The Turnover Clause: A Cornerstone of Retail Leases
In the world of commercial property, lease agreements are the foundation of your property transactions.
One of the most crucial components of some agreements is the turnover clause.
While less common in most leases, this clause plays an important role in determining rental payments, particularly in scenarios where the tenant’s business performance is directly tied to the property’s success.
This article will help you understand the Turnover clause and how it can increase your rental income and property value.
What is a Turnover Clause?
A turnover clause, also known as a percentage rent clause, is a provision in a commercial lease agreement that ties the tenant’s rent payments to the gross revenue or sales generated by their business operations at the leased premises.
In essence, it establishes a rent structure where the landlord receives a portion of the tenant’s business success.
In some cases the landlord receives a base rental PLUS a percentage of the tenants turnover.
This can drastically increase the rental income collected by the landlord.
In other cases where the property/location is seen as risky to the tenant, they may start their lease agreement by only paying a turnover rental with no base rental.
If the store succeeds there may be a clause in the lease that allows the landlord to collect a base rent once a certain turnover is reached.
The term “turnover” in this context refers to the total revenue or sales generated by the tenant’s business activities within the leased space. It can encompass various aspects, such as sales of goods, services, or both.
The specific definition of turnover may vary depending on the lease agreement and the nature of the tenant’s business.
How Does a Turnover Clause Work?
A typical turnover clause outlines a formula for calculating rent based on the tenant’s turnover.
This formula often involves a base rent component, a percentage rent component, and potential adjustments.
- Base Rent: This is a fixed amount that the tenant pays regardless of their turnover. It serves as a minimum rent guarantee for the landlord.
- Percentage Rent: This is the portion of the rent that is calculated based on the tenant’s turnover. The percentage rate is agreed upon in the lease agreement and typically ranges from a few percent to a significant portion of the turnover.
- Turnover Calculation: The tenant’s turnover is calculated using a predetermined method, such as gross sales, net sales, or a combination of both. The calculation may exclude certain items, such as returns, discounts, or taxes.
- Rent Calculation: The total rent due is determined by adding the base rent to the percentage rent calculated based on the tenant’s turnover.
For example, a large supermarket chain like Shoprite, normally pays a discounted rental to other tenants in a shopping centre.
Shoprite might pay for example R60/sqm (ie. the base rent) for their store, while all other tenants might be paying R120/sqm.
In a case like this many landlords add in a turnover clause that allows them to collect the base rent of R60/sqm PLUS 1% or more of Shoprite’s monthly turnover, if it is higher than a certain amount per month.
So let’s say Shoprite occupies 3,000sqm.
This means that at R60/sqm, Shoprite’s rental per month is R180,000pm.
But let us assume that the lease agreement says that if Shoprite’s monthly turnover is more than R1m, they also pay an additional 2% turnover rental.
So if Shoprite achieves a turnover of say R3m in a given month, depending how the lease is structured, they pay an additional R60,000 (2% of R3m) to the landlord.
This means the landlord collects R180,000 (base rent) + R60,000 (turnover rental), for a total rental of R240,000 for that month.
Common Variations and Adjustments:
- Minimum Rent: To ensure a minimum level of income for the landlord, the lease may specify a minimum rent that the tenant must pay, even if their turnover is low.
- Maximum Rent: In some cases, the lease may set a maximum percentage rent to protect the tenant from excessive rent payments in periods of exceptional business success.
- Proration: If the lease term does not begin or end on a calendar year, the rent may be prorated to reflect the actual time period the tenant occupies the space.
- Rent Holidays: Some leases may include provisions for rent holidays or reduced rent payments during specific periods, such as the initial months of occupancy or periods of low turnover.
Where is the Turnover Clause Used Most Often?
Turnover clauses are commonly found in commercial leases for properties that are directly tied to the tenant’s business performance.
This is particularly prevalent in retail spaces, restaurants, and other businesses where the success of the tenant’s operation significantly impacts the value of the property.
Here are some of the most common scenarios where turnover clauses are used:
- Retail Spaces: Shopping centers, malls, and strip centers often employ turnover clauses to align the landlord’s income with the tenant’s success. This incentivizes tenants to operate their businesses efficiently and attract customers. In most cases it is the anchor tenant (eg. Shoprite, Woolworths, Pick n Pay) that pays the turnover rental.
- Restaurants: The performance of a restaurant can directly influence the foot traffic and overall appeal of a property. Turnover clauses can help landlords share in the success of a thriving restaurant.
- Specialty Stores: Businesses that sell unique or high-demand products may be subject to turnover clauses, as their success can drive foot traffic to the property.
- Service-Based Businesses: Some service-based businesses, such as hair salons, spas, or fitness centers, may also have turnover clauses in their leases.
In these cases, the turnover clause provides a more equitable rent structure, as it allows the landlord to benefit from the tenant’s success while also providing the tenant with a potentially lower base rent.
Benefits of Using a Turnover Clause
Both landlords and tenants can benefit from incorporating a turnover clause into their lease agreement.
Benefits for Landlords:
- Increased Revenue: A well-structured turnover clause can provide landlords with a significant source of income, especially if the tenant’s business is successful.
- Risk Mitigation: By tying rent payments to the tenant’s performance, landlords can mitigate the risk of non-payment or reduced rent during periods of economic downturn.
- Incentive for Tenant Success: A turnover clause encourages tenants to operate their businesses efficiently and attract customers, which benefits both the tenant and the landlord.
Benefits for Tenants:
- Lower Base Rent: In exchange for sharing a portion of their turnover, tenants may negotiate for a lower base rent, which can reduce their overall costs.
- Flexibility: A turnover clause can provide tenants with more flexibility in their rent payments, especially during periods of economic uncertainty or business challenges.
- Alignment of Interests: By aligning the interests of the landlord and tenant, a turnover clause can foster a more collaborative and mutually beneficial relationship.
Overall, the turnover clause offers a win-win scenario for both landlords and tenants, providing a flexible and performance-based approach to rent payments.
Conclusion
The turnover clause is a valuable tool in commercial lease agreements, providing a flexible and performance-based approach to rent payments.
By understanding its definition, mechanics, common applications, and benefits, both landlords and tenants can make informed decisions and negotiate favorable terms.
While the turnover clause can offer significant advantages, it’s essential to consider potential challenges and best practices for its implementation.
By carefully defining turnover, ensuring accurate reporting, and seeking expert guidance, both parties can maximize the benefits of this clause and foster a mutually beneficial relationship.
Aslam is from Johannesburg, South Africa and graduated with a BComm degree from the University of South Africa and followed that up with a BComm Hons degree in Finance and Investments.
He has spent over 18 years in the financial services sector, with 12.5 years in the commercial property finance arena with 3 of the major banks in the country.
His specialty being deal structuring and finance solutions for commercial property investors and developers across the commercial property sector, including large scale retail developments, high density residential investments , industrial and office property.
Aslam was also a fast food franchise investor for 7 years, is experienced in digital marketing and online lead generation and has owned and managed multiple residential properties.
