A new lease on leases?

1 May 2017 , 10:19am

You walk in front of Chanel’s display window several times eying the purse. You get something to eat and walk by again. It seems to beckon you as if by a magical string. You give in and walk into the store. Encouraged by the eager sales person you try it on. The sales person prods you, pushes you, tells how this is so "you". You touch it, feel it, smell it. Then with a gasp from the sales person you turn on your Louboutin heels and walk out. You then go home, take your heels off, open a bottle of a fine wine, go online and search for the same purse in different stores, looking for different colors and maybe better prices. If you are also a player in the new shopping experience, you will identify with this scene.

This new shopping experience has had a huge impact on the retail fashion industry. Even luxury retailers who were resistant have moved online. It is a well-known fact that in the United States hundreds of shopping malls have closed their doors because of the changes in shopping and driving habits of people.

In the wake of this trend lease agreements have become more challenging.

Traditionally, Brazilian mall leases provide that tenants must pay the higher between a minimum agreed rent or a percentage of the profits of the store.

The fixed rent guarantees the landlord a minimum income and is annually adjusted for inflation.

The percentage rent is based on the assumption that the mall has attracted consumers to shop, which in turn generates more profit for the stores. This enables both landlords and tenants to share the risk of market fluctuations, without burdening either party.

In Brazil, different from other countries, the landlord must comply with the full term of the lease except in case of breach by tenant. If tenant pays the minimum rent but performs poorly, the landlord will not be able to terminate the agreement by law.

The percentage rent is an important component of the landlord’s compensation. They have seen their incomes plunge with shopping becoming Omni-channeled, not only because in-store sales have gone down, but also because it is difficult to track down the origin of the sales to determine exactly if and which of the brick-and-mortar stores had a hand in the sale.

Many lease agreements in Brazil already entitle the landlord to audit tenant’s books and records upon notice. However, online sales are not posted to the physical store and the auditing of only the books and records of the stores is not sufficient enough to track down their influence on online sales.

In addition to the purse case above, there are several other examples of codependent sales between physical and online channels: a costumer may take delivery of an on-line purchase in-store, or return/exchange in-store a good purchased on-line, or purchase online in-store. The costumer can also buy online without ever even visiting the retail store.

There is currently no specific legislation to rule the treatment of online sales. Therefore, lease transactions must comply with the Brazilian Lease Law[1] and with the respective agreement. The Lease Law allows tenants and landlords to freely agree upon the basis of the rent.

However, a recent case in Brazil ruled against a department store, which had been selling online inside the store, but invoicing from another entity. The judge determined the eviction of the store for breach of the lease agreement. It ruled that any sales closed within the store, including those online, should have been considered in the calculation of the variable rent.

This subject will have to be consolidated in the Courts. In the meantime, tenants and landlords will have to devise an agreement on new lease terms, taking into consideration that Omni-channel sales are essential to the survival of tenants but physical stores are still very important for all players, including consumers.

There are several available rent provisions that could be considered to address the concerns of the market players:

(i) variable rent on the profit from any sales that relate to the physical store in any way at all, including in-store online purchase and one where the costumer buys a product online outside the store and the product is shipped from, picked up at or exchanged within the leased store;

(ii) two variable rents, one from online in-store sales and typical sales in-store, and a different percentage for products bought online outside the store with the product shipped from, picked up at or exchanged within the leased store;

(iii) a reasonable flat rate rent that compensates the owners without burdening the retailers.

For alternatives (i) and (ii), new mechanisms will have to be created to measure the impact of the physical store across all sales channels. This will depend not only on the development of new tracking and reporting systems but also on the revision of the auditing process.  

Such mechanisms will empower the landlords with more data to more accurately determine the variable rent due.

Some Brazilian retailers have used a very simple method that could help to determine the influence of individual stores and salespeople on online sales: discount coupons are given in-store by the salesperson for online shopping. The newly to-be created systems could use this as one element to track down online sales influenced by the physical store.

The Brazilian market has already felt the effects of this disruption. Many banks have closed branches after a workers strike showed that people could live without so many physical agencies, because consumers already massively use online services.

But Brazil is still far from the case of The United States. Many Brazilians are still wary of shopping online, or they do not have the means to do so. They ultimately still prefer to buy the Chanel purse in the store and bathe in the full in-store shopping experience.

[1] Law N. 8,245, from October 18, 1991.