Turnover rents for fashion companies – not the new kid on the block

With tough trading conditions for fashion retailers, turnover rents are becoming more appealing for tenants and more acceptable for their landlords.

We look at the concept of turnover rents and provide five key suggestions for retailers considering moving to this model.

What is a turnover rent lease?

Turnover rents are calculated as a percentage of the gross turnover the tenant makes at the leased property. By their nature, turnover rents are therefore uncertain and subject to change, potentially upwards or downwards annually, depending on the terms agreed with the landlord.

A turnover rent is usually determined using one of two standard models:

1. A pure turnover lease where the whole rent is calculated as a percentage – say 10% of the tenant’s annual turnover. This is generally less common and less favoured by landlords.
2. The more commonly used ‘top up’ model where there is a minimum base rent – generally around 20% lower than the open market – which would be topped up with a fixed percentage of the tenant’s annual turnover, insofar as it is over and above that base rent.

Conceptually, turnover rent leases depart from the more rigid structure of the traditional market rent lease and allow the flexibility and creativity sought by tenants (and, less frequently, landlords) in a turbulent market.

Turnover rents in action

Turnover rents can be beneficial to both landlords and tenants as they generally foster a more collaborative relationship – it being in both parties’ interests to make the store as profitable as possible.

If the alternative for the landlord is an empty premises, this model can help the landlord to avoid paying business rates on empty units, and, with an occupied store, there will likely be tenant obligations to keep it in repair and pay service charges at the very least.

The use of revenue-based rental models in outlet villages and shopping centres, such as Bicester Village and the London Designer Outlet has much to do with the landlord’s control over substantial common parts and amenities, and so some ability to drive footfall to the retail units. As a result the use of such models is quite commonplace.  

But post-COVID, the frequency of tenants entering Company Voluntary Arrangements (CVAs) have forced landlords to accept this model where they might have previously resisted. New Look, AllSaints and Clarks are just some examples of this.

However, moving from a fixed market rent to a turnover rent has seen a fall in the rents received by some landlords. It is therefore unsurprising that many of them, including major landlords such as British Land, have challenged the attempts made by their tenants to pay rent based on the turnover model, with varying levels of success.

On the other hand, in an unusual case in 2022 involving JD Sports, the landlord argued that a turnover rent should be payable (presumably based on healthy figures at the subject store) but the court determined that it would not be appropriate to impose a turnover rent. The result was a much lower fixed market rent than what would have been payable had the turnover model been awarded!

Five top tips for retail tenants

If you are thinking of moving to a turnover rent lease, or are in current lease negotiations, tenants can consider the following:  

1. Do you want a turnover rent? Bearing in mind the JD Sports judgment above, it might be that, in the current market, a fixed market value rent is the better option. Running worked examples will help you to decide which model works best for your business.
   
2. Seek clarity. Understand what is included in the meaning of turnover for the purposes of calculating the rent. Here, it generally means gross turnover and not profit.
   When calculating the gross turnover, all sums received in or from the premises by the retailer will be considered. Typically, that includes payments received by concessions or subtenants at the store, ancillary charges such as delivery and postage, and the full sale value of any items where staff discounts or rewards are given. It is widely accepted that VAT, other sales taxes and customer refunds will be deducted.
   
3. Negotiate the finer detail. We often find that the biggest headache comes with the detail. For example, how will you deal with online sales, click and collect, and showroom stores? How will you report to the landlord on your store figures? Will you be required to employ external auditors.
   Ensure whatever you agree actually works for you and your business, and that the right personnel in your company is talking to your lawyers and agents when negotiating the terms.
   
4. Get creative. There is often a lot of scope to tailor the turnover rent provisions to suit your business and its needs. If you have some bargaining power, use it and do not be afraid to explore your options.
   
5. Watch out for other lease clauses. The turnover rent provisions are often seen as distinct from the rest of the lease, but it might impact other lease clauses such as ‘keep open’ obligations, landlord termination rights where the turnover rent isn’t performing, and reversions to a fixed rent if the lease is transferred to a new tenant.