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The move from physical to online stores during the pandemic left many companies with the issue of managing the real estate costs of the business.

The lockdowns that were brought in as means of tackling the pandemic meant many in the retail and hospitality sectors had to adapt and adapt quickly in order to survive. In some instances, those wanting to continue to trade had to very quickly enhance or create an e-commerce offering.

This was the case for SMEs through to large corporates, all at different stages of their digital journey. The different levels of sophistication and scale of those businesses meant each one faced a different challenge. Part of that challenge (where business did not have a pure play online storefront) was managing the real estate costs of the business.

Turnover rents

Turnover rent models are not new and they do in part address some of the issues that the pandemic brought to tenants.

Unlike a lease that has a rent that represents the full open market annual value of a holding, turnover rent is based on the income the tenant makes from its use of the property.

The income is defined in detail in the lease, usually as "gross turnover" and allows for some items to be deducted — it is the job of the draftsman acting for the landlord and tenant, and in a lot of instances the parties’ accountants, to accurately define what comprises turnover for the purpose of the lease.

Ostensibly, turnover rent can benefit both landlords and tenants as it spreads the risk between the parties and should help create a collaborative relationship through a common goal of maximising the turnover at the premises. Landlords have their part to play in ensuring (to the extent possible) that any common parts they are responsible for maintaining are as appealing to shoppers as possible in order to maximise the turnover.

However, turnover rents can be complex to manage and impose an administrative burden on both parties. Crucially for landlords, especially where turnover rent makes up a sizable percentage of their rent roll (whether on one property or over a portfolio) they have to accept fluctuations in their income that are outside of their control and, as was the case during lockdown, possibly periods where the rent they receive (on a pure turnover model) is lower than the market rent. It is that uncertainty, which the pandemic did nothing to alleviate, which meant landlords may prefer a traditional rent model — as may their funders.

Omnichannel transactional rents

To address some of the issues that were laid bare in turnover leases during the pandemic, CACI, a consumer and location intelligence specialist, launched a data-driven, objective model in August 2020 to help landlords and retailers agree new commercial lease terms.  

Rather than just the turnover (as defined) generated by a store the new lease model considered the value of a store in how it helped that retailer perform in an omnichannel transactional relationship between the retailer and the ultimate consumer.  

The new model valued the store’s worth on its ability to deliver footfall, to connect with the consumer and to unlock spend. Rent was in part calculated by factoring in the so-called ‘online halo effect’ on a physical store, as well as sales completed at the till. Footfall was a consumer metric used to compliment the base rent. A rise in sales — either in store or online in a catchment area — would see the base rent top-up increase, while low or less relevant footfall would mean that it were reduced.

These metrics were then used to quantify part of the rent. It was particularly relevant to grocers who had seen online sales increase during the pandemic through click & collect, store-pick and Q-commerce.

This new methodology took an objective view, rather than the traditionally opposing positions in landlord and tenant relationships.

It is an admirable and sensible objective which was to address what was touted as the breakdown of the old models — given the issues with turnover rents and the fact that neither traditional rack rent leases or turnover leases value the multi-faceted role of some stores in adding value to the brand.

Market adoption

Earlier this year, nearly 18 months after the launch of the new model, it was reported that landlords were struggling to implement the adoption of the new model with tenants; landlords have understandably seen its benefit but apparently retailers were struggling or reluctant to enter into a model which recognises a direct link between online transactions and their physical store.

Whilst there is always uncertainty with the implementation of the turnover rent model, clearly in distressed times such as a pandemic (which accelerated, in some sectors, the shift to e-commerce) there is less of an ‘upside’ to the rent - unless of course the new model is adopted and online sales and the value of a store are rentalised. 

Plenty of tenants may wish to stick to their exiting turnover arrangements which are likely to exclude some of the metrics derived from their other channels and incorporated in this new lease model, but it may well be that as more and more retailers inexorably use more channels to engage with consumers, there is a greater acknowledgement (and perhaps insistence from landlords) that new models like this one are used.

For expert advice with regards to this article and any other aspect of commercial landlord and tenant agreements you can contact our leading team of retail and leisure solicitors. We also have a dedicated team to assist you with any queries related to e-commerce.