The traditional leasing model with lease terms of ten years or longer, open market rents and five yearly rent reviews has been coming under pressure for some time. The COVID-19 pandemic has only strengthened the desire for change, especially from tenants within the hospitality, leisure and retail markets.
During the pandemic many landlords have worked with their tenants to agree rent concessions such as deferrals or rent free periods but longer term solutions will be needed going forward.
Turnover rents have been fairly rare in the market until now, except for certain sub-markets such as airport departure lounges and some outlet villages. Historically they were viewed as having downsides for both landlords and tenants. Landlords and their lenders have concerns about rental uncertainty and the effect on valuation. The added administrative burden of turnover rents has sometimes been a stumbling block for both landlords and tenants.
However, deal specific considerations can help alleviate some concerns around rental uncertainty and new technologies can assist with reducing the administrative burden. Turnover rents are now emerging as a genuine option for many landlords and tenants looking to forge new collaborative relationships in challenging times.
Turnover rent arrangements are very flexible and the parties can agree a wide range of options. The following examples are probably the three most common:
Base rent with additional turnover rent payable. The base rent is usually a percentage (typically 80% or less) of the open market rent. In addition, an agreed percentage of turnover is payable to the extent it exceed that base rent.
- 'Full' or 'pure' turnover rent in which no base rent is payable, or only a low minimum amount, with the bulk of the rent entirely dependent on the tenant's turnover.
- Open market rent plus a turnover top-up payable if the expected turnover is exceeded. This is probably less common.
The provisions dealing with turnover rent are usually long and detailed, as they have to cater for a wide range of possibilities. The parties will need to agree key principles to ensure that the provisions work in the expected manner during the term of the lease. Some of these critical drafting points are:
- Turnover – What is included? With the growth of online retail, landlords will be keen to ensure online sales and click & collect orders are captured. A contemporary example of turnover drafting is that "Eat Out to Help Out" subsidies ought to be included in the figures.
- Alienation – How will assignment and subletting affect the turnover provisions? Will the turnover-based rent continue? Will the agreed percentage be re-assessed, and if so, then how? Or should an assignment or subletting trigger a return to conventional open market rent?
- Keep open – Traditionally turnover rents require the tenant to be open for trade, to ensure turnover is maximised. In light of the COVID-19 pandemic, careful thought will need to be given to such provisions and any 'deemed turnover' that may be agreed in the event of a property being closed on days it should be open.
- Confidentiality – Landlord and tenants may want to keep the details of any turnover rent confidential. Steps may need to be taken to ensure sensitive parts of the document do not become publicly available at the Land Registry.
- Term length and break options – Landlord will be keen to ensure that they are not stuck in a long term lease with an underperforming tenant. Flexibility will likely be key.
Turnover rents won't be suitable in all circumstances, but with collaboration from both parties they may be a crucial part of a wider industry response to the crisis currently facing many tenants and landlords.