spending habits, we expect traditional turnover rent models will continue to evolve and perhaps even be disregarded in favour of more easily manageable - and in some respects predictable - open market rents.
If this course of action is not appropriate, where a landlord is unduly concerned about the effect of "e-tailing", there may be scope to negotiate an arrangement whereby it receives a percentage of turnover generated from the premises and a further percentage of the overall Internet sales achieved by its tenant.