The basis of paying rent in a lease of commercial business premises is often a fixed amount per year with whatever rent review arrangements in the future to suitably adjust to the market level at that point or though a prescribed RPI basis in the index-linked calculation.
Whilst you may have slight differences in how this is apportioned over every quarter or charging period, it is essentially a fixed amount that everyone can budget for.
However, ‘turnover rents’ are different and variable year-on-year. Designed to connect the amount of rent a tenant pays to their successful trade at a property, they can be a helpful incentive for both a tenant and landlord at a property.
But on the other side of the coin, they can get complicated.
Therefore, here are five key aspects to such turnover rents within commercial property leases to help fully appreciate them:
1. Determining What is a Turnover Rent
In the UK context, turnover rents are a way of agreeing on a variable rent from a tenant in a lease of a property connected to how successful and profitable they are trading from that building.
So, if they have double the turnover, sales, and profit in one year compared to another, they may well need to pay double the rent.
You tend to see these in retail and leisure properties where the success of the tenant’s business is more dependant upon factors like the local footfall, demand, and specific location.
A prime example is through the Covid-19 lock-down, where such businesses have been seriously hindered from trading if not completely closed, and therefore renewed interest in looking at such turnover rents in the future.
2. Getting the Right Principle Agreed
It would help if you then began looking at the landlord and tenant's goals to shape the right turnover rent clauses and basis, as each situation is very much different.
Landlords may well want a minimum fixed rent still for at least some income in difficult times and the ability to benefit from more prosperous times.
Understanding the reality of how the tenant’s business operates and what factors affect its success is the absolute key. Ideally, looking at past accounts and comparable businesses and locations will help identify this better.
3. Agreeing on Correct Rental Calculation
It would help if you looked at how tenant turnover rent is actually calculated and start the number crunching.
It’s often based upon the actual income, sales, gross receipts, or whatever financial measure you use to gauge the true turnover.
This may need to cover other sources not strictly on the actual premises like internet sales or other mail orders and telesales.
You then have various accounting adjustments to look at, such as receipt of cash, deposits and return of goods and services, taxes like VAT, transaction fees, bad debts, and discounts and benefits.
Plus, don’t forget any other connected companies and businesses within the same group or on a licensee basis within the property, such as a cash machine or a separate coffee shop operator.
4. Determining the Best Rent Clause
Then comes the point of clearly documenting this basis in the final lease and coming up with a turnover rent clause and model that clearly covers all angles.
Plus, ideally, give a working example of how such a turnover rent can actually work in the lease or by separate reference, to leave less room for different interpretation afterwards.
This is definitely where solicitors are needed, but with some common sense input as well.
It also needs to include other angles that just the literal calculation, such as timeframes and what happens if the tenant does not provide sufficient information quickly.
5. Understanding the Consequences
Finally, it’s worth considering the knock-on effects of a new turnover rent clause in your lease.
This will affect taxes such as VAT on rents and SDLT on new leases and transactions, plus of course, the fees involved in agreeing these tend to be higher because of the work involved with them.
Budgets can also be more difficult to establish into the future, and aligning dates of rental change with the landlord’s and tenant’s accounting years.
Plus, use the opportunity to think outside the box at other rent and lease changes that can be looked at at the same time, for example, a pandemic clause in case of future lock-downs from circumstances like Covid-19, re-gearing the lease for better terns, and even a basis of stepped rents over time.
Turning Over a New Leaf with Turnover Rents
The principle of matching how much rent a tenant pays towards how successfully they can trade and profit from the property is a great idea in principle.
And certainly, in ever-increasing uncertain times, these can be a realistic way to allow business occupiers to not only profit but actually survive.
However, take care in how these are practically drafted and ensure that all the t’s are crossed, and I’s are dotted to save lots of uncertainty and costs later on.
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