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5 Things Tenant’s Should Know About Turnover Rent

In Retail Leasing, Tenant Representative by LibertyLeasing

If you have a retail shop lease then you may have an obligation to pay a percentage of the gross sales derived from the Premises to the Landlord. This is in addition to the base rent payable under your lease.  We refer to this as either turnover rent or percentage rent (both mean the same thing: to-may-to, to-mah-to).

What is excluded from gross sales calculations?

In a nut shell, your gross sales are effectively going to include the sales made at, or attributed to by, the Premises. The retail legislation in each State or Territory sets out certain exclusions. For example, delivery charges or outstanding debtors are prevented from being included in the calculation of gross sales.

Unfortunately, in recent times there has been some incorrect advice floating about in respect of Tenant’s rights to negotiate the gross sales inclusions / exclusions with Landlords. Let us clear this up now:

The Retail Legislation sets minimum standards. The gross sales exclusions set out in the Retail Legislation must be applied, at a minimum.  It does not prevent a Tenant, for the purpose of calculating turnover rent under their lease, to negotiate further exclusions. You can. And you should.

Landlords will generally put forward the most broad-spectrum gross sales definition so that in the event of favourable legislative changes the current lease drafting will capture any potential benefits (aka more rent revenue).

INTERNET SALES 

The exclusion we see most fiercely negotiated is internet sales and when they should form part of a Tenant’s gross sales for the purpose of calculating turnover rent. In today’s omni-channel retailing the impact of e-commerce on the physical store is a highly relevant discussion for all retailers and Landlords.

A natural landing point during negotiations often emanates the following logic:

If there was an internet sale and the stock to complete that sale was filled by stock from the Premises, then it is included in the gross sales calculations.

The rationale is that the physical store, and by extension the Landlord’s shopping centre, is required to facilitate that specific internet transaction. Whether this sentiment is appropriate for your lease or not depends on your brand and your business framework. To find the natural landing point during negotiations, you need to consider circumstances which give rise to a direct nexus between the sale and the Landlord’s shopping centre. If you are having difficulties with these considerations, we always offer Tenants a free strategy session. Get in touch with us to discuss.

APPLY A HIGHER THRESHOLD

A standard turnover rent provision is operating on the foundation that the base rent is working as a threshold. Namely, you commence paying turnover rent to the Landlord when the agreed percentage of your sales exceeds the base rent in that financial year. For example:

On a lease with 10% turnover rent and an annual base rent of $100,000 a requirement to pay turnover rent will be triggered once the gross sales exceed $1,000,001 in the relevant financial year.

You can negotiate the structure of your turnover rent depending on your circumstances. The ideal turnover arrangement is unique to each business. Influential factors include the location, the brand and of course, the market conditions. In today’s market, we are seeing Landlords willing to negotiate with Tenants and we are using innovative turnover rent structures.  This innovation has offered extraordinary benefits to our clients.

ALTERNATIVES

Tenants do successfully negotiate a higher threshold than the base rent amount. For example, rather than using the base rent, you may negotiate a threshold of $1,500,000.

This means that you have an additional buffer of $499,999 before you need to start paying turnover rent. It is arguable that raising the threshold gives Landlords even further motivation to partner with you and ensure your success at the centre.

The above is an elementary example of constructing a turnover rent provision that deviates form the standard position. However, there are many ways you can negotiate turnover rent configuration and the right configuration will vary from deal to deal.

EARLY TERMINATION BASED ON GROSS SALES

If you are a relatively new retail brand or moving into a recently developed shopping centre there is a lack of valuable data points for consideration.  An effective risk management tool here is to consider negotiating an early termination clause based on gross sales.

Such a provision will conceptually operate as follows:

If the business doesn’t hit a targeted amount of gross sales within a certain period (e.g. the first two years of the lease term), then you can elect to terminate the lease without any compensation being payable to the Landlord.

If you are a Queensland retailer the Landlord may seek an equal termination right. This is because it is also beneficial to the Landlord -top performing retailers generate a higher income for the asset. For retailers outside Queensland, an equal termination right is prevented by the retail legislation.

MONTHLY AND ANNUAL STATEMENTS

The lease terms will contain provisions surrounding when you need to provide your Landlord statements of gross sales. Usually a monthly statement is provided, with a certified statement being provided annually.  The retail legislation guides these requirements in some States. However for the majority of Tenants it is critical to review these clauses. You should particularly consider the requirements surrounding audits and accountant certification.

A lot of companies have an internal accountant or CFO that will prepare and certify financial reports. However, the lease terms will often have a requirement for an independent accountant. A failure to review these provisions or ensure they reflect your current accounting practices can result in costly unforeseen accounting costs.

CONFIDENTIALITY

In most jurisdictions a Landlord is required to keep your gross sales confidential, except under certain circumstances. If a Landlord breaches those confidentiality obligations then under several jurisdictions a penalty/fine may be imposed.  In addition, Tenants are potentially entitled to compensation.

KEY TAKEAWAYS

Contrary to the usual advice, judge turnover rent by its cover. It does exactly what it says on the box. It is RENT! If your lease contemplates the payment of turnover rent, negotiate a structure that is compatible with your business.

If you require any assistance scoping out the best turnover rent structure (or negotiating it out of your lease completely), you can always contact us here and we will arrange for a consultation with one of our tenant representatives.

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