Are turnover-based rents the future in UK retail?

My final post of 2020 avoids the predictable review of the retail sector over the past year or the trap of forecasting what might happen in retail during 2021. Instead, I am returning to a subject increasingly mentioned in debates and discussions about the future commercial relationship between retail landlords and their tenants, which is turnover-based rents.

Landlords typically can forfeit the lease by peaceable re-entry if the rent is not paid within 14 or 21 days. However, the Government’s support for business during this COVID-19 crisis included a moratorium on the ability of retail landlords to take any action, in the event of non-payment of rent. This temporary protection for retail tenants started in March 2020 (because of the COVID-19 national lockdown) and was initially in place for three months but has just recently been extended for a fourth time until the end of March 2021.

Unsurprisingly these continued extensions have been criticised by both the British Property Federation and other landlord groups as they feel this just pushes forward an increasingly huge backlog of delayed rental payments which is bound to cause problems when this moratorium eventually ends.

However, beyond this, it has been clear for some time that both landlords and retail tenants need to move away from the traditional commercial relationship of quarterly rent payments and regular upward-only reviews. The well documented challenges faced by ‘bricks and mortar’ stores, which have been exacerbated over the past nine months by the impact of COVID-19, has highlighted landlord-tenant relationships and lease obligations and focussed the attention of both the retail and the property sectors on better ways of working going forward.

The retail landscape has irrevocably changed, but fundamentally, the way the retail property sector approaches rents, and leases has not. This historic leasing system no longer works for either party and needs fundamental reform which needs to be led by the industry but also requires Government to then put into place the appropriate legislative framework.

Whilst landlords are always going to want fixed-rate leases, the current retail property market, with occupancy levels falling, and retailers resorting to CVA’s, then looking to shrink their portfolios, and rent and rates liabilities, means property owners now have little option but to compromise.

Many think that turnover-based rents (already quite common in some European markets) are the best solution for the future of the retail and leisure sectors. In the UK, several national retailer brands, such as New Look, All Saints, Clarks, and Anne Summers have already begun, or are looking to move, many of their remaining stores to this more flexible and bilateral model.

Some have also argued that a more equitable solution would a margin-based rent.  As margins vary significantly across the retail sector it is perhaps a fairer approach for each type of retailer, regardless of the products they sell.

There is another ‘hybrid’ model that provides the landlord with some level of income security and so might begin to become more popular which is for retail tenants to pay a base rent, but a top-up based on turnover.

Whatever the precise details agreed, turnover based rents create an inter-connected relationship between the retail landlord and tenant since in good times, both parties benefit but in less favourable trading conditions both have an incentive to seek improvements. They would seem, in whatever form, to be a realistic way forward post COVID-19 avoiding the destructive tensions that have plagued many retailers and their landlords over the past few years.

For shopping centre or retail park owners, this provides them a real requirement to consider the wider shopper experience and ways they can drive up footfall levels and dwell times and to consider innovations that benefit their retail tenants and shoppers.

However, turnover rents are not a completely straightforward alternative to UK upward-only, market-based rent reviews, since the terms agreed are almost always going to be retailer, subsector, or location specific.

The real challenge of course is transparency and whilst many retailers are now prepared to share turnover details with their landlords, revealing full P&L numbers is likely to be a completely different matter! Clearly, the tenant must have confidence that whatever information is provided as part of the rental agreement is kept confidential and doesn’t ever leak into competitors’ hands.

Another important factor is the quality of data and an added complication of turnover-based rents is how a sale is attributed to a store and there needs to be more work undertaken to measure this accurately and consistently. Many retail brands now have a significant proportion of online sales, but of course also use the stores for showrooming, click & collect, or online order returns etc. True ‘omnichannel’ retailers leverage their online channel to support their physical stores, and vice-versa.

Even where turnover rents are already in place, transparency of multichannel sales remains limited because of the difficulty in establishing exactly the value of an individual physical store in any e-commerce transaction. These challenges will need to be addressed, and quickly, so that the commercial relationship that has existed for decades between landlords and their retail tenants can move to a real partnership approach, both for the benefit and survival chances of both parties in a retail sector which is both changing rapidly, and unpredictable.