Specialist commercial property solicitor at Holmes & Hills, Laura Gale, discusses revenue linked rent and the various factors that need to be considered before entering into an agreement.
Revenue-linked rent, commonly known as turnover rent, is normally based on a tenant’s gross turnover generated at the premises – the principal rent payable to the landlord will usually be a percentage of the tenant’s annual turnover, derived from the business being run from the premises.
There will ordinarily be a “basic rent” payable in additional to the revenue-linked rent. This enables the landlord to continue deriving a rental income in periods where the tenant is making no income (particularly relevant during the current pandemic). This is also favourable because, as with any business, there will be successful and unsuccessful sales periods. The rent model allows both parties to benefit during prime trading times, with the benefit of allowing tenants some relief in off-peak or start-up times. Landlords of larger retail complexes may also be more inclined to take more responsibility for the overall success of the complex, knowing that they will share in the profit.
A tenant should consider whether there should be any cap on the percentage of revenue the landlord is entitled to, if the anticipated turnover is great.
There is a burden on the tenant to demonstrate the revenue to the landlord at the outset. It may therefore be that turnover rents are more common for established businesses with a trading and accounts history. Albeit, for businesses with multiple premises, a set of special accounts may be required to demonstrate the likely turnover specific to the property in question (particularly because a percentage of goodwill of a business attaches to the business premises). Greater due diligence by the landlord should be undertaken prior to the grant of the lease, as a landlord will want a clear and unambiguous view of the tenant’s likely turnover (and how it will be calculated for rent purposes) before committing to a lease. The landlord will need to weigh up whether a revenue-linked rent is beneficial at all (or whether a different rent model (such as open-market rent, or RPI rent) will provide them with more financial comfort) and whether it will be acceptable to their lender(s) (if applicable).
It is worth noting that headleases more commonly incorporate turnover rents. Headleases often stipulate the way that rents should be collected and reviewed under permitted underleases, and so it is rare that underleases encompass turnover rents.
Turnover rents were fairly commonplace in the retail industry prior to COVID-19, and it is likely their prevalence will increase as a result of the pandemic. Tenants such as Clarks are more commonly asking for landlords to take more of the risk by agreeing a turnover rent, as a way of avoiding insolvency. Whilst not always an attractive prospect for landlords, many have been more inclined to agree in present times, instead of facing the prospect of empty units (which in itself brings business rates implications).
Turnover rents are usually agreed either (1) at the outset, when the initial lease is being negotiated, or (2) at the renewal stage. Landlords are not obliged to agree to vary an ongoing lease to incorporate a turnover rent agreement, but many may agree for the reasons outlined above.
It is likely that landlords agreeable to turnover rents will seek to include a keep-open covenant in the lease, to encourage profits. Further, the Coronavirus Act 2020 has brought with it a moratorium on forfeiture for unpaid rents, but no such moratorium on forfeiture for other reasons (such as breach of covenant), so inclusion of a keep-open clause is likely to give the landlord a greater degree of control. Likewise, landlords may seek to include a landlord’s break option to enable them to terminate the lease if the rents become too low, so that they can replace the tenant with one with stronger prospects. Leases encompassing turnover rents often include commercially sensitive information such as turnover thresholds which the parties may not want to be in the public domain. Care should therefore be taken as to confidentiality. Further, if the lease is compulsorily registrable at H. M. Land Registry, the parties should consider whether a redacted form should be prepared for registration. The landlord should also consider whether the arrangement is specific to this tenant, and what will happen if the lease is assigned to a third-party – the alienation provisions in the lease should be carefully drafted so as to protect the landlord’s position in this regard.
If you are a commercial landlord or tenant considering offering/taking a new commercial lease and would like to consider revenue linked rent you should seek expert legal advice from a commercial property law specialist.
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