Leases in the retail sector: Annual rent and rent review

The annual rent is a key negotiating point between the landlord and tenant or their respective agents before agreeing to the heads of terms. The structure of the rent can however vary, and there are several common bases for calculating the annual rent in retail leases:

1. Fixed annual rent
   This is a set rent for the duration of the lease, which remains constant unless otherwise agreed by the parties. It provides certainty for both parties but may not reflect changes in the market or the tenant’s financial performance.
2. Stepped rent
   A stepped rent arrangement involves agreed increases in rent at set intervals throughout the term of the lease. This type of rent structure is often used when landlords want to ensure that rent increases are anticipated, especially in long-term leases.
3. Open market rent review
   In longer leases, typically with a 10-year term or more, the rent may be reviewed at specific intervals (e.g., every five years) based on the open market rent at the time of the review. This approach bases the rent on the current lease with certain assumptions and disregards. Historically, open market rent reviews have been upward-only, but downward rent reviews are occasionally agreed, particularly in areas where retail demand has decreased.
   
   However, landlords are likely to resist downward rent reviews. This type of rent review may also present challenges if the landlord's property is subject to a charge. Lenders may be unwilling to accept such terms as they could impact the repayment of the secured charge.
4. RPI/CPI rent review
   In leases where the rent is linked to the Retail Price Index (RPI) or Consumer Price Index (CPI), the rent adjusts in line with inflation. This structure provides an automatic adjustment based on changes in economic conditions, offering a predictable change in rent but without reflecting the specific dynamics of the retail property market.
5. Turnover rent
   Turnover rent is a common structure in the retail sector where rent is based on a percentage of the tenant’s income derived from operating in the leased premises. This means that if the tenant’s business performs well, the rent increases, but if the business suffers, the rent decreases. This structure has become increasingly popular, particularly post-pandemic, as it offers tenants protection against downturns in business while still providing landlords with a share of the tenant's success.
   
   However, turnover rent provisions are complex and require detailed agreements on how turnover is calculated, including the percentage of turnover that will constitute rent and the specific items that should or should not be included in the calculation. With the rise of online retail, it can also be difficult to determine how much of a tenant’s total turnover is attributable to the physical store. Regular assessments and audits are needed to determine the rent payable, which can result in a significant administrative burden for both parties.
6. Base rent with additional turnover rent
   This hybrid structure combines a base rent with an additional turnover rent element. The base rent provides the landlord with a guaranteed minimum income, while the turnover rent acts as a top-up based on the tenant’s revenue, typically assessed annually. If the tenant exceeds a certain revenue threshold, they will pay additional turnover rent, but if the threshold is not met, only the base rent will apply.
   
   For both pure turnover rent leases and those with a base rent and turnover top-up, landlords should include a keep open provision. This provision requires the tenant to keep the retail store open and operational throughout the lease term. Failure to comply with this requirement can give the landlord grounds for forfeiture of the lease. This provision is crucial for retail leases to prevent tenants from avoiding rent payments by simply closing the store.

Rent review caps and collars

Both landlords and tenants should consider the possibility of setting a cap and collar for rent reviews:

• A cap ensures that rent cannot exceed a certain amount, providing tenants with protection from excessive rent increases.
• A collar ensures that the rent cannot fall below a specified minimum, offering landlords some protection.

Rent-free periods

In many retail leases, a rent-free period may be negotiated, where rent is not due for a certain period at the beginning of the lease term. This can be a helpful concession for tenants, particularly when setting up a new store or business. Landlords may agree to such a period in exchange for other considerations, such as a higher rent after the rent-free period or a longer lease term.

For more information or advice, please contact Steve Faragher in our Real Estate team