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The retail sector has been on its uppers in recent years. One need only walk the once bustling high streets of the UK's regional cities and towns to be struck by the number of "To Let" signs and the proliferation of charity shops, fast food takeaways and betting establishments. What started with the advent of American-style, out-of-town shopping malls has accelerated through the rise of online shopping. Councils and businesses seem powerless to react to the gradual and constant decline of the high street.
According to the UK's Office of National Statistics, in 2023 online sales accounted for 25.8% of the value of all retail sales in Great Britain. 10 years ago, that figure was 10.4%. In 2007, it was 3.4%1. The result? A rise in vacancy on our high streets with all the antisocial elements that accompany unused and unloved property.
At the beginning of the previous decade, the UK government commissioned English retail consultant and broadcaster Mary Portas to conduct "An independent review into the future of our high streets". The Portas Review, which was published on December 13 2011, included 25 recommendations. Free controlled parking schemes to encourage in-town shopping struck me as a good idea. Then there was number 18:
"Encourage a contract of care between landlords and their commercial tenants by... supporting the use of lease structures other than upward only rent reviews, especially for small businesses."
At the time, I baulked at the idea of (yet more) government interference in the landlord and tenant relationship. But what Mary Portas was suggesting was actually a very good idea. Perhaps not something the government needed to "encourage" upon businesses, but one for the markets and market makers to take note of.
David Toubian of Toubian Real Estate, a specialist in high street retail, expresses the situation succinctly:
"Partnering with the tenant is necessary these days, 'covenant' means very little."
These days, high street rents aren’t guaranteed. When rents fall, as we’ve seen on many high streets, the barriers to entry are lowered, opening the doors to disrupters and start-ups - new blood and vital energy moves in. The one problem for landlords has been the lack of covenant strength these potential tenants represent. Properties funded by debt will encounter a further issue when looking to sign-off new leases to a start-up concept. The solution? Closer alignment of interests between landlord and tenant – i.e., what Mary had been advocating for. How best to achieve this? Could the turnover rent2 be the solution?
Turnover rent provisions in leases have had their detractors, and for good reason. Traditionally, landlords and banks have resisted this lease structure due to the reliance which the landlord has to have on production of accurate turnover information by the tenant. As an investor and asset manager, I was always concerned about how one truly monitors cash transactions, particularly in the restaurant world, where it was commonplace to see "cash only" notices over the lucrative Christmas period. Times move on and today you are more likely to see signs proudly proclaiming "cashless-only" emblazoned over the shop window. The upside to this - transactions are now more easily monitored and audited.
I asked Mark Shelton, a legal expert with a vast experience of retail contracts and turnover rents, if my suspicions were correct.
"I’m sure (the cashless retail model) helps. Given that most leases provide for the tenant to self-certify turnover, landlords seem generally to be willing to trust anyway. Of course, there are obligations to keep turnover records for inspection, and the landlord can usually call for an audit if so minded. As Ronald Reagan used to say: 'Trust but verify'."
I asked Mark if he is seeing more turnover rent-based leases and if so, who is taking them.
"Certainly. There was a trend in that direction even before the Covid-19 pandemic, which hit retail and hospitality particularly hard as we know. Suddenly it seemed that almost all retail tenants were looking to shift to turnover-based rent… Transport hubs are a great example… (where) trading performance can be impacted by circumstances beyond the tenant’s control, such as strikes, long-term infrastructure works, extreme weather events or just seasonal travel patterns. It makes sense to have some downward adjustment of the property overhead to insulate the tenant against the worst effects. But the appeal is wider than that and extends right across retail and hospitality, down to small pop-ups."
Mary Portas's advice to high street communities within her eponymous review was clear – "They must be ready to experiment, try new things, take risks." The same could be said to investors and landlords. This is the only way to survive in the long-term. Encouragingly, Mark names a number of property investment companies doing just that:
"With Hammerson’s policy statement in 2020 including a pledge to move towards terms including a top-up element based on store performance, and then the Crown Estate and Capital & Counties offering turnover terms to their West End tenants, it has not all been tenant-led. Aside from negotiated turnover rent arrangements, high-profile retail CVAs3 such as New Look and Paperchase have re-written leases irrespective of landlords’ preference to substitute turnover rent for rack rent."
It is true, CVAs have certainly changed the landscape and given landlords more cause to align with, and pay more interest in, their tenants’ businesses and turnover rents could be an obvious way to do this. A silver bullet they are not, but turnover rents are certainly one tool in the box and a useful one for both landlords and tenants to help overcome the impact of our changing shopping behaviours.
2. A turnover rent is one where a tenant pays a percentage of their turnover rather than a fixed monthly or annual fee to their landlord.
3. A Company Voluntary Arrangement is an out-of-court insolvency process that allows a company to pay creditors over a fixed period. If creditors agree, the company can continue trading during this period.
David Toubian, based in Marylebone, London, is recognised as a leading adviser in leisure and investment property. He has brokered over £750m in real estate transactions. His clients include Soho House, Stefano Ricci, Dior, Waitrose, Leon, Yum, Al Shaya, Aura Group, Simit and numerous institutional investors, private family offices and developers.
Mark Shelton is a freelance legal trainer, having practised in major commercial law firms for thirty years. He qualified with Linklaters and has always specialised in property litigation. Mark was a Partner at Lawrence Graham, and has acted for major property investors, financial institutions and leading retailers. He was a Professional Support Lawyer for a number of years, most recently at Eversheds Sutherland LLP, working with the UK’s largest specialist real estate litigation team. He is a contributor to Estates Gazette, Property Week and Property Law Journal, and the author of books on a range of commercial property management topics.
Harry Iles is a Sterling board advisor and commercial real estate investor, developer and asset manager.