Will coronavirus mark a shift towards turnover rents?

Traditionally commercial tenants pay an agreed amount to their landlords by way of rent.

However, traditions are now being upended faster than ever and this traditional rent payment is going the same way.

The Covid-19 pandemic has fundamentally altered the norms for the commercial property industry especially for retail and leisure tenants.  They were required to shut their doors overnight and these tenants’ income dried up.  Even now as the country takes its first, slow steps out of lockdown, no one is really sure what the new normal is going to look like.

Tenants have told their landlords they simply cannot continue to pay their fixed rent.  During lockdown they argued, of course, that they were not even able to use their premises so is it fair that they should have to continue to pay the fixed rent?  Many landlords have since looked to turnover rents as a fairer means of charging for their space.  Under a pure turnover rent arrangement, the tenant pays a certain percentage of its turnover (not profit) to its landlord instead of a fixed rent.  This approach has been gaining traction over the last few years, especially for restaurant or café leases but it is now becoming more popular across the retail and leisure sector.

For the tenant, this means that when times are tough, as they are now, its landlord shares in the pain.  The tenant is at less risk of going insolvent and can ride through the storm.  Of course, the quid pro quo is that in good times, the tenant may well end up paying more rent than it otherwise would.

The difficulty for landlords is that turnover rents are not secure.  Landlords are themselves businesses with people to pay and banks to answer to so turnover rents create risks for them.  Longer term, what impact might this have on the sector?  Will investor be less willing to invest in commercial property with more risk and no guaranteed return?  Will banks still be prepared to finance retail or leisure led commercial property development when the return is so uncertain?

The answers are not going to be easy to find but, for now, for many landlords they have little choice.  If they accept a turnover rent, they will at least keep their tenant and receive some income.  If their tenants go bust then they end up with no income and an empty unit.  In the current climate that really is the worst of both worlds.  Perhaps some landlords might consider offering turnover rents on a temporary basis only, so that they can try to return to the normal approach when things return to normal.  Or, it might be that landlords accept turnover rents on a more permanent basis but linked to a break option such that a persistent underperforming tenant can be replaced with one that might generate higher turnover.

The future is not clear but it is unlikely that things will return to the way they were before the virus.

This article first appeared in Costar on 10th July 2020