Turning It Over – Turnover rent points to note for both landlords and tenants7th July 2017
Turnover rent is a useful way for landlords and tenants to share the success and risk of trading premises. Turnover rent is typical in most leases in shopping centres, factory outlet centres, airports and railway stations but is increasingly common in high street units and other locations.
Below are some points to note for both landlords and tenants:
- Turnover rents are typically calculated on a fixed percentage of turnover excluding VAT insofar as such figure exceeds a base rent. However, sometimes they are not linked to a base rent but to a turnover threshold after which turnover rent is payable. If the lease is longer than, say, five years, the tenant needs to consider whether the threshold should increase in line with the Retail Prices Index as a £1,000,000 turnover threshold in 20 years’ time might be very different from £1,000,000 today.
- Traditionally, the base rent in turnover rent leases was discounted from the open market value (typically by 80%) and which also applied on rent review, the idea being that the tenant had a discount on its base rent but paid turnover rent in excess of the open market rent where trade was very successful. However, increasingly there is no discount to the base rent as some landlords simply view turnover rent as a bonus rent. If a tenant’s lease is in a location where there are either leases without turnover rent or turnover rent leases with an 80% open market value provision, then there will be a two tier market on rent review and the tenant could find their rent is increased to a full open market rent plus turnover rent. If the rent review clause doesn’t disregard the turnover rent then the tenant may be able to argue for a discount anyway.
- Care needs to be taken in relation to sub-letting turnover rent leases and how and on what the turnover rent is calculated. Should the turnover rent be calculated on all sales generated from the unit by whoever is occupying or should it be limited to the receipts by the tenant? Landlords will want the former and may prohibit sub-letting to avoid the tenant circumventing the turnover rent provisions. Tenants need to be cautious if they are sub-letting or allow concessions to trade from the premises and consider if licence fees or sub-lease rents are treated as turnover or if sales generated are captured.
- Some leases have a “ratchet” rent review provision which provides for the base rent to go up by a percentage of the previous year’s total rent. Where there is a turnover rent clause and a tenant has a great trading year, the base rent will ratchet up to a high level which may not be sustainable in future less successful trading years.
- Restaurant tenants need to exclude gratuities paid directly to staff in calculating the turnover rent.
- Landlords will often require “keep open” obligations in relation to the premises to protect the turnover rent but to provide some teeth to this obligation (which is otherwise partially unenforceable) leases should include either a fixed penalty or an assumption that turnover is generated even when the premises are closed.
- Landlords will be keen to capture all sales including online sales generated from the premises.
- Tenants need to be aware that they will pay stamp duty on a reasonable estimate of the turnover rent and this needs to be assessed at the end of the first five years and if necessary further tax paid.
For further information, please contact the Real Estate Team at Hamlins.