What is turnover rent and how does it work?

What is turnover rent and how does it work?

A guide to turnover rent

Fiona Knight is an experienced associate in Frettens’ specialist Commercial Property team. In this article, she looks at a topic of increasing importance in commercial property: turnover rents.

Fiona explains how do they work, why they are in the news, and outlines their advantages and disadvantages.

What is a turnover rent?

Essentially, a turnover rent is exactly what it sounds like. A tenant pays a percentage of their turnover rather than a fixed monthly or annual fee to their landlord.

A turnover rent is also commonly referred to as a turnover-based rent. I will use both terms in this article.

What is a turnover lease?

A turnover lease, or turnover-based lease, is a lease agreement that includes the terms and conditions of a turnover rent.

How does a turnover rent work?

When the tenant’s business does well, and their turnover rises, the rent they pay will increase.  But when the business struggles, and turnover falls, the landlord will receive less rent.

As a result, turnover rents are particularly attractive to tenants in difficult trading circumstances, such as those currently facing many high street retailers.

Many in the industry are forecasting that turnover rents will become more common as tenants try to find ways of reducing overheads and surviving the economic impacts of the pandemic.

Are turnover rents good for tenants?

Whilst there has been a temporary ban on commercial tenant evictions and winding-up orders, and other business support mechanisms put in place by the government, trading has been exceptionally tough.

Negotiating a turnover rent means a tenant’s rent decreases proportionally with their turnover in difficult times, so they are an attractive prospect for many tenants in current circumstances.

However, poorly-negotiated turnover leases could prove costly as turnover increases.

Are turnover rents good for landlords?

The high street has been hit hard by the pandemic, an area of the economy that was already being squeezed by online retailers. As a result, many commercial tenants have had to either break their leases or transfer them to another tenant if they are able to find one.

This leaves many commercial landlords with a decision to make: Either have units sat vacant or negotiate on rent. Many have opted for the latter option, deciding that some income is better than none in the circumstances.

Turnover rent vs vacant property

By retaining the tenant on a lower rent, the tenant’s obligation to pay their share of the buildings insurance and any service charge continue. Plus the obligations to maintain the premises and keep them secure.

If premises are empty, the landlord loses the above and is also liable for the rates after 3 months for some types of commercial property and 6 months for others.

If the landlord has a mortgage on the property, they may also need to obtain their lender’s consent. Need to review their mortgage terms.  

Do landlords have to accept a turnover rent?

Legally, there is no obligation in almost all circumstances (for an example of an exception, you can read Malcolm Niekirk’s article on the Clarks shoes CVA).

Negotiating a turnover rent can mean that a commercial unit remains occupied, but income will be lower while a tenant’s turnover is low.

It is a commercial decision for a landlord to make, but it is crucial that any turnover rent agreement is well-negotiated and drafted.

How is turnover rent calculated?

Typically, a turnover rent is calculated based on a fixed percentage of the tenant’s turnover.

Savills reported recently that turnover rents requested by retailers range from 1 to 15%, with an average of 7%. This figure was based on analysis of their rent negotiations in the UK, and pointed out that almost all details are in some way unique.

Margin-based rent

Rent can also be calculated as margin-based. This is worth considering, as two retailers with the same turnover could have very different profit margins.

Hybrid commercial rent

Many landlords and tenants have opted for a hybrid model, where there is a baseline amount, topped up by a turnover- or margin-based element.

So, how do you work out turnover rent?

To summarise, a turnover rent can be calculated in whichever way the parties agree.

Terms are a result of a negotiation between landlord and tenant. While each deal is unique, there are some common issues that emerge from all options, which I will outline below.

How do you prove turnover for a turnover rent?

Any agreement should include a provision for how turnover is to be proven.

A typical and simple model would base an annual rental amount on the previous accounting period, or by the tenant providing a turnover certificate.

We are not, however, currently operating in normal circumstances, so other options and timescales may need to be considered. Any alternative option will inevitably be based on an element of trust between the parties.

A turnover lease agreement should therefore aim to clearly set out exactly how this process will work to avoid potential disputes.

Turnover rents for multiple sites

Working out a turnover rent for a single retail unit should be relatively straight-forward.

But what if a tenant has multiple units? Or has a ‘bricks and clicks’ business model, where the store is a showroom, but many sales come from online?

How do you attribute a sale to a particular store in these circumstances?

The answer, probably unsurprisingly by this point, is that it depends and is open to negotiation. The key to a successful long-term lease agreement will be an understanding of the tenants’ business model and landlords’ requirements.

Temporary Turnover Rent

With increasing awareness of turnover rents as a result of the current difficult trading conditions, landlords may wish to consider a temporary move to turnover-based rent.

If this is the case, it is important that any agreement includes clearly-stated controls on time frames.

Turnover rents and CVAs

Malcolm Niekirk, Frettens’ resident insolvency guru, advises on turnover rents in administrations. There have been many of these in the news lately, with administrators of businesses with multiple commercial tenancies negotiating to reduce overheads.

He outlines how they work and looks at the recent Clarks CVA in an article you can read here.

Advantages of turnover leases

  • Tenants’ overheads decrease in difficult trading conditions
  • Landlords receive some rental income rather than have vacant units
  • Tenants will still have to pay insurance, service charges and rates

Disadvantages of turnover leases

  • They can lead to complicated disputes if not properly drafted
  • Turnover can be difficult to classify or prove
  • A poorly-performing tenant business can affect the value of the commercial property
  • Landlords may need to get mortgage provider approval

How to negotiate a turnover lease

Whether you are a landlord or a tenant, there are advantages and disadvantages of moving to a turnover-based rent.

When negotiating the lease, it is extremely important to:

  • Understand the tenant’s business model
  • Decide which model of turnover lease works best for both parties
  • Have agreements in place for proof of turnover
  • Establish whether the agreement is temporary
  • Include mechanisms for resolving any disputes

Turnover lease solicitors

At Frettens, our specialist commercial property team is one of the best-resourced and most experienced in the area, and are recommended in the Legal 500 guide.

Bright commercial property lawyers

Our bright lawyers offer straight-forward advice in plain English. We offer a free initial chat to all new clients, so if you are a landlord or tenant considering a turnover lease, don’t hesitate to pick up the phone or contact us here.

The team also work closely with the firm’s dispute resolution and insolvency departments on turnover rents, so whatever your query, we can help.