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A commercial lease is where a business owner occupies a property or part of it to run their business in exchange for rent. Typically, rent is an agreed amount and will not increase rapidly, except where a landlord conducts a rent review. However, some commercial lease agreements are turnover leases. These detail a reduced base rent and a turnover rent in addition. Most of the time, a commercial landlord has no legal obligation to accept the proposal for a turnover lease and instead charge a higher rent as per a standard commercial lease. It is, therefore, helpful for both commercial landlords and tenants to consider how a turnover lease may or may not benefit them in deciding whether to enter a turnover lease. This article will explain the pros and cons of turnover leases.
What is a Turnover Lease?
A turnover or turnover-based lease is a commercial lease with a different rent structure from the average commercial lease. A tenant in a turnover lease usually pays a base rent that is less than the standard rent for their commercial lease. On top of that, they also pay a turnover rent or turnover-based rent.
The turnover rent is a percentage of the commercial tenant’s turnover. The landlord and the tenant will agree on the percentage before they enter the lease. This tends to range between 1-15%, and the average is 7%. The set percentage should only cover turnover over an agreed threshold. Therefore, where the tenants’ business is successful, the turnover element of the rent increases and where it is suffering, it decreases.
A landlord may require approval from their mortgage provider before they can enter a turnover lease with a tenant.
Pros of Turnover Leases
A primary advantage of turnover leases is that both parties will benefit when the tenant’s business progresses. Naturally, the tenant will gain increased profits, and the landlord will receive more rent under the turnover lease. Accordingly, this kind of commercial lease can encourage both parties to remain motivated and ensure the business’ success. A commercial lease agreement may even contain a provision that requires both parties to invest in the success of the tenant’s business.
Additionally, commercial tenants benefit from turnover leases as the lower base rent is advantageous when their business is not doing well. Financial difficulties can arise when:
- the business is new;
- new competition arises;
- the economic climate for their trade is terrible; or
- a pandemic breaks out and affects their trading.
Rather than have a situation where their rent remains the standard-based amount, they may only have to pay the lower base rent until their turnover reaches a level where turnover rent applies.
Turnover leases can also be advantageous for commercial landlords. Their commercial property may appeal more to business owners due to the turnover rent element than if offered a standard commercial lease. Where a landlord usually offers a standard commercial lease with the typical base-only rent, it may be advantageous to consider a turnover lease rather than lose income with a vacant property.
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Cons of Turnover Leases
One of the cons of turnover leases is that a tenant must pay a greater rental amount when their business goes well, especially compared to other tenants in the same commercial property.
Also, a tenant may be reluctant to divulge financial information about their business to their landlord, which will be necessary to determine the turnover rent amount.
Additionally, a turnover lease will typically contain stringent keep-open provisions in the commercial lease. These state that a commercial tenant must keep the business trading during certain times, which the lease will detail. When tenants fail to abide by these, they allow a landlord to recover rent for the business closure. Keep-open provisions in a turnover lease that are too strict may disadvantage a commercial tenant. However, those that are not stringent enough may fail to protect the landlord’s interests. Keep-open provisions should allow for closure in some instances, such as for necessary alterations to the commercial premises.
Further, calculating the turnover figure for the turnover rent can sometimes be challenging. A commercial tenant might make sales from the brick-and-mortar store plus online ones. Also, where a tenant sublets the commercial premises or part of it or assigns it to a third party, this can confuse the turnover amount. It could negatively affect the turnover amount for the landlord. Issues with the turnover figure can also result in a leasing dispute.
This cheat sheet outlines what you should be aware of in your lease agreement.
Key Takeaways
A turnover lease involves a tenant paying a base rent that is less than a standard rent for their commercial lease, plus turnover-based rent. There are pros and cons of turnover leases. For example, an advantage is that a landlord benefits when their tenant business does well. A disadvantage, however, is that turnover can sometimes be confusing to calculate and result in disputes between the parties to the lease.
If you need help understanding turnover leases, our experienced leasing lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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