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A cross the world, shopping habits are changing rapidly, with consumers increasingly moving towards online buying. Traditionally the UAE has bucked this trend, with in-store retail continuing to account for a larger overall proportion of retail sales. Last year, online accounted for only 2 per cent of all retail sales. However, research suggests that this will change significantly over the coming years, with internet sales forecast to rise to 5 per cent of all retail sales by 2019. This swing towards online retail is reshaping traditional concepts of turnover rent, with implications for both landlords and tenants.
What is a turnover rent?
In basic terms, a turnover rent—commonly referred to as a percentage rent—is calculated by the turnover generated at the leased premises. The turnover element could account for all or, more commonly, part of the overall rent payable to the landlord.
Turnover rents are most commonly encountered in the retail sector, particularly in shopping malls where they tend to be institutionally enshrined across international markets. Given the number of malls in the UAE, it’s no surprise that turnover rents are widespread in the region.
Why use turnover rents?
Aside from institutional expectation, there are a number of reasons why turnover rents have become a mainstay of the retail sector.
Turnover rents align the interests of landlord and tenant and allow them to share risks and rewards effectively. When the tenant’s business at the premises is performing less well, the rent payable to the landlord will decrease, but when the tenant’s business at the premises is prospering, the landlord will participate in that success.
From a tenant’s perspective, the alignment of interests ensures that the landlord is incentivised to promote footfall, consumer spending and the overall success of the scheme. The landlord’s spending on promotions and upgrades is hedged by its expected return through increased turnover rent.
For a landlord, the ability to participate in upside reward is attractive, not least because the landlord can benefit immediately, rather than at the next rent review. The ability to share downside risk can also be attractive. For example, in a new development, the landlord might be able to secure lettings with cautious tenants on the basis of a turnover rent, which might not otherwise be achievable if the landlord were looking to rent at open-market value.
How do they work?
There are several ways a turnover rent can be structured. One of the most common is where a tenant pays:
• A pre-agreed base rent, usually 70-80 per cent of the open market rent.
• An amount calculated by reference to a fixed percentage of the tenant’s gross turnover — commonly between 7-15 per cent — which is only payable to the extent it exceeds the base rent.
Using this structure, the landlord has the certainty of knowing it will achieve at least the base rent, but with the possibility of this amount being supplemented by turnover. This structure allows the tenant to benefit from a lower fixed base rent and lessens its risk in the case of difficult trading conditions.
What is gross turnover?
Gross turnover is intended to include all sums earned from the tenant’s business at the leased premises. The exact detail of the goods and services to be included and excluded from gross turnover will always be subject to negotiation between the parties, but typically include some or all of the following kinds of sale:
• Those originating from, or received at, the store
• Sales that are made outside the store by those employed at the store
• Revenue made by mechanical devices or vending machines at the store
• Sales on credit or hire-purchase terms
Typically, a number of items will be excluded from gross turnover. These could include the following:
• Sales tax imposed on the tenant in relation to the supply of goods and services from the premises
• Cash refunds or credits given for returned goods
• The value of goods transferred from the premises to other premises of the tenant, unless for a transaction attributable to the premises to which the turnover rent in question relates
How is this reshaping online retail?
As mentioned above, consumers are increasingly moving towards online shopping, including in the UAE. While conventional over-the-counter sales were largely unproblematic when defining and calculating gross turnover in older lease agreements, the growth of online shopping has led to the need to revisit turnover rent provisions.
A commercially astute landlord might seek to include the following as part of a broader definition of gross turnover:
• Orders placed using in-store terminals or other smart media, but which are delivered from the tenant’s distribution centre directly to the customer’s home
• Orders placed using the customer’s own smartphone or tablet at the store, but where goods are delivered from the tenant’s distribution centre directly to the customer’s home
• Products ordered online and delivered to the store for customer collection
From the landlord’s perspective, failure to capture value from such items could lead to a significant reduction of the rents achievable by it. This effect could be magnified as the exponential growth of online retail and new methods of in-store shopping continue.
Therefore, by ensuring that the turnover rent provisions accurately capture the actual nature of the tenant’s trading practices, a well-advised landlord can seek to offset this risk and maximise turnover rent.
Naturally, tenants might see things differently — particularly if they consider that the majority of sales are principally attributable to a strong online presence independent of the premises from which it trades. A well-advised tenant could thus seek to limit the parameters of how gross turnover is defined.
The parties should consider these issues at the outset of lease negotiations. The parties will also need to ensure that the lease documentation contains robust and comprehensive provisions for capturing, monitoring and verifying the accuracy of the accounting information, which relates to such items (and upon which turnover rent is calculated).
Looking to the future
As online retail continues to grow exponentially in the UAE and worldwide, landlords and tenants should be mindful of the effect this will have on turnover rent provisions in lease arrangements.
Going forward, standard lease documentation might no longer be fit its purpose. There is no one-size-fits-all approach, and bespoke provisions might be required on a case-by-case basis.
It is, therefore, advisable to involve legal counsel in this process from as early a stage as possible, before any binding commitments have been entered into.
Source: Helen Beaumont and Duncan Pickering, Special to Property Weekly
Duncan Pickering - Partner with DLA Piper and regularly acts for international investors on high-value transactions across all property sectors.
Helen Beaumont - Legal Consultant with DLA Piper who specialises in commercial real estate and has particular experience in the acquisition and disposal of freehold and leasehold property and landlord and tenant matters.
Al Nisr Publishing accepts no liability for the views or opinions expressed in this column, or for the consequences of any actions taken on the basis of the information provided