Turnover Rents – Godsend or Godawful?

16 / 06 / 2021

Background

As trouble on the high street continues, many retail tenants and their landlords are considering moving to turnover rents as one way to help share the risk and pain involved in an economic downturn. The theory behind a turnover rent is extremely simple: the tenant pays a lower fixed annual rent, but in exchange it will also pay to the landlord rent on a certain percentage of its turnover made from the premises above a given threshold. If its turnover exceeds the given threshold, this should therefore be a ‘win win’ situation for both parties. In practice however, the reality of negotiating and then operating a turnover rent can be anything but simple.

What is Turnover?

Oxford Languages defines ‘turnover’ as ‘the amount of money taken by a business in a particular period’. Again, this sounds straightforward enough on the face of it – but what should actually be included in the ‘takings’ when the turnover figures are being calculated? Should it include goods bought online but collected at the premises, or should those goods be excluded on the basis that they were sold online only and could have been collected from any number of locations? If the tenant chooses to sell goods at a discount, should the turnover be calculated on the discounted sale price or the full sale price? Is the situation to be different if the discount is being offered temporarily to members of the public, or if it is a staff discount that is always on offer? If the goods are sold on a credit arrangement is the full purchase price to be included in the turnover figures upfront, or only when the tenant actually receives the full purchase price? It is easy to see how so many things are suddenly up for negotiation when the parties start to consider the turnover calculation in any detail, and how a lot of time (and expense) can be involved in documenting that final calculation method.

The guiding principle usually adopted by tenants is that it must actually be ‘cash through the till’ to count towards turnover (which would exclude online sales, for instance) – but from a landlord’s perspective this is often seen as a gross oversimplification of the issues involved.

How is it Paid?

Assuming a final method of calculation can be agreed between the parties, a turnover rent is usually paid either quarterly in arrears, or quarterly in advance on the basis of an estimate that is then subject to a final reconciliation (in much the same way that a service charge would be). This is because it is only possible to ascertain, of course, how much money a tenant has taken for a given quarter once that quarter has actually ended.

The tenant will usually prepare and deliver to the landlord a certificate for each quarter, setting out its turnover for that quarter in accordance with the agreed calculation method. The landlord will then review and verify this calculation, before invoicing the tenant for the appropriate amount of turnover rent (assuming any has fallen due). As this exercise must be repeated each and every quarter, it can inevitably create a significant additional administrative burden for both parties (and their unfortunate accountants).

What about Disputes?

This exercise of preparing and verifying turnover certificates can also of course lead to disputes, most commonly if a landlord suspects a tenant is deliberately underreporting its turnover figures to minimise any rent payable. In this case the parties will usually have agreed that the landlord can inspect the tenant’s sales records and have them independently audited. But again, exactly what records will a landlord have access to in this scenario, and how will it ensure those records are kept confidential? And who will pay the cost of the audit if it turns out that the tenant’s figures were, in fact, within an acceptable margin of error? And what margin of error will be acceptable?

A turnover rent may therefore be one possible solution to help see both parties through a tough time, but it is clearly a solution which also brings with it an awful lot of questions that will all need very careful consideration.

Key points

  • Turnover rents should mean tenants’ rents are more closely aligned to the success of the business at that store
  • The detail of what is included in turnover can be difficult to agree
  • Checking whether or not turnover has been correctly reported is a time consuming and challenging exercise