Turnover rent is a type of rent used in commercial leases. As in the name, turnover rent, is rent based on the turnover of the tenant’s business. This is opposed to the standard commercial rent payment due to the landlord on a fixed monthly or annual basis. Turnover rents are becoming increasingly popular arrangements, here we set the scene and help to analyse whether turnover rents would be worthwhile for you and your business.
Topics to be answered in this article
What is turnover rent?
For a turnover rent to work, the tenant must be generating income at the premises. The more the business turns over, the more the rent that will be payable. Comparatively, when the business income declines, the rent payments decline.
This dynamic arrangement can be particularly attractive for tenants given the ever changing environment on our high streets. For that reason, turnover rents are commonly used within high street retail properties, with large retail fashion chains paving the way to favour this arrangement.
How does turnover rent work?
Turnover rent needs to be negotiated at the outset of the lease and ideally provided for within the Heads of Terms, which will be drafted into the lease by the solicitors involved.
It is important to clarify what is to be included within the definition of ‘turnover’ in the lease. Typically, this would cover money received for goods within the premises. It should be ironed out between the landlord and tenant whether this would also apply to additional provisions such as online orders, discounts and gift cards.
Unlike many lease provisions, there is no one size fits all and turnover rent provisions differ from lease to lease.
Turnover rent calculations can be agreed as follows:
- The tenant pays a pure turnover in which 100% of the rent is in consideration of the tenant’s business turnover; or
- The tenant pays a base rent which is either an agreed fixed sum in conjunction with the open market at that time. The turnover rent will then be considered in addition to the base rent.
For transparency on the business’ turnover, the tenant needs to maintain records of the profit figures and how they have been calculated. Records are to be provided to the landlord in accordance with the turnover period. This tends to run with the financial year with landlords calling for audits to manage the reports.
Legal considerations
There are legal considerations to bear in mind when faced with a turnover rent. Here are a few parameters that should be discussed with your solicitor.
SDLT: Leases can be subject to stamp duty land tax (SDLT) payments to HM Revenue and Customs. SDLT is calculated on the net present value of the lease. The net present value is taken from a mixture of both the lease term and the rent payable. Therefore, for leases with a turnover rent, the SDLT is based upon a reasonable estimate for the turnover. This is then to be reassessed after the first 5 years and a further return submitted to HMRC if necessary.
Breaks: The landlord may insist on a break clause being inserted into the lease to provide for the uncertainty that comes with a turnover rent. For example, if the turnover falls below a certain level for an agreed period of time, the landlord may choose to terminate the lease.
Rent free periods: Any rent free periods should be clearly set out as to whether they apply to the element of turnover rent or simply just the base rent, where applicable.
Rent reviews: Rent reviews should only be subject to any base rent payable, with the review to disregard any clauses specific to the turnover rent.
Assignment: A turnover rent is perceived as a concession to the tenant. Where an assignment of the lease takes place it is most likely that the landlord would not afford this to the new tenant.
Fit out: The landlord may seek to encourage footfall and enforce that the premises is fit out to a high standard with attractive signage, window displays and lighting.
Pros & Cons of turnover rent
Now you are aware of the process and points to consider of the turnover rent process, let’s explore its distinct advantages and disadvantages. The below overview will equip both landlords and tenants with valuable insights into both sides.
Advantages of turnover rent
Reduced costs: Tenants pay less when times are tough and sales are low. Tenants of course found this to be a great advantage during the 2020 covid-19 pandemic.
Flexibility: Tenants are afforded more flexibility on payments with the rent directly linked to turnover.
Shared risk: The risk of business fluctuations is shared between both the landlord and the tenant with their mutual alignment of interests.
Performance based rewards: Landlords are rewarded with increased income from successful tenants and successful businesses.
Less vacant properties: Landlords are more likely to retain their tenants with a turnover rent, especially in times of an uncertain market.
Disadvantages of turnover rent
Complexity: Turnover rent adds a further complexity to the lease and requires more negotiation and drafting than a standard fixed rental lease.
Admin: The formalities required to keep a check on the business turnover encourages more administrative effort with audits sometimes proving to be quite costly.
Inconsistency: Both the landlord income and tenant payments are not consistent and each month is unpredictable.
Disputes: The potential for disputes between the landlord and tenant over the calculation of turnover can be high.
How can Goughs help?
We recommend seeking legal advice at the outset of the transaction when negotiating the Heads of Terms. Please let us know if our Commercial Property team can provide further assistance on this.
