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Alternative leasing models

Has the Coronavirus pandemic been the catalyst to a change in the nature of the landlord and tenant relationship?

Most shops, pubs, restaurants and offices have been shut for almost a year because of Lockdown and, sadly, some may never re-open their doors.

Accordingly, alternative leasing models may need to be adopted to allow landlords and tenants to navigate their way out of the current fragile letting market. As a result of the consequences of the pandemic, leasing structures which are flexible and dynamic will have an increased role to play in the landlord and tenant relationship of tomorrow.

Landlords and tenants each have their own interests to protect and, historically, may therefore have been reluctant to engage fully with each other if either party suffered due to an issue outwith their control. However, the Covid- 19 pandemic has taught both sides that they need to interact and work together to address future challenges which might arise. If they fail to do so, then tenant default, tenant insolvencies and increased voids will occur, in turn leading to an adverse affect on the investment value of the landlord’s asset. There could also be a risk to some landlords of being unable to meet their borrowing covenants due to a drop/loss of rental income.

Turnover leases offer an alternative to open market leases for certain sectors of the market. A turnover lease has typically been used mainly in retail units but it's use has now become more widespread in the pub, café and restaurant sector as those sectors have been hit hardest during Lockdown.

A turnover lease is one where the rent payable by the tenant is linked either wholly or (more commonly) partly to the actual turnover achieved by the tenant and is an alternative to the classic  headline rental model based on open market rent.

Various types of turnover leases can be used:

  1. A rent based solely on the tenant’s turnover but with the tenant guaranteeing a minimum amount of turnover (and, in many cases, with the landlord receiving no benefit from turnover above a certain figure);
  2. The tenant paying a minimum base rent with an additional turnover rent based on a percentage of gross turnover. In this case the rent payable is usually the greater of the base rent and the percentage of gross turnover;
  3. A minimum base rent with the tenant paying a percentage of gross turnover above an agreed amount e.g. 10% of gross turnover in excess of, say, £500,000.

The main benefits to landlords are that where the tenants trade above expectations, the landlords benefit immediately rather than waiting for a rent review. The landlords can more closely monitor their tenants’ performance which may enable them to take early action if performance dips rather than waiting until the tenants default or become insolvent.

For the tenants, the turnover lease will allow their rental liability to reduce in poor trading conditions (subject to any base rent which has been agreed) thereby reducing their exposure due to closures outwith their control. Some tenants - particularly national chains - are also successfully negotiating complete suspension of rent provisions if another Covid-19 Lockdown is imposed.

The pandemic has changed the dynamics of the landlord and tenant relationship and some of those changes are unlikely to be temporary given the need to legislate for future unforeseen events. The changes made to leasing models in the retail, hospitality  and leisure sectors in particular which are being implemented now to address these changes are likely to be here to stay - which will place the occupational market in a stronger position to weather the storm of future events.

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