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Benefits of turnover leases

IS the turnover lease the answer to the retailers' prayers? As recession puts them on their knees and bites into their takings, many retailers are looking for a miracle that could extract them from the traditional 25-year lease with its ''upwards only'' rent reviews.

It's an arrangement that suits the landlords who own the shopping centres or high-street stores, but when takings are down retailers are beginning to rebel against the idea of paying higher rentals. A turnover lease means that the landlord and tenant share the ups and downs of the economic cycle.

Turnover leases are not a new idea: they are well established in most of Europe and in the US, Canada, and Australia. But in the UK they are about as easy to find as downward rent review clauses. So much so that corporate lawyers W. & J. Burness and chartered surveyors Hillier Parker jointly hosted a seminar at the weekend to explain the concept.

Turnover leases usually consist of two elements -- an agreed percentage of the gross turnover (net of VAT) and a fixed percentage of the open-market rental. The key area of negotiation is around what percentage of the turnover should be paid to the landlord. There is a tendency for businesses with a high turnover but low profit margin (such as a newsagent's) to have a low percentage while those with a lower turnover but a higher margin (a jeweller, for example) will pay a higher percentage.

Some figures provided at the seminar by W. & J. Burness include: fashion shoes 8-11%; confectionery 10%; stationery 4-6%; food and catering 11-20%; greengrocer 3-6%; cards 14-16%; supermarket 1-2%; gifts 8-12%; books 9%.

Where a retailer offers an unusual product or service it can be difficult to establish a turnover percentage, but as turnover rents become more common comparisons become easier.

From the landlord's point of view it is vital to base the rent on turnover rather than profits. David Gibson of W. & J. Burness told the seminar: ''The turnover percentage is never in my experience linked to the actual profit of the tenant's business -- the landlord would be unable to control deductions and the system would be open to abuse.''

Glasgow's Princes Square makes the most widespread use of turnover rentals north of the Border, although there are other examples in The Forge at Parkhead, the St Enoch Centre, and elsewhere in Scotland.

The rent-review system in Princes Square means individual tenants pay a rent which reflects pro rata their share of the total turnover in the centre as a whole. In England, the idea has been pioneered by landlords Capital & County who have introduced turnover leases in all of their shopping centres.

Typically, the base rent element of a turnover lease is fixed at about 75-80% of the full open market rent. ''It balances the landlord's desire to receive the major part of the open market rent while sales are low -- while at the same time sharing some of the risk with the tenant,'' said Gibson.

For the landlord the advantages of a high base rent are obvious; ie income and return on capital, a level of financial leverage to prevent the run-down of the tenant's business, and the avoidance of valuation problems which can occur if the base rent is below 75%.

Ian Wattie of Burness told the seminar that landlords have to maintain a high degree of control over the type of business carried out on the premises, since income will depend on the tenant's turnover.

''If a lease to a jeweller simply permitted 'the sale of jewellery', the tenant might decide to abandon the sale of cheap items and introduce Rolex watches and other high-quality items,'' he said.

''The landlord will still be entitled to receive only the agreed percentage of the turnover, which is likely to be on the low side if it has been set on the assumption that the tenant will be trading at the low end of the market. It is not unusual in the leases of foodcourts, where there is a turnover rent, for the landlord to insist on approving the tenant's menu and price list.''

Wattie also makes the point that the landlord might want to restrict a tenant from carrying out a competing business within a specified distance. The landlord will also probably want to maintain strict control over sub-lets, concessions, or assignations -- it's all part of trying to make the turnover rental income as predictable as possible.

Landlords also have to be careful about the number of days on which a tenant trades. If somebody decided to open on only certain days of the week, turnover might be affected and the landlord's income will fall. One way of getting around this problem is to apply an average daily turnover calculation to those days on which the outlet is closed.

John Hamilton of surveyors Healey & Baker says turnover leases are becoming more common in the UK, but we still have a long way to go before we reach the US situation where it is the most prevalent type of lease in shopping malls.

''In the current market, with their takings dropping, retailers tend to favour the idea of a turnover lease,'' he said. ''But there's not much demand from them when the retail sector is booming.

''I think we shall see more turnover leases come into play, but we won't see a wholesale switch, because that would require an alteration to the whole basis of development and investment in retail property.

''There are also a lot of retailers who would resist the idea of a landlord having a look at their accounts to calculate the turnover.''

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