Summary and implications
A turnover rent is calculated by reference to the turnover generated by the tenant. It goes without saying that if the landlord is to be able to calculate the turnover rent, it must have access to accurate turnover information but tenants do not always provide the information or provide it on time. Careful drafting of the terms of the lease and early negotiations with the tenant can encourage tenants to produce the information and reduce the delay in receiving rent and potential litigation costs.
Turnover rent leases come in many shapes and sizes e.g.:
- The “classic model” with a principal rent based on a percentage of open market rent (usually 75 per cent or 80 per cent) plus a fixed percentage of the tenant’s turnover to the extent it exceeds the principal rent;
- A rent based solely on the tenant’s turnover but with the tenant guaranteeing a minimum amount of turnover although, in many cases, the landlord will receive no benefit from turnover above a certain figure;
- A rent based on the tenant’s turnover, the tenant paying an agreed base rent with annual uplifts or “ratcheting” of the base rent payable. The uplifts will be based on any increase in turnover for the previous accounting period.
The classic model provides the landlord with a large degree of certainty as to the rent it will receive. Other forms of turnover rent leases provide less certainty. The lack of certainty can have knock on effects e.g. upon a valuation of the relevant property. The landlord will want to ensure that, so far as possible, lack of turnover information will not deprive it of the ability to demand and recover rent.
What are the pros and cons?
With the reduction in consumer spending hitting retailers hard, landlords are under pressure to fill vacant units and have to focus much more on providing attractive deals to tenants. They have had to become more commercially savvy, offering flexible deals rather than pure open market terms. Landlords have to demonstrate value for money and offering a turnover rent is one way in which they can achieve this. The advantages of turnover rent leases include:
- Flexibility for both the landlord and tenant which may tempt an otherwise cautious tenant to take a new unit or try out a new brand;
- Landlords can keep a much closer eye on a tenant’s performance. This may enable the landlord to take early action if performance dips;
- Where a tenant trades above expectations, the landlord is able to take immediate advantage rather than waiting for a rent review.
The main disadvantages are the lack of certainty of the amount of rent payable and the reliance which the landlord has to have on production of accurate turnover information by the tenant.
However, there are ways in which these can be reduced.
Payment on account
The amount of rent payable in a turnover lease will be calculated over a period of time (usually a year but this can be shorter) and so turnover rent leases often operate in a way which is similar to a service charge, i.e. the tenant pays something “on account” of the final turnover rent payable (e.g. on each quarter day) and when the final figures for the annual accounting period are available, there is a reconciliation and the tenant pays any excess due to the landlord or if it has overpaid, the landlord repays the excess or offsets it against the next payment due.
These provisions only work effectively where turnover information is supplied by the tenant. Some simple provisions included in a turnover rent lease can assist and provide more certainty about income. These include:
- If the turnover rent is based solely or largely on the tenant’s turnover, agree the amount of the on-account payment for the first accounting period with the tenant and insert it in the lease.
- Future on-account payments would normally be based on the total turnover rent payable for the previous accounting period, but if no turnover rent was payable or it cannot be calculated due to a lack of turnover information, consider providing for a default payment which could be a percentage of the guaranteed minimum rent (if payable). As an example, in the classic model, if the principal rent is 80 per cent of the market rent, then the interim payments of turnover rent should amount to 25 per cent of the principal rent.
Accounting and payment provisions
Details of the tenant’s total turnover for an accounting period are confirmed by means of a turnover certificate which the tenant is obliged to produce at the end of each accounting period. It is common for there to be a provision for an interim final payment of turnover rent to be made if the turnover certificate is not delivered within the agreed period after the end of an accounting period. The interim payment is usually calculated by reference to the final payment of turnover rent due in respect of the previous accounting period, which then relies on turnover rent having been paid!
To reduce the risk of the tenant’s failure or delay in supplying the certificate, we recommend the following as an approach:
- In the case of the classic model the interim payment should reflect the reduction in the rent. For example if the rent is reduced to 80 per cent of the original “market” rent the interim payment would be one quarter of the reduced rent. Any payments made on account should, of course, be taken into account.
- In other forms of turnover leases, the amount of the interim payment should be agreed during negotiations and inserted into the lease.
- Consider charging the tenant an administration fee where the turnover certificate has not been produced or in circumstances where the turnover certificate provided is not complete or does not comply with the provisions of the lease.
- Provide for the interim payment to be payable within a specified period of the date by which the certificate should have been delivered. The landlord should be entitled to demand the interim payment on expiry of the delivery period if no turnover certificate has been delivered.
- Try and include a provision for a notional turnover figure to be applied to any period during the accounting period when the premises have been closed. It is usual, though, to ignore certain types of closure, e.g. where the premises have been damaged by fire etc.
Leases usually provide for interest to be paid on any payments not paid on the due date. To ensure the effective operation of the interest clause, the drafting of the turnover provisions should include the following:
- The turnover rent should be deemed to be due from the date by which the tenant must deliver a turnover certificate (whether or not it does so) and interest will be calculated from that date.
- The interim payment should also be made due and payable on expiry of the delivery period with interest being calculated from that date.
These provisions are designed to encourage tenants to deliver the turnover certificate before the end of the delivery period. With modern accounting systems, it should be easy for most tenants to provide turnover certificates within a month of the end of the accounting period although some tenants try to negotiate longer periods.
A balanced approach
One of the perceived advantages of turnover rent leases is that they foster a sense of partnership between the landlord and the tenant. The suggestions and recommendations referred to above cannot be imposed on the tenant but will have to be negotiated. The approach should not be one of seeking to penalize the tenant (note that any attempt to impose a penalty will be deemed to be void in any event) but to encourage the tenant to perform its side of the bargain, namely to provide the landlord with accurate information about the turnover so that the rent can be calculated.