Turnover Rent: A future consideration for commercial landlords and tenants

Senior associate solicitor, Hannah Hughes, offers an alternative arrangement that may be suitable for future commercial property leases to improve business relationships between landlords and tenants during times of financial uncertainty.

Whilst many commercial leases are typically structured around a tenant paying a landlord a fixed sum of rent for a fixed period, and usually roughly in line with market values, some leases contain an alternative method of calculation of rent, known as a Turnover Rent.

Turnover Rent is not a new concept, it has been used, particularly across the retail and leisure sector, for many years. However, up until now, it has not been wildly popular in mainstream commercial property transactions.

The unpredictable circumstances surrounding many businesses resulting from the coronavirus crisis and knock-on effect of lockdown and social distancing, has seen many businesses struggling to manage regular cashflow. For businesses also committed to a commercial lease agreement, seeking an alternative way of agreeing commercial rent payments during a time of such uncertainty may be helpful for both them and their landlord.

Opting for a Turnover Rent agreement would see the relationship between the landlord and tenant become more of a business partnership. Both parties, not just the tenant, will then want to see the operational side of the tenant’s business being very profitable.

A Turnover Rent agreement requires a degree of mutual dependence from both the landlord and tenant. Both stand to benefit from the success of the business, yet both must also weather any periods of hardship.

How is Turnover Rent calculated?

Turnover Rent is not a fixed sum rent, it is based on a calculation. The rent is calculated by the turnover achieved by the tenant’s business that is operated from the rented property.

Generally, not all rent is calculated based on the tenant’s turnover. There is usually an agreed base rent which is then topped up with an agreed percentage of the tenant’s turnover.

Typically, the calculation takes the aggregate of the gross turnover for the relevant turnover period (usually annually in line with the tenant’s business accounting year) and then multiplies the figure by the agreed Turnover Rent percentage.

In most circumstances, in a Turnover Rent agreement, the agreed base rent ensures the rent received by the landlord does not fall below a certain minimum amount.

In a Turnover Rent arrangement, the tenant usually pays the base rent either weekly, monthly, or quarterly, in accordance with their agreement with the landlord. Following each subsequent turnover period, the tenant then pays the base level of rent plus the additional percentage of the turnover.

How does a tenant benefit from Turnover Rent?

In the current financial climate, a Turnover Rent may reduce the tenant’s sleepless nights worrying about cashflow as the market conditions, to a degree, will determine the rent payable. This is based on the tenant believing that his business turnover will improve in the future.

Tenants may also find their landlords become more engaged, supportive and approachable under this agreement, as ultimately the success of the tenant’s business benefits the landlord.

Some would deem a Turnover Rent calculation a fairer and more dynamic approach. In a standard market rent lease, reviews can be ‘upward only’ and wholly in favour of the landlord and do not take the tenant’s profit and business success into consideration.

Why would a landlord consider agreeing to Turnover Rent?

Considering how the commercial property market and businesses may operate after the COVID-19 pandemic and once lockdown ends, landlords and property owners will no doubt seek to keep their properties tenanted. Therefore, landlords may have to consider other ways to work with tenants to keep properties occupied and income generated. This could include Turnover Rent arrangements.

It is important to note that some landlords may not be able to afford to receive potentially fluctuating rent. Despite a base rent providing a guaranteed level of rent, any uplift is wholly dependent on the success of the tenant’s operational business. A landlord may argue that they should not lose rental income as a result of a tenant’s business failure.

Landlords also need to consider the additional administration required in monitoring the gross turnover of the tenant’s business, calculating the uplift percentage and being more heavily involved in the tenant’s business throughout the term of the lease.

Could Turnover Rent help the commercial property market in the future?

Turnover Rents require a great deal of honesty from the tenant as their turnover must be shared with the landlord for the rent calculation to be done.

If a Turnover Rent is agreed but ultimately does not work for the parties, the use of a break clause linked, for example, to a minimum turnover, could give the landlord and indeed their lender, some control and certainty. This may potentially require the tenant to give up some of its landlord and tenant rights to allow this to be achieved.

It will be interesting to see how, if at all, the commercial property market moves towards alternatives including Turnover Rent. Whether or not these new arrangements work between a landlord and tenant ultimately depends on the parties involved in the transaction and their respective bargaining positions. This includes receiving guidance from their legal advisors, banks, accountants and property agents.

If you would like to learn more about Turnover Rent or for general enquiries regarding landlord and tenant agreements, please contact Harrison Drury’s commercial property team on 01772 258321.