Turnover leases: an alternative to open market rents and their review

Retail leases come with risks for both the landlord and the tenant. Landlords must set rents at the right level – one which gives them adequate returns without overburdening the tenant – then hope tenants trade well enough to meet their obligations. For the tenant, they must balance rental obligations against their trading prospects and the risk of failure. Turnover leases offer an alternative to open market leases which can mitigate against the risks of both sides and potentially benefit both parties.

What is a turnover lease?

A turnover lease is one where the rent payable by the tenant is either wholly or partly determined by the actual turnover achieved by the tenant, and is an alternative to the classic open market rent review. Turnover leases are most often used in relation to retail operations and almost exclusively used in factory outlet centres, airports and railway stations.

There are various types of turnover leases in use in the UK today:

• a rent based solely on the tenant’s turnover but with the tenant guaranteeing a minimum amount of turnover (and, in many cases, with the landlord receiving no benefit from turnover above a certain figure);
• the traditional model where the tenant pays a minimum base rent with an additional turnover rent based on a percentage of gross turnover. In this case the base rent is usually determined as a percentage of open market value-typically 80%. Usually the rent payable is the greater of the base rent and the relevant percentage of gross turnover;
• a minimum base rent with the tenant paying a percentage of gross turnover above an agreed amount e.g. 10% of gross turnover in excess of £700,000.

Benefits

The main benefits to landlords are that where a tenant trades above expectations the landlord benefits immediately rather than waiting for a rent review, and if the landlord refurbishes a retail development it will benefit immediately from its investment where the tenant’s turnover increases as a result. Moreover, the information given by turnover rent tenants enables the landlord to monitor the success and effectiveness of its development and of promotional schemes or changes in opening hours, and landlords can more closely monitor a tenant’s performance which may enable them to take early action if performance dips rather than waiting until the tenant defaults or becomes insolvent.

Cautious tenants are often tempted to take a new unit, on a turnover rent basis, as the risk of failure is shared. Not only will a tenant’s rental liabilities reduce in poor trading conditions (subject to any base rent which has been agreed), but a tenant’s trading position within a development will to an extent be protected as it will not be in the landlord’s interest to increase competition and thereby potentially reduce turnover and rent.

The small print

For turnover leases to operate effectively they must contain the following:

• keep open/continuous trader clauses with provision for notional turnover to be applied to the tenant when it is not trading during the minimum trading hours;
• tight controls on use, since the percentage of turnover on which the turnover rent is based will depend to some extent on the authorised use of the premises and the quality of the products sold;
• strict landlord control over assignations and prohibition of subletting;
• obligations on the tenant to provide the landlord with an audited turnover certificate at least once per annum and quarterly non audited certificates, and provision for the tenant’s sales records to be independently certified;
• provision for online sales to be taken into account where they can be directly associated with the premises (e.g. online orders made from a terminal in the premises or goods ordered online and collected from the premises);
• provision for the tenant’s turnover records to be kept confidential by the landlord.

Both SDLT (Stamp Duty Land Tax) and LBTT (Land and Buildings Transaction Tax) on turnover leases are calculated on a best estimate of the turnover rent. Under the new LBTT regime, leases are re-assessed for tax every three years, and tenants will be required to notify the Revenue if the rent increases, whereupon any additional tax will become payable.

Get in touch

Turnover rent leases are not always straightforward in terms of both their drafting and administration but they do go some way to striking a balance between risk and reward for both landlords and tenants and may be one way of assisting our struggling High Streets and shopping centres.

If you would like to find out more information about turnover leases, and how we could help you, contact David Bell on 0141 227 9318 or email [email protected].