Don't worry, you've not strayed onto a fashion page or a new fetish column, I'm talking about commercial property leases (as opposed to the residential leases I spoke about last time)
Commercial leases have been around since time immemorial, but it was only in the 1950s when it was felt by some landlords that it was unfair the rent could be fixed for a long period of time with the tenant getting more and more benefit as his turnover and profits increased merely with inflation but his rent stayed static. I believe that it was Land Securities, (the largest property development and investment company in the UK) who first introduced the principle of reviewing the rent during the term of the lease. And so it became standard that most commercial leases were held for either 21 years with rent reviews every seven years or 25 years with rent reviews every five years. The situation has changed somewhat recently with shorter leases becoming more the norm, say 10 years with rent reviews every five years or sometimes every three. Rent reviews are based on a variety of different formulae, the most common being to “market value” – what would be worth today. Other possibilities include a percentage of market value, an increase in line with a known index such as the RPI or just fixed increases to a certain amount. What is important to note is that most rent reviews are “upwards only” – that is, if rents do fall, then at review time the rent will stay the same as before the review. The tenant does not benefit from any negative change in the property market and the landlord does not lose. A concept that started in the United States and spread to England with the development of shopping centres such as Eldon Square and The Bridges is the concept of a “turnover rent”. In this situation, the rent is estimated and agreed between the parties – as usual – but then what is known as “caps” and “collars” are applied to this. Then there is an agreement based on a percentage of the shop’s turnover that the landlord will accept as rent. For example, say a clothing shop expecting to sell £500,000 worth of clothes in a year, may agree that the market rent for the unit is say £20,000 per annum. This is of course 4% of turnover. So they will agree a rent of 4% of turnover, subject to a “cap” of say £25,000 and a “collar” of £15,000. If trade increases dramatically then the landlord sees some of this benefit but if it suffers then the landlord shares in the pain. This situation is becoming ever more common and I believe that it is likely to become the norm by say 2030. So as a business person occupying a property, or as an investor looking at buying a property investment (commercial properties are still popular as a purchase for pensions as they slip nicely into SIPPs) with the future rent increase uncertain, both sides need good quality professional advice. The main thing to be established is the percentage of turnover that is to be paid as rent. In order to do this, a full analysis of the business plan is required and this takes a different skill to analysing comparable evidence based on a floor area valuation. A good advisor (I know just the one!) can help on this. The secret however is to know the gross margin that any given trade is likely to earn and then also be aware of likely overheads for the business. For example, a jewellery shop or furniture shop may have a high gross profit margin (60% – 80%) but sales volumes will not be so high as a supermarket where the gross profit margin may only be 5% – 6%. The supermarket will have considerably more wage costs but the turnover will be considerably greater than the jewellers shop or furniture shop. It may not be public knowledge, all trades have a “norm” for trading within a defined floor area and with this, an industry standard gross profit margin range and wage cost as a p
