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PropTech to take a leading role in the future of retail leases

Technological changes in the way we shop, the fast rise in e-commerce and the upheaval caused by Covid-19 are all creating a lasting impact on the UK’s retail sector.

We no longer shop the same way…

With the recent lockdown measures and a shift towards social distancing, shoppers are unlikely to return to retail destinations in the same numbers as before or for the same purposes. Consumer trends indicate more shopping online supplemented with trips to the shops for inspiration and for sizing. Many retailers who were struggling to pay rent before the crisis will surrender or forfeit their leases and landlords could be left with a large number of empty stores.

Retail Lease terms are changing…

Committing to a retail lease can be risky for both the landlord and tenant. A landlord needs to strike a balance by setting the rent at the right level so that it benefits from the tenant’s trade, but does not prohibit the tenant from operating profitably. For the tenant, entering into a lease constitutes a large financial commitment for a fixed number of years and with no guarantee of trade and profit.

Unsurprisingly, retail tenants are increasingly demanding new terms from their landlords and are specifically looking to mitigate the risks associated with fixed rents. Many commentators now believe that the future lies in the emergence of a data driven, turnover rent - calculated not just by physical sales in store, but by considering other metrics such as online collections, footfall both in store and the wider shopping centre and the average time spent in store. Turnover leases impose turnover reporting requirements on the tenant and in some cases (particularly in shopping centres) the landlord can require the tenant to link its tills (and therefore turnover information) directly into the landlord’s systems. This will incentivise landlords to draw the customers into their destinations and ensure that tenants can survive during economic downturns.

How do turnover rent leases work?

Opting for a turnover rent lease is one method of spreading the risk between landlord and tenant. Already becoming more prominent in the retail sector before Covid-19, a turnover rent lease usually involves the tenant paying a base rent at a certain percentage of the open market value with a turnover “top up” which is paid in addition to the base rent where turnover exceeds the base rent. There is a perception of the Lease being ‘fair’ in having a proportion of the rent tied to the tenant’s trading performance at the premises. The landlord takes a smaller slice of the rent during times of hardship and takes a larger slice during times of success.

The issues which occur…

However a move towards turnover-based leases is by no means a simple solution. Whilst for retailer tenants there are clear benefits (such as allowing greater control over property costs in relation to sales, removing an upward-only rent review provision and preserving an economic operating model) there are significant issues for Landlords. There’s the obvious lack of security when it comes to income, as well as the reliance upon retailers sharing transactional data and trading figures. There can be issues obtaining accurate turnover projections ahead of new lettings.

The Click-And-Collect dilemma

Another sticking point which has increasingly come to light in recent days is the issue of how to account for the boom in ecommerce and ‘click-and-collect’ sales. This poses challenges for traditionally drafted turnover clauses which assume that all sales upon which turnover is payable would be paid for in and completed in the store. If an item is ordered and paid for outside of a store but then physically collected from the store should this be deemed to constitute turnover generated from the premises?

Needless to say Landlords will want to ensure that all proceeds of click-and-collect sales are included within the sales figures for the purpose of calculating turnover so as to maximize rents. The challenge for Landlords is how to police online sales figures in the same way as in store sales. Tenants may be surprised to learn that sales completed online outside of the store can be included within their turnover figures where these products are collected from the store and are likely to have concerns about allowing the Landlord access to sensitive sales data not generated in store.

Given the wide basis upon which turnover clauses are usually drafted, the inclusion (or not) of online and click-and-collect sales for calculating turnover rent is an important issue which should be addressed when agreeing heads of terms. The only way for tenants to protect themselves is to specifically exclude revenue generated by online sales from the turnover clauses otherwise these figures are likely to be captured by the clause.

Going forward, we expect to see even wider definitions of turnover being included in turnover clauses so that any click-and-collect sales are included and as online sales increases in popularity year on year this will become an even greater issue in the future. The treatment of gift vouchers, returns, partial payments and staff discounts can also be problematic. Multiple retailers have firm policies on what they consider constitutes turnover and can rarely be persuaded to deviate from those policies.

The increase of data-sharing

Use of turnover rents can encourage and facilitate data sharing and collaboration as landlords work with tenants to promote the overall shopping experience in a shopping centre or parade. At last, there is now an opportunity for “PropTech” to take a leading role. Tech-savvy landlords are now able to monitor how many customers are in their shopping centres, how long they stay and when the centre is at its busiest. Tenants are now able to collect further data such as in-store turnover, footfall, average time spent in store per customer etc.

With a data driven turnover rent, there is no one-size fits all model. Different retailers use their stores for different purposes and so the metrics used to calculate rent would need to be appropriate. If the store was a showroom used to drive online sales such as a Nespresso or Apple store, you would want to use different metrics to a traditional retailer such as Marks and Spencer or Primark.

Data-collection has its problems. Historically, landlords and tenants have been reluctant to share their data with each other. If the popularity of one shopping centre is falling due to the emergence of a competitor on the other side of town, the landlord will not want to make the tenant explicitly aware of that. Equally, there has always been suspicion that the turnover figures provided by tenants have been artificially lowered.

Consideration also needs to be given to the collection and use of data. Shoppers will demand that all their data is anonymised, and any collection of data will have to comply with the General Data Protection Regulations.

Legal advice in drafting a retail lease

For lawyers it will be essential to ensure that any data driven turnover rent provisions are clear, concise and do not leave room for manoeuvre.

When drafting a retail lease, there are many other ‘turnover-related’ issues to consider (alongside the actual definition of ‘turnover’) such as:-

  • Confidentiality - in order for a turnover rent lease to be effective, a landlord requires access to a wide range of sales information to support the turnover certificate provided by a tenant. Tenants are keen for this private information not to be shared and to be used solely to verify the turnover rent.

  • Keep open provisions - where tenants are required to keep the premises open for trade during set hours - ensuring premises continue to trade and generate income and protecting the landlord’s income stream. Well-advised tenants are seeking carve-outs to the keep open obligation for force majeure events, specifically including epidemics and pandemics such as Covid-19.

  • Deemed turnover provisions - if the tenant breaches the keep open obligation, turnover will reduce which damages the landlord’s income. The deemed turnover clause assumes a ‘deemed turnover’ for any such period of time, based on historic trading

  • Alienation - parties need to consider whether the payment provisions continue if the tenant assigns or sub-lets the lease. Turnover leases sometimes refer to the payment provisions as being personal whereupon a landlord looks to ensure the full open market rent is paid on assignment or subletting.

  • Land Registry - turnover rent leases often include a number of commercially sensitive provisions (base rent, thresholds, percentages etc.) that landlords may not want the wider market to know about. If a lease has to be registered at the Land Registry it is possible to only submit a redacted form to the Land Registry and your solicitor can assist with this.

As we emerge from the Covid-19 crisis, it is becoming apparent that the traditional retail landscape is rapidly changing and that leases will need to adapt to provide for this. Shops are increasingly becoming showrooms and data is enabling the industry to price units in a different way. Through the use of data, and especially through the increase in data-driven turnover rents, it has never been more important to word a retail lease in the right way.

Original Article by: Rachel Duncan

Image by: Morning Brew

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