A turnover lease is a lease where the rent payable by the tenant is calculated either wholly, or partly, by the actual turnover achieved by the tenant’s business operated out of the premises. They can be used as an alternative to more traditional forms of open market leases whereby the rent is determined by a number of factors and is largely driven by market conditions. Turnover leases are most often used in connection with retail operations and almost exclusively used in factory outlet centres, airports and railway stations.
Examples of the types of turnover lease used:
- A traditional model whereby the tenant pays a) a minimum base rent and b) an additional rent which is calculated on a percentage of gross turover. In these circumstances, the base rent is ordinarily determined as a percentage of open market value (for example, 80%) with the additional top up added.
- A minimum base rent as above with the tenant paying a percentage of gross turnover above an agreed amount, for example, 10% of gross turnover in excess of £500,000 with the provision that if turnover does not exceed this amount that it is just the base rent paid.
- A rent based solely on the tenant’s turnover but with the tenant guaranteeing a minimum amount of turnover. Often in this type of lease, the landlord will receive no benefit from turnover above a certain figure.
Cautious tenants may be tempted to take on a new unit on a turnover rent basis as the risk of failure is shared. The tenant’s rental liability will reduce in poor trading conditions (subject to any base rent which has been agreed). Also, a tenant’s trading position within a development will, to an extent, be protected as it will not be in the landlord’s interest to increase competition and thereby potentially reduce turnover and rent by leasing an adjacent unit to a competitor of the tenant’s.
Also, from a landlord’s point of view, the main benefit is that, when a tenant trades above expectations, the landlord benefits immediately rather than waiting for a rent review.
If the landlord refurbishes a retail development, it will benefit immediately from its investment where the tenant’s turnover increases as a result. Landlords can also closely monitor a tenant’s performance which may enable them to take early action if performance dips rather than waiting until the tenant defaults or becomes insolvent.
If you are thinking of entering into a turnover lease, it is important to consider the following:
- To ensure that the lease has a keep open or other clause specifying continuous trade from the property with provision for some form of notional turnover to be applied to the tenant when it is not trading during the minimum trading hours.
- Tight controls on how the tenant uses the property. This is important as the percentage of turnover on which the turnover rent is based will depend to some extent on the authorised use of the premises and the quality of the products sold.
- Strict control by landlords over potential assignations (transfers) of lease and prohibition on creating sub-tenancies.
- Obligations on the tenant to provide the landlord with an audited turnover certificate at least once a year and quarterly non-audited certificates and provision for tenant’s sales records to be independently certified.
- Provision for online sales to be taken into account where they can be directly associated with the premises, for example, online orders made from a terminal in the premises or goods ordered online and collected from the premises.
- Provision for the tenant’s turnover records to be kept confidential by the landlord.
- Tax implications. It is important the parties are aware of the tax implications. Both Stamp Duty Land Tax and Land and Building Transaction Tax on turnover leases are calculated on a best estimate of the turnover rent. Under the new Land and Building Transaction Tax regime, leases are reassessed for tax every 3 years and tenants will be required to notify HMRC if the rent increases whereupon any additional tax will become payable.
If you are considering entering into a turnover lease, it is important to obtain detailed advice as the terms may not be seem straightforward at the outset. Please do not hesitate to contact me if I can provide any further assistance.