The pressure on bricks and mortar retail has intensified following the pandemic. Usha Sharma looks at ways that shopping centre leases could be adapted to promote greater flexibility.
The retail landscape is evolving like never before. Shopping centres in particular have grappled with the issues surrounding Covid-19 and attracting consumers when only a handful of shops may have remained open during the pandemic and other non-essential shops were forced to close.
Prior to the pandemic, the retail sector had already been facing pressures and uncertainties, and these seem to have been intensified by Covid-19. Business hates uncertainty and many shopping centre landlords and tenants have been tasked with continuing to, where possible, serve the public in a safe and enjoyable environment.
It’s not all doom and gloom though and numerous retailers have adapted their business models to meet the new trends in retailing. It is clear that those retailers who are seizing the opportunity to adapt are not only surviving but are thriving. Granted some of their business may now be conducted online but there remains a fundamental attitude that the use of a retained physical presence in our towns and cities means “bricks” lead to “clicks”.
One thing is for sure: to effectively navigate the commercial real estate landscape today, landlords have to think carefully about tenants’ needs and tenants must engage and show consideration towards their landlords. What are the leasing provisions that landlords and tenants are currently negotiating and what are the accompanying commercial lease negotiation tactics and strategies?
Key issues and concerns facing commercial landlords
Rent
Tenants are looking for more flexibility in their rent arrangements and in particular, in addition to a widespread shift away from quarterly rents to monthly rents, a percentage turnover rent approach is becoming more attractive. This means that tenants aren’t saddled with large losses through fixed rent payments and instead the rent level more accurately reflects what can be earned from the premises. On the plus side for landlords, offering turnover rents potentially attracts businesses that may have been denied mainstream exposure and the kickstart they deserved or needed because they did not meet the financial criteria to pay the first quarter’s non-negotiable rent. It also gives landlords detailed knowledge and insight of their tenants’ financial performance, enabling them to learn and really understand how their centres are operating (with tenants providing information such as average spend per head and dwell time).
User
Generally, a lease contains an express provision which regulates what a tenant is and is not permitted to use the premises for during the lease term. However, the growth in consumers enjoying experiences, which offer them an opportunity not only to shop but also to enjoy events such as craft workshops, fashion talks and yoga, is proving a challenge to those traditional use clauses. Experiences of this sort are something which online retail cannot offer, and so are increasingly valuable to bricks-and-mortar retail. For landlords, flexibility in use restrictions to allow this sort of offering creates an increasing variety of reasons for customers to visit a scheme. Landlords and tenants are appreciating that a holistic approach to retail includes the promotion of mental health, as well as physical health, to make consumers feel good about themselves.
Signage
Advertising has always been an important part of retailing, but now the fast pace of social media means that businesses need to be even more responsive and dynamic than ever. Tenants understandably want landlords to focus on agility and, in that context, tight lease controls on signage or public displays can restrict a tenant’s ability to undertake timely marketing campaigns to capture a trend at the right moment.
Lease term
With the uncertainty posed by business and lockdowns during the pandemic, there has been a tendency among tenants to opt for a shorter term. While short-term leases can pose a greater risk for landlords, where they then have to deal with unpredictable waves of tenants moving in and out, it does mean a landlord has greater control. The tenant, for example, could sign a short-term lease and, if rents trend higher in the future, that higher rent could easily be reflected in the new lease when the market strengthens.
How are those issues being reflected in leases?
Rent
Percentage provisions are usually drafted to enable a landlord to take a percentage of their tenant’s gross turnover instead of a more conventional fixed amount of rent, thereby linking the level of rent to the income of the premises. Historically there would be a “guaranteed” base rent, with a “top-up” turnover rent, based on the turnover derived from that unit. Turnover rent mechanisms are now becoming even more flexible, with a number of landlords willing to consider turnover-only rents.
Either way, there tends to be some disagreement as to what should be included in the definition of “turnover”. Some tenants earn all their income from the turnover at the shop, whereas for others, the shop may only be a physical presence with most of the turnover being generated elsewhere such as online, mobile shopping or click-and-collect. It’s important to ensure that turnover rent clauses are flexible enough to capture physical and online sales within the rental calculation, so landlords are properly remunerated.
In terms of the payment and accounting for turnover rent, leases will commonly require that turnover rent is paid quarterly in arrears on the usual quarter days, with a reconciliation at the end of each year and with any balancing charge or balancing credit being due. However, from a tenant’s perspective, and certainly in terms of cash flow, the ideal arrangement is payment of turnover rent in arrears (ideally monthly or quarterly).
User
In order to extend the user clause, some landlords and tenants are now negotiating bespoke user clauses to facilitate tenant creativity. For example, clauses permitting retail tenants to host entertainment events and collaborations with other brands to sell limited-edition merchandise, or for restaurants to host celebrity chef evenings which can create a buzz and be captured and promoted on social media.
This can also spill over into the alienation provisions and tenants being granted greater freedom to share space with concessions or franchisees, thereby allowing the tenant to freshen up their offer by livening up the mix of occupiers. Again, care must be taken by the landlord to ensure they do not breach the terms of other leases in the centre (where, for example, the landlord has agreed with a specific tenant to not allow other tenants in the centre to sell certain goods which would conflict or compete with that particular tenant’s business). It is also important for the tenant that the lease and the relevant planning permission will allow them to conduct their type of business from the premises.
Signage
With regard to signage, the usual position is that signage will be permitted with the landlord’s consent (not to be unreasonably withheld or delayed). Clearly with changing trends it would be impractical to obtain consent to every change of signage. In shopping centres tenants may want the ability to change and place signage on their shop front and fascia or any other part of the exterior of the premises and the landlord will need to carefully consider what level of control it would wish to retain while trying to accommodate the tenant’s requirements.
Lease term
With shorter leases becoming the norm, the trend seems to show that three, five and seven-year leases are becoming more popular. We could even find a 10-year term for a lease may soon be regarded as a long lease. There are obvious benefits of shorter leases, apart from not entering into a “long-term contract”, for example, there will be less stamp duty land tax payable, which has cash flow benefits and is particularly important in the current climate.
In terms of future lease agreements, it will be interesting to see how the real estate market continues to evolve and what sort of clauses parties seek to negotiate to allocate the commercial risks that may arise from this public health crisis or other unexpected and significant events. Indeed recent case law has accepted that pandemic-specific clauses are now common. Covid-19 has given us real pause for thought and has made us aware of both our vulnerabilities and opportunities.
Suggested lease amends
Flexibility in shopping centre leases, which landlords could consider going forward:
- Easing of tenant covenants for signage (to allow for quick social media trends/marketing campaigns)
- Turnover rents
- Allowing public gatherings which leases usually prohibit, ie (socially distanced) beauty demos, craft workshops and anything that online cannot physically offer to draw the public back to bricks and mortar destinations
Usha Sharma is a senior associate at Brabners
Next time
In next month’s Back to Basics, Zoe Conroy looks at the new Breathing Space Regulations and their implications for social landlords.
