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PROPERTY REVIEWER

Retail leasing must turnover

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OPINION: RETAIL leasing is fraught with conflict. On one hand, landlords desire certainty of income and to maximise the value of their investment. On the other, tenants commonly want to minimise their overheads and ensure their rent reflects the performance of the store.

A compromise of sorts has seen various forms of turnover rent clauses negotiated into a range of retail leases over the years (in particular for supermarkets, department stores, and larger specialty store networks in shopping centres), whereby the tenant would generally pay a fixed base rent, plus a variable ‘turnover’ rent component directly linked to annual revenue performance.

Traditional turnover rent clauses worked effectively when we all shopped conventionally in-store. There was no disputing a retailer’s turnover and little debate about the definition of the term ‘turnover’.

However, in an era where we are increasingly shopping online, are turnover clauses still relevant, at least in their previously accepted forms for some retailers? Many retail landlords will not yet have had the opportunity to address the impact of online sales (particularly for longer term leases) and how they are impacting store revenue and therefore turnover rent payable.

With Amazon soon to arrive in Australia, the amount we spend online is poised to increase (especially as Australia’s online sales penetration is lower than similar western economies) and there will be fierce competition for the traditional in-store shopping dollar.

Amazon provides businesses of all sizes with the opportunity to scale – to reach a much greater market without the requirement of a significant retail footprint or associated staffing costs. Subsequently, new ecommerce ventures will be born and established online businesses will expand. Hybrid (in-store and online) retailers will simultaneously feel the pleasure and pain of the world’s dominant online player.

This, combined with slow growth in household income and continued challenging retail trading conditions, has placed pressure on retailers and resulted in a number of stressed operators which will impact retail landlords in the short to medium term – if not already.

Amazon’s arrival will further alter Australia’s retail landscape and may be the catalyst for further changes to the traditional retail tenancy and retail lease model.

As a result, landlords may bear the brunt of the online impact and a broader change in shopping habits. We see the potential for:

Some collateral damage, where underperforming stores and sites will be under pressure and some will ultimately downsize or close.

Downward pressure on rents as stressed retailers attempt to renegotiate lease terms in an effort to turnaround struggling locations.

A reduction in total rental income as a result of existing lease agreements and turnover clauses not adequately addressing or capturing the leakage to online revenue in turnover rent calculations.

Government intervention 

In amending the Retail Leases Act 1994, which came into effect on 1 July 2017, New South Wales legislated how online revenue for turnover calculations could be dealt with, broadly summarised as follows:

Turnover rent excludes online revenue except where the goods are delivered or provided from the shop, or the transaction takes place while the customer is at the shop. 

A tenant is not required to provide information to the landlord regarding online transactions except where the goods are delivered or provided from the shop, or the transaction takes place while the customer is at the shop.

In late 2016, it is understood Coles agreed to include a percentage of online sales revenue as turnover under the lease of its Eden Rise store in Melbourne.

Other landlords will also likely be actively seeking to capture ‘click and collect’ purchases, and online purchases by households within a certain radius of a store, within turnover figures to structure rent and calculate turnover rent provisions.

This will no doubt become an ongoing national topic of conversation and the definition of ‘turnover’ will be a hotly contested consideration during negotiations for new leases and renewal of existing leases.

FTI CONSULTING’S OUTLOOK

Landlords will seek to future proof their leases and, for longer leases, may seek to include provisions that allow for a periodic review of any turnover rent mechanism, to ensure it remains relevant and reflects market conditions through the course of the lease.

Landlords will become more focused on arresting revenue leakage and will look for ways to attribute online revenue to physical stores.

Traditional or ‘all inclusive’ turnover definitions may become a thing of the past. Landlords and tenants will be more focused on defining terms such as turnover, and on expressly negotiating what is and is not included in turnover.

Landlords will request that tenants disclose accounting information regarding online transactions in support of turnover calculations.

Following New South Wales, other States and Territories may feel compelled to amend their retail leasing legislation in response to the impacts of new technology and changing consumer purchasing behaviour.

In response to these ongoing changes, landlords will need to consider how they structure their lease agreements. They may ultimately need to reach more sustainable and/or relevant rental structures in an effort to attract and secure new tenants and to ensure existing tenants remain viable at their centres.

*By Kate Warwick, senior managing director and read of retail and consumer products, FTI Consulting and Glen Smith, managing director, real estate advisory, FTI Consulting.

Property Reviewer on Australian Property Journal