Sales Reporting and Turnover Rent
If you are located in a shopping centre, it’s highly likely that you have a lease that requires you to report gross sales, usually on a monthly basis, but sometimes annually and in many cases, both monthly and annually.
Retailers who own their premises need not be concerned about this, together with those retailers who lease a single holding building, as most landlords who own these types of assets are generally not that interested in their tenant’s sales.
Of course many retailers do have their businesses located in a shopping centre, so this article will be very relevant to them.
Why do shopping centre landlords want your sales figures? Well, it’s important to understand that landlords collect sales from most tenants in shopping centres for three main reasons. Firstly to gauge the performance of the shopping centre as a whole, in terms of how the asset is performing – they use this data for the purposes of Marketing, Asset Valuation and Annual Reporting (where a shopping centre is owned by a public company).
Secondly they use this information for leasing purposes by segmenting sales into the various retail categories such as Mens Apparel, Ladies Apparel, Unisex Apparel, Fresh Food, Eat In/Takeaway Food, Household, Services etc…so that they can determine how specific categories are trading. This helps them decide on whether or not they should increase the number of retailers in a particular category or perhaps create a new category or even reduce the number of tenants in a certain category.
Leasing Managers also review sales figures on a regular basis to assess individual retailer’s performance to determine if they are likely to pose a risk in term of default (in cases where sales are declining at an alarming rate). Strong sales growth could actually indicate that a retailer is overtrading, so the Leasing Manager knows that there could be potential to increase the size of the premises, so in either case, sales reporting is critical for the purposes of leasing.
The third reason why sales reporting is so important is to determine whether or not a retailer should pay turnover rent. What is turnover rent? Essentially turnover rent is paid when a retailer’s sales exceed a specific threshold or “Overage Point” during a designated period. In most cases this is easily calculated by simply taking your annual base rent and dividing it by the agreed turnover rent percentage. For example, let’s say a retailer has an 8% turnover rent clause in their lease and their base rent for the year was $100,000 – we simply take $100,000 and divide it by 8% to give an Overage Point of $1,250,000. What this means is, if this particular retailer exceeded $1,250,000 in the given year, then the landlord would be entitled to 8% of sales which exceed this level.
On the surface this may seem reasonable, but what if you are a retailer such as a Lottery Agent and operate on low profit margins? Let’s say lottery sales for the year where say $2,000,000 – that would mean our agent would need to pay the landlord 8% of the difference between his annual turnover ($2,000,000) and the Overage Point ($1,250,000) – the calculation is as follows: $2,000,000 less $1,250,000 x 8% = $60,000. Turnover Rent of $60,000 is now payable in addition to the base rent of $100,000 already paid, so all up $160,000. This is seriously problematic as the commission paid on lottery sales is only 8-10% (depending on which state or territory you are located in), so this would mean that you would literally have very little or nothing to pay all of your other operating expenses such as wages, insurances, electricity etc…
Guess what, I have encountered many situations where this exact situation has occurred. The numbers were different, but in each case the retailer should have paid the landlord turnover rent in addition to their base rent. Luckily in most cases the landlords in question had no idea how the turnover rent clause operated and those who did understand, realised that it was very unfair and did not charge the tenant additional turnover rent.
Unfortunately in some cases the retailers did have to cough up the additional turnover rent, which placed a massive financial burden on them.
So… how do you avoid something like this happening to you? In this particular case I would only ever report commissions on lottery products and any other commission based revenue, not the actual raw sales, as this artificially inflates your turnover.
Also when negotiating your lease, I would insist on a special clause that states that if turnover rent applies, it is to be calculated only on commissions based income, not on gross sales relating to those sources of income.
If possible, I’d try to dissuade your landlord from having a turnover rent clause at all, particularly given the slim margins certain industries have to work with. However if your landlord insists on you reporting all gross sales and not just commissions and they also want a turnover rent provision, then I would only agree to a nominal turnover rent percentage, say 1% (or preferably less depending on how high your base rent is). What this does is significantly increase your Overage Point to the level where you would not likely exceed it. Using the same example above where our Lottery Agent is paying $100,000pa in base rent, but now adopting a new turnover percentage of say 1% instead of 8%, this would alter the Overage Point significantly up to $10,000,000 (ie. $100,000 divided by 1% = $10,000,000). Given our Lottery Agent is turning over $2,000,000, they are now well below the new Overage Point of $10,000,000 and will never pay any additional turnover rent, unless of course they experience a massive increase in turnover in excess of $10,000,000pa, in which case I suspect that our Lottery Agent might actually be more than happy to pay some additional rent.
Seriously though, given the implications I urge all retailers to carefully check the commercial terms and fine print of their proposed new lease to make sure that they understand the impact of reporting sales and the effect this has on turnover rent.