231: Turnover rent leases – what to consider

Turnover rents have been used for many years, but this kind of rental structure became very topical during the pandemic, particularly in the retail sector, because of the uncertainty surrounding retail businesses.

Turnover rent is based on a percentage of the tenant’s gross turnover at the rental property. Traditionally, the tenant pays a base rent which represents a discounted market rent (say 75-85%), plus a turnover top up based on a fixed percentage of gross turnover for the year.

More recently, we have seen a rise in pure turnover rent leases where no base rent is included within the lease, although this type of arrangement is still relatively unusual.

1. What landlords and tenants need to consider when negotiating turnover rent leases

What will ‘gross turnover’ include?

An agreement as to what is to be included and excluded from ‘gross turnover’ is crucial and must be settled at the heads of terms stage to minimise the likelihood of later disputes. Monies received for goods sold, hired or leased are usually included, along with consideration received from orders (whether placed in person or remotely). VAT and cash refunds or credit notes are usually deducted, but there are a number of grey areas, such as:

• gift cards – should they be included in gross turnover at the time when they are sold or when redeemed by the customer in store?
• ‘Click and collect’ – the landlord’s attempt to include these sales is likely to be countered by the tenant’s argument that the store is merely a collection point for an online sale; and
• turnover of undertenants or concessionaires at the property – how will this be treated?

Definition of turnover period

Typically a turnover period is a full year, but the parties should consider accounting dates and the burden of administering the turnover rent provisions for a short period. It may be preferable for the first turnover period to run from the date of grant of the lease until the second accounting date, for example.

On account payments

Because turnover rent is usually calculated at the end of a turnover period, the lease will often provide for payments on account of a fixed figure to maintain the landlord’s cashflow. There will then be a reconciliation exercise at the end of the turnover period once the turnover certificate is produced.

Reporting

The tenant must provide turnover certificates and maintain records to show how the turnover figure has been calculated. Landlords usually require turnover certificates to be audited by an independent accountant, but tenants will resist this as audited certificates are costly and can take some time to produce.

Audit

Landlords usually want the ability to call for an audit of the turnover information. Audit costs are significant so the tenant will often ask that the landlord bears the cost of the audit if the difference is within a certain tolerance.

2. Effect of turnover rent provisions on other provisions within a lease

Permitted use

The landlord will want to control user to ensure that the property is turnover-generating, so may require a narrow definition of permitted user. This needs to be taken into account if the tenant is likely to want to assign the lease or sub-let during the term. Will a narrow definition of the permitted use inhibit alienation?

Keep open covenants

The landlord may want to include a keep open clause to prevent the tenant from circumventing the turnover rent provisions by restricting trading hours.

The tenant, however, will usually want to exclude certain circumstances from the keep open obligation. For example, where there is destruction of or damage to the premises; where the tenant is to undertake repairs or works permitted under the lease (although the landlord will want to limit the length and frequency of these closures during a specific turnover period); for staff training or stock taking; or where to open would be contrary to any regulation or requirement of a competent or statutory authority, for example during government closures for the Covid-19 pandemic.

Rent free period

If there’s a rent free period within the lease, should this include both the base rent and the turnover rent? If the parties intend to suspend both, the rent suspension clause should refer specifically to both to avoid confusion.

Rent review of main rent

The landlord is likely to require that the base rent in a lease should be subject to a rent review which disregards any turnover specific clauses and reviews the full market value of the lease. Turnover rent provisions are often agreed with a tenant as part of a concession arrangement and, in the event that the lease is assigned, the landlord may require that the rent reverts to market rent, so it is important that the base rent has been reviewed in the usual way during the term of the lease.

3. Practical considerations

SDLT

Tenants must provide a reasonable estimate for turnover rent at the grant of the lease for the purposes of the initial SDLT return. They should then reassess turnover at the end of the first five years and submit a further return if necessary.

Retail environment

Footfall to the tenant’s premises is obviously important in turnover leases, so the landlord may want to impose certain other obligations on the tenant, for example, signage obligations, window designs, lighting etc, so that the premises is attractive to customers.

Uncertainty of turnover rent

The landlord may require the ability to break the lease if the tenant underperforms and turnover falls below a certain level. Parties should carefully consider how the parameters can be calculated to assess whether the right to determine the lease has arisen.

Conclusion

Leases which include a turnover element are advantageous to both landlord and tenant, as they allow for the parties to share in the risks and rewards involved in a retail business. This type of lease does, however, necessitate a number of additional considerations and these are invariably best addressed at the heads of terms stage. An early agreement between the parties on how turnover will be calculated can help to avoid later disputes.