September 20, 2020

Are Turnover Rents the Answer?

Conexus Law, the specialist advisory firm that provides legal and commercial advice to clients who work in sectors where the built environment, technology, engineering and people converge, are tipping ‘turnover rent’ as a potential go-to model for the commercial lettings sector as landlords and tenants continue to experience unprecedented operational challenges. However, where historically turnover structures would see a landlord share in the good times with the tenant, measures undertaken on a global scale have had an unmatched negative effect on the performance of businesses with a necessary physical presence – cafes, bars, restaurants, and retail.

As would-be commercial tenants grapple over whether and on what terms to take on new leases, and existing tenants look for ways to adjust to difficult and unpredictable economic circumstances, Conexus specialists have tipped ‘turnover rent’ (where rent is linked to the turnover of the tenant) for a possible resurgence.

Across the sector parties are seeking to achieve a compromise, and there are no hard and fast rules steering the negotiations. Whilst some sectors have thrived – data, hosting, and connectivity, as well as e-commerce and the tech industry, others have seen their revenue decimated, and through no fault of their own.

Emma Cordiner, from Conexus Law, said: “Changes in consumer habits and routines, financial uncertainty and even fear, will no doubt continue to impact on the ability of commercial tenants to cover the rent following the recent and on-going upheaval, and this is where ‘turnover rent’ may play a part. Traditionally, turnover structures would see a base level of rent paid (usually around 75-80% of the open market value), and a top-up element which would be a percentage of the tenant’s net turnover over a given time period – usually between 5-12%. This would generally have been in tandem with a landlord option to fall back on a full open market rent if turnover fell below a certain threshold, and in some cases, keep-open covenants by the tenant such that turnover could be optimised, but in the current circumstances such measures would clearly defeat the object of assisting tenants.”

However, whilst pinning rental levels to the performance of a tenant’s business during this unique period of economic uncertainty may be one answer, turnover rent provisions in leases can be complex. Moreover, the task of gathering and providing evidence of turnover, as well as the verification or audit of calculations can be burdensome and even costly. These calculations also have the potential to lead to dispute, and any party considering a turnover rent structure, or indeed any change to existing rental or wider letting arrangements, would be advised to take expert advice.

Emma Cordiner added: “The turnover rent approach could prove a useful tool for both prospective and existing commercial tenants, as well as to landlords. If we assume a period of zero turnover, no longer unthinkable, a turnover rent structure with a base rent element would at least provide the landlord with some degree of certainty of continued rental income, and some capacity to continue to satisfy any related debt obligations and covenants. At the same time, the tenant might be cushioned from the very worst of any ongoing or renewed impact on its business. Then, whilst at first glance, a turnover-only structure will look hugely unpalatable to a landlord, faced with the dual prospect of tenants that simply won’t survive if they must pay a rent over and above a level linked to their income, and a potentially tough lettings market, this type of structure might begin to look more feasible.”