Will turnover rents affect your online business?

Historically commercial leases have been based purely on open market rents.  2 tenants next to each other with the same sized units would generally pay the same rent as each other.  One tenant could be doing significantly better than the neighbour but they would pay the same rent.

Things have been changing in the last two decades and turnover rents are now becoming more common.

What is a Turnover Rent?

A Turnover Rent is where your rent as a tenant is measured against your turnover for that store or shop.  The more money you turn over the more rent you pay.  It is important to note that this is not a profit rent.  The rent is not measured on your profit, just on your turnover.  So if you sell water bottles for £10 and you sell 10 bottles your turnover is £100.  It makes no difference if you bought the bottles for £2 or £5 – your turnover is still £100.

Turnover Rent is usually a percentage of your turnover.  It could be 10% of your turnover.  So in our example you would pay 100 x 10% = £10 rent.

What is a base rent?

The problem with a straight turnover rent as detailed above is if the tenant doesn’t turn up for the day the landlord doesn’t get paid rent (no turnover, no rent).  To solve this problem the landlord normally wants a minimum rent.  That is called the base rent.

How does it work in practice?

Example:

Base rent – £50,000 per annum.

Turnover Rent – 10% of turnover over £500,000

If in year 1 you make sales of £300,000 you will pay the minimum base rent – £50,000.

In year 2 you make sales of £600,000.  Now you will pay 10% of £100,000 (as that is the amount above £500,000).  That is £10,000 additional rent so you pay £60,000 rent in total that year.

In year 3 you make sales of £450,000.  This year you will pay the base rent again without a top up – £50,000.  (It makes sense to check this point with your lawyer as landlords sometimes like to peg a minimum rent based on the previous year – or at the very lease collect “on account” rent based on the previous year.)

You’ll pay a minimum rent every year but your “turnover top-up” will be different each year.

Will I get a better deal on a turnover rent?

You should do.  If the landlord is going to benefit in the good years it should share the pain in the bad years.  It leads to more of a partnership in retail where the landlord wants to help the tenant get a larger turnover.

Your base rent should be set lower than the average rent for it to make sense.  People used to say that base rent should be set at 80% of the open market rent.

What actually amounts to turnover?

This is your sales figure, but it should not include VAT.  VAT is a tax which the tenant has no control over and it is not the tenant’s property – it is the government’s property.

If you get an order on the internet but someone collects it from your store, that needs to be included in your turnover figures.

The landlord will clearly want more things to be counted as turnover.  The tenant will want fewer things.

Do you think gift cards should be included?  They often are because the tenant has received the money so that counts as turnover.

What about sales and discounts?  Usually only the price paid is counted but “family and friends” discounts are frowned upon because an item should have been paid at full price so the landlords want the full price to be included, even if it wasn’t paid.

Tenants should be careful to ensure that customer refunds are deducted from the turnover figures.

All in all tenants need to really understand and split up their turnover.  Some turnover heads should count and others should not be.  If a tenant doesn’t remove customer refunds from their turnover they will end up paying more rent!

How do you prove turnover for a turnover rent?

You start with your till.  That will show what your gross sales are.  Then an accounts person checks everything should be there and you pass a figure to the landlord for checking.

Tenants should be aware that they may need to employ professional auditors for these shops as landlords certainly want annual figures to be checked by a professional.  Tenants should do what they can to make sure this is only a requirement once a year and that quarterly or monthly figures can be provided by someone other than a professional.

Can the Landlord count my online orders in turnover?

This is where you need a lawyer to look at the fine print!

There are various scenarios for a complex business:

1. An order is made online but collected at a store – the classic “click and collect” scenario
2. An order is made in store but sent from your online delivery service
3. An order is made in one store but collected in another store

Which of these should count towards turnover in your store with turnover rents?  It all depends on how the turnover rent provisions are drafted in your lease.

Sometimes your shop or store acts as a showroom.  Then landlords will really want to work out the special provisions of what counts as turnover.

Are Turnover Rents for all Commercial Property Leases?

You mainly find turnover rents in retail leases as it is much easier to work out what the turnover is.  Till systems fully capture gross sales which gives the tenant’s gross turnover.

They can be used for leisure leases in shopping centres too.  There is no reason why turnover rents should not be applied more widely but they are unlikely to be suitable for offices, even retail offices.

Are turnover rents good for tenants?

Yes they are.  If there is no base rent then you only pay rent according to how well you perform that year.  Surely turnover rent in a turnover lease must be a good idea for a tenant.

If there is a base rent you must be sure it is at a level in your turnover lease that is lower than regular rent.  If it is not lower only the landlord will benefit as he will do well when you do well and ok when you do not do well.

Tenants know their business best.  They can use this to their advantage.  They should be able to structure a deal that will mean they pay less rent for a few years whilst they get a foothold in the location.  After that they may pay more through their own success but they probably won’t mind.

Are turnover rents good for landlords?

Yes they are.  How can they be good for both landlords and tenants at the same time? Commercial Property is all about win win.  If both sides win then you have a great working relationship.  The more you work with your tenants, the more they sell and the more rent you receive.  You don’t even need to worry about their expenses as turnover rent is based only on turnover, not profit.

How could turnover rent clauses affect other provisions in the lease?

They don’t really.  There may be minor changes to other clauses but turnover rent in commercial property leases is more of an addition rather than a change to a lease.  Clearly the landlord will want the tenant to sell as much as possible so you may see clauses to that effect.

There is a “keep open” clause in virtually every shopping centre lease.  Even if the rent is a vanilla rent landlords want all the shops in their shopping centre to remain open.  No-one wants to go to a shopping centre where only half the shops are open.  Shops rely on each other to create business.  Someone who wants some cosmetics may want some clothes too.

On a turnover rent lease this clause often goes into overdrive as it is now crucial for the landlord that the shop remains open as much as possible, rather than just being a “nice to have”.

What SDLT (Stamp Duty Land Tax) does a tenant pay?

This is a tricky question to answer.  The tenant needs to give a rough estimate of how much rent they will pay in the first 5 years.  From that, a tenant can work out their SDLT.

The reality is that a tenant should have good visibility on their turnover for the first 5 years in a store.  They should give that estimate to their lawyer so that their lawyer can work out the SDLT they will owe.

Turnover rents can be complex and you need a solicitor who understands things and can explain the complex and make it simple.

Please do not hesitate to contact Robert Rosenberg or one of our Property team.

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• Call – 0208 349 5504