A customer sits at home browsing the internet. They go to their favourite shop’s website, peruse for a while and then choose an item of clothing: it looks great on the model and would be perfect for that upcoming special event.
But, when the garment arrives, what looked good on the model doesn’t have quite the same effect on the customer. Instead of the hassle of sending it back to the store’s warehouse, the crestfallen cybershopper takes it back to a local branch and gets a refund.
The store fulfils its customer service remit, the customer is happy, but the store’s landlord is, as one agent says of this increasingly common scenario, “royally pissed off”.
The reason? The retailer will mark the returned item down as a negative sale against the shop’s profit and loss, despite the item having been sent from a central warehouse. If the store is seeing a lot of internet returns, then what was a profitable site for the landlord could becomes less so. And what does this affect? The turnover rent.
In the UK, turnover rents, where used, can form all or part of the lease agreement. For instance, with one of the UK’s biggest landlords, Land Securities, just under 10% of its rent roll comes from pure turnover-only rents, with a lot of turnover leases paying out on a rent base.
So, with shopping increasingly happening online, any effect on turnover rents cannot be ignored. “Chinks are starting to appear in the turnover rent model as changing customer habits and methods of shopping change the very nature in which traditional bricks and mortar stores work,” says David Harper, of Harper Dennis Hobbs.
Ian Parish, head of retail for BNP Paribas, goes further in saying that turnover rents will not exist in their current form in five years’ time.
Clearly, the importance of online sales to retailers, especially fashion retailers, cannot be underestimated as the major houses quote the internet as providing 10-15% of their sales. It is, says Harper “the most profitable store for most, if not all of them”.
As a result, says Harper: “Landlords will try to capture the extra revenue stream from internet sales, but retailers will be reluctant to give it. For this reason it could be that retailers will start moving away from turnover-only rents because they will not want to give away sales originated from the internet. Equally they could play hardball and always stipulate that returns be taken to shop units, which would depress a unit’s turnover and therefore work to the detriment of the landlord.”
Land Securities for one, would not be happy with this. The company’s head of retail portfolio management, Ashley Blake, says: “I do know of one big retailer where we sometimes look at the sales densities and think, ‘blimey, that looks a bit poor’, but actually, as a group they are trading their socks off. They are one of the huge success stories and that’s because as a group they are pushing so much through their online sales. But they need the stores to generate the online sales. The whole thing is symbiotic in terms of returns/click & collect. But, the landlord would only see a small part of that pie.”
Blake says that, quite simply, retailers need great locations. “They need that store to be a key part of their multi-channel offer and landlords, I’m afraid, need that five-to10-15-year income security in order to put capital up front.”
There are two ways to try to guard against this. One is simply that the retailer changes the way it records a return, putting it down against the company PLC instead of an individual shop. Then there is tracking. Keeping a log of where, or in what postcode an item was purchased, would help offset it against the store the item was bought in.
“With John Lewis both internet sales and returns are recorded at a store level – not purely internet returns,” says Jonathan De Mello, head of retail consultancy at CBRE. “This seems like a far fairer way of doing things. But it’s easier for John Lewis, given the smaller relative size of its portfolio than retailers with hundreds of stores as it is easier in the case of John Lewis to attribute a specific internet sale to the catchment area of a store. It is more difficult with many stores and consequently a large number of overlapping catchments.
De Mello adds: “As many retailers do not operate in the same way as John Lewis however, landlords will be far more reluctant to offer turnover rent deals.”
Given the advance of internet shopping, and the difficulty of tracking, is it really the end for turnover rents? End – no. Change, yes. “We won’t see the death of turnover rents. Quite the opposite in fact,” says Jason Sibthorpe, head of national retail agency GVA. “The reality is that the vast majority of retailers now have an indirect disregard to property ‘values’ and assess their operational expansion strategy based purely on sales projections.
“If the rental affordability marries up to the property value then great, but if not they won’t pay it. Therefore both landlords and tenants need to be aligned and recognise margins, profitability and ultimately affordability based on turnover.”
However, Harper ponders whether there will be a two-tier market of straight rents for prime fashion retail space and turnover only for sub-prime.
“Perhaps there might be a system whereby a small element of top-up could be provided if the tenant generates significant sales in a store unit,” Harper says.
He believes that whatever the future holds, landlords and tenants will need to be on better terms than ever, “rather than going back to the secrecy of yesteryear”. “So perhaps it’s time to accept that it will be impossible to track sales in the future and decide what the new way of working will be.”
Harper adds: “We are all aware of the number of tenants who have faced insolvency caused by too many rental commitments. Landlords now need to nurture quality tenants and reassess their rental pattern because certainly when it comes to fashion in particular it seems that logic will dictate a return to the straight rents of the past.”
Land Securities
As one of the UK’s biggest landlords, Land Securities has many different types of retailers and leases on its books. And, as Ashley Blake, the company’s head of retail portfolio management, says, there is not a “one-size-fits-all lease” for tenants.
While Blake believes “turnover-only rents are a very useful tool to help with new brands, unusual operator pop-up shops, and temporary lettings” he is adamant these rents should only be used appropriately because failing to do so could have a detrimental effect on future retail development.
“There are a lot of people who are pushing this agenda [of turnover-only rents]. Not aggressively, but they would love it that we all end up doing turnover rents. But, that ultimately will harm the business because we won’t have the funding available to build great locations.
“Our country at the moment has tens of millions of square feet of very old retail stock from the 1960s, 1970s and 1980s. These needs refurbishing and improving and that won’t be possible if the cash flow coming out of it is so uncertain that people won’t be able to raise bank funding or attract new equity investors.”
Blake says: “Turnover-only rents just don’t work for banks, funders, and valuers where property is a long-term play; it needs a long-term fixed return basically. If you go down the pure turnover route, it’s a bit like having management agreements on hotels, which is effectively a pure turnover deal where someone manages it and the owner of the hotel gets a share of the profits. But that’s a completely different financial setup and is not valued in any way in the same regard by purchasers funders and that means it is harder to raise money and it is harder to do developments.”
He adds: “And of course we can’t get away from the fact that with the internet and mobile shopping, it is very hard to ensure landlord’s get their fair equity share out of a store, and that may be not because the retailers are not reporting it, but that they may not know how to attribute some of these sales.”
But on the bright side…
Far from the rise of internet sales sounding the deathknell for turnover rents, cyber shopping may actually help increase a store’s sales. Capital and Regional managing director Mark Bourgeois says customers returning goods are up to 40% more likely to buy something else while in-store.
Standard Life Investments head of UK retail Ed Jenkins agrees. He says: “What has become clear is that store visits by online shoppers represent a huge cross-selling opportunity. Retailers such as Argos and John Lewis are positively encouraging click-and-collect, in part because this type of customer can essentially be more valuable to retailers because of the cross-selling opportunities presented by at least one store visit to collect and maybe a second to return.”
Turnover and out?
Stephen Hedley, partner at South East law firm Cripps Harries Hall
New shopping trends should make landlords review how turnover rent is defined in both existing and new leases. We will have to wait and see whether these issues lead to the death of the turnover rent lease. If retailers continue to resist bringing online sales into play, wherever they are made, it is likely we will see turnover arrangement used less frequently and the element of rent attributable to turnover will reduce.”
Alan Evans, partner, Taylor Wessing
Well-drafted turnover leases already catch online sales received or fulfilled in-store, landlords may look at catching a share of online sales in turnover calculations. Landlords could argue the increasing blur between store and online sales, including shoppers trying in-store then purchasing online, means some online revenue should be attributed to stores. We may see landlords considering an outlet’s catchment area being used to calculate online sales to a particular store for example.
Rob Williams, head of shopping centre development, Strutt & Parker
Turnover rents will become increasingly important for tenants who want to share the risk with the landlord. In the high-end centres 100% rents may continue, but in weaker centres retailers will be well placed to drive deals with turnover rents, if landlords are struggling to lease accommodation on straight rental terms.
Ian Parish, head of retail, BNP Paribas
It’s unlikely that turnover rents in their current form will continue to exist in the next five years. As shopping patterns change retailers will be looking to get more and more flexibility in their lease terms – landlords are already showing their willingness to engage with tenants as customers and adapt their lease structures accordingly – and as leases expire and renegotiations take place this flexible approach will become increasingly necessary.
Here lies the history of turnover rents
Turnover-based rents were introduced in the early 1990s following the opening of a spate of new retail shopping centres, including Lakeside and Meadowhall, and they marked a significant step change in the tenant/landlord relationship, writes David Harper, Harper Dennis Hobbs.
The idea came at a time when most landlords were still offering 25-year full repairing and insuring leases. The concept was borrowed from the US where turnover rents – which comprise a percentage base rent topped up by a remainder based on a retailer’s turnover within the individual store – were commonplace.
Back in the 1990s their advantages were undisputed and as such, turnover-based rents caught on quickly, bringing landlord and tenant closer together, while fostering more of a partnership approach than in the past. With the landlord now having direct knowledge of turnover, it was better able to maximise its centre’s potential and attract new retailers in over-performing sectors when sales were strong. Equally, such leases allowed landlords to better identify and deal with tenants who had poor sales.
Of course, there was some nervousness from retailers and that has remained. Retailers are wary of confidential information falling into the wrong hands, and also understandably, about landlords knowing which are their best stores. But there was an attraction for them too – partly because of the idea (usually false) that the retailer was effectively paying a discounted fixed rent.
Some shopping centres, such as East Kilbride, offered tenants straight turnover deals to try to attract quality tenants in the hope that the centre would be stronger, trade flourish and rents rise, not realising that it takes more than a simple turnover deal for a shop to be profitable.
The nature of turnover rents particularly flourished in tougher times where they have worked particularly well, enabling retailers to negotiate contracts and secure occupation on more tenant-friendly terms.
But whereas in the US market the model remains as relevant today, in the UK things are fast changing.
