PROPERTY JOURNAL

The risks and rewards of flexible leasing

Structural changes in the retail and leisure sector are meaning increased demand for flexible leases and turnover-based rents. How can landlords ensure they manage these most effectively?

Author:

  • Saagar Sachdev

26 February 2021

COVID-19 has taken its toll on the retail and leisure sector, resulting in greater demand from occupiers for flexible lease terms and turnover-based rents. Therefore, while recent announcements from commercial landlords L&G and Hammerson to introduce new turnover-based lease models across their portfolio may seem a bold step, they may simply represent an acceleration of the inevitable. 

The flexible lease model is nothing new. Turnover-based rents and short-term leases have always been an option, but the intent of both Hammerson and L&G is a clear long-term commitment to flexible leases. There has been a desire for some time from both landlords and tenants to move away from the traditional relationship, with tenants more like customers instead. The pandemic and associated lockdowns have simply accelerated the process, since good communication between both parties has been critical throughout this period. 

Landlords and managing agents are now introducing a consultation process to fulfil the key performance indicator (KPI) for customer satisfaction, which will enable them to identify customers' common concerns and find ways to ameliorate them; for example, by simplifying lease terms or making better use of technology in administration. 

Reciprocal benefits

This, coupled with a move towards turnover-based rents, has its positives for landlords. But it does also mean taking on greater operational and income risk. Naturally, the landlord will share the potential risk and reward with the tenant, meaning that they will be encouraged to work together to ensure success

Flexible leasing puts landlords in a position to support the development of new businesses or brands – like the 'incubator model' employed by the likes of WeWork and Regus. Providing the tenant with low-commitment accommodation, the landlord gains a better understanding of their turnover and trade, and the potential to nurture a fledgeling business into an established brand. The business then has the potential to reciprocate the benefit by expanding its commitment to the landlord on a more permanent basis.  

The difficulties for landlords are of course manifold: a heavy reliance on accurate data from the tenant or others, the cost implications of measuring footfall and car park use, which usually involves a third-party supplier, forecasting tenants' annual turnover – which can be volatile – and ensuring consistency in what is accounted for, such as click and collect or online ordering by the tenant's own customers. This approach is labour-intensive, and with shorter lease terms comes a higher churn of tenants. 

Managing flexible leases and turnover rents

The move towards more flexible leases and turnover-based rents fits into the wider trend of shortening terms across the real-estate sector. Given the structural changes in retail and leisure, such as oversupply and the growth of online shopping, it is difficult to disagree with the approach taken by L&G and Hammerson to adapt quickly. 

Turnover-based rents require a schedule in the lease that governs how the rent is calculated, what is included in the turnover e.g. online orders, shop orders, VAT etc. This schedule also provides the calculation and percentage of turnover rent payable. The tenant then supplies a turnover certificate to the landlord on a set date or frequency as governed by the schedule, which confirms the amount of turnover generated by that tenant over that period of time. The managing agent can then use this to calculate the turnover rent due. 

At Workman, we have been managing turnover-based leases for our clients for a number of years. In our experience, successful implementation of turnover-based occupancy relies on:
  • technology to collect transparent data on sales, footfall and car-park use
  • analytics that allow evaluation of footfall, sales density and peak trade periods
  • a thorough understanding of the lease's turnover schedule
  • active diary reminders for turnover certificate due dates so tenant engagement can start early; Workman adopts a reminder-letter process before the due date, comprising three stages
  • a three-tier approval process for turnover calculations to ensure accuracy; upon receipt of the certificate, an accountant carries out the initial calculation of turnover rent due, this is approved by a senior accountant and then finally approved by the property manager
  • management KPI for turnaround time from receipt of the turnover certificate to final calculation and charging
  • foundation for financial forecasting in base rent plus turnover top-up.

As my colleague Georgina Grazebrook wrote in Property Week at the end of 2020, a well-balanced relationship between landlord and tenant that aligns their respective interests is the way forward. Having the arrangements in place to deal with this inspires confidence in all parties that the transition to turnover-based leasing – when executed well – can be a smooth one.  

saagar.sachdev@workman.co.uk

Related competencies include: Landlord and tenant, Leasing and letting

"The move towards more flexible leases and turnover-based rents fits into the wider trend of shortening terms"

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