Turnover Rent

What is a turnover rent and how does it work?

The real estate market in England is diverse and dynamic, reflecting various business models and economic conditions. One notable structure that has gained traction, particularly in retail and hospitality sectors (in London particularly), is the turnover rent. This rent model aligns the interests of landlords and tenants by making rental obligations contingent on the tenant’s business performance.

This article will explore the concept of turnover rents, their advantages and disadvantages, and the relevant clauses that should be included in turnover rent leases.

What is a turnover rent?

A turnover rent is an agreement where the lease rental amount is determined by or topped up by a percentage of the tenant’s gross turnover or revenue generated from that particular property. Unlike traditional fixed rents, turnover rents fluctuate based on the tenant’s sales performance. This model is particularly beneficial in sectors susceptible to market volatility, such as retail and hospitality, where consumer demand can significantly impact revenue.

How turnover rent works

Typically, a turnover rent comprises two components:

1. Base rent: This is a fixed amount that the tenant pays regardless of sales performance. It serves as a safety net for the landlord, ensuring some income even if the tenant’s performance is subpar.
2. Percentage rent: This is a variable component calculated as a percentage of the tenant’s turnover. The percentage can vary depending on the type of business, location, and market conditions.

For example, a retail tenant might agree to pay a base rent of £20,000 per year along with 5% of their annual turnover exceeding £400,000. If the tenant achieves a turnover of £600,000, they would pay £20,000 + (5% of £200,000) = £30,000 in total rent for that year.

Advantages of turnover rents for tenants include:

1. Reduced risk: Turnover rents can alleviate financial strain during slow sales periods, allowing tenants to pay less rent when their revenue dips. This flexibility can be crucial for new businesses or those in fluctuating markets.
2. Cash flow management: Turnover rents help tenants manage cash flow more effectively, as they can adjust their rent obligations in line with their sales performance.

Advantages of turnover rents for landlords include:

1. Aligned interests: Turnover rents foster a partnership mentality between landlords and tenants. Both parties are motivated to enhance the tenant’s business performance, which can lead to a more stable tenancy.
2. Potential for higher returns: In high-performing businesses, landlords can benefit from increased rental income through the percentage rent component, potentially yielding higher returns compared to traditional fixed rents.
3. Attracting quality tenants: Offering turnover rent agreements can attract high-quality tenants who may be wary of committing to high fixed rents in uncertain markets.

Disadvantages of turnover rents for tenants include:

1. Uncertainty of rent costs: While turnover rents can lower costs during downturns, they can also lead to higher rental costs during peak performance periods. This unpredictability can complicate financial planning.
2. Complex accounting: Tenants must maintain detailed records of their sales, as landlords will often require regular reporting to calculate the percentage rent accurately.
3. Pressure to perform: The obligation to report sales figures and pay rent based on performance can create additional pressure on tenants, especially in competitive markets.

Disadvantages of turnover rents for landlords include:

1. Risk of lower income: During periods of poor tenant performance or economic downturns, landlords may receive less income compared to a fixed rent arrangement, which could affect their financial stability.
2. Dependence on tenant success: The landlord’s income is tied to the tenant’s performance, which may not always align with the landlord’s expectations or financial needs.
3. Potential for disputes: The need for sales reporting and verification can lead to disputes between landlords and tenants regarding turnover calculations and payment amounts.

Key clauses in turnover rent leases

When drafting a lease with a turnover rent structure, several crucial clauses must be included to ensure clarity and protect the interests of both parties.

1. Definition of turnover

It is essential to clearly define what constitutes “turnover.” This should include all relevant sales generated from the property, but may also exclude certain items like VAT, discounts, and returns. A precise definition helps avoid disputes over what sales figures the turnover rent is based on. It is also very important to think about what should not be included withing the turnover such as monies paid to staff as tips form customers.

2. Percentage rate

The lease should specify the percentage rate applied to the turnover. This rate can vary widely depending on the type of business and local market conditions. Additionally, consider including different percentage rates for different turnover thresholds to incentivise growth. For instance, a business may pay 5% on turnover up to £500,000, and 7% on any turnover exceeding that threshold.

3. Base rent and payment terms

Clearly outline the base rent amount, payment schedules, and any provisions for increases over time. This section should also detail how and when the percentage rent is calculated and paid, including the frequency of reporting sales figures. For example, the lease might stipulate that the tenant must provide monthly sales reports, with the rent payable quarterly.

4. Reporting obligations

Tenants typically need to provide regular sales reports to the landlord. The lease should specify the format, timing, and content of these reports to ensure transparency. It may also include provisions for audits, allowing the landlord to verify sales figures if there are concerns about accuracy or compliance.

5. Rent reviews

In traditional leases, rent reviews are common, allowing landlords to adjust the rent periodically based on market conditions. In turnover rent agreements, it is important to establish clear guidelines for how and when rent reviews will occur. It is unusual, however, to  include provisions to adjust the base rent or percentage rates based on market performance or changes in the tenant’s business circumstances.

Turnover Rents can be particularly tricky to agree and in turn negotiate but, certainly in today’s market and environment it is certainly something that should be considered as an option for both landlords and tenants alike. If you have any questions about turnover rent, please get in touch.