Reduced footfall in malls and highstreets in changing the way commercial leases will operate.
New York, London, Paris, Milan; all major cities renowned for their fashion industry and high end stores. But with in-store shopping at a standstill since almost year, the prime real estate of Bond Street, 5th Avenue or the Champs Elysees is becoming a major drag on retailers’ balance sheets.
What cases have been challenging this relationship in the past few months? What are the key considerations that both parties will have to look for when negotiating their future contracts?
Two blocks down from Trump Tower, the elegant, Valentino store is now panelled with wood and closed to in-person customers. As the rent averages $2,513 per square foot from when the lease began in 2013, the italian designer has filed a lawsuit to get out of his 16-year lease with landlord Savitt Partners LLC, 9 years early.
In its lawsuit, Valentino said shoppers have grown fearful of “in person, ‘non-essential’ luxury retail boutiques,” and that “even in a post-pandemic New York City (should such a day arrive)” the Fifth Avenue location was irreparably damaged. Thus, keeping the store open has been “substantially hindered, rendered impractical, unfeasible and no longer workable,” for the company.
In another recent lawsuit, Stella McCartney is also pushing back on the rent issue. The brand filed a counterclaim earlier this year against the sub-landlord Mallett Inc., which has been subleasing the store on Madison Avenue in NYC. Stella McCartney, which hasn’t paid rent since March 2020, stated that Coronavirus impact “eviscerated” Madison Avenue shopping and voided the sublease. Mallett claims the brand owes it more than $1 million in current past-due rent, and wants payment of more than $9 million for future unpaid rent.
The truth is, even before the pandemic, brands already had a complicated relationship with their brick-and-mortar stores. Customer habits had changed, outgrowing traditional retail approaches though brands still needed an in-store experience to convey powerful story-telling. The pandemic has catalysed changes in consumer behaviour and boosted e-commerce; brands with a strong store presence have suffered as a result. The most recent example is the high street giant Arcadia Group (owners of Topshop, Dorothy Perkins) which has been bought by online-only ASOS.com.
When negotiating rental agreements in the future, turnover rent clauses (or percentage rent as it is called in the United States) will become a key consideration for both landlords and tenants, as high street and premium fashion retailers have seen a downside that landlords haven’t yet taken into consideration.
Turnover rent is a term designating a situation where the landlord takes a percentage and a base rent, instead of a more conventional and inflexible model. Several representations are available, the most common one for fashion retailers being a fixed based rent from 75% to 80% and a flexible amount from around 20% to 25% of the monthly rent.
Turnover rents, already heavily used in outlet villages (such as Bicester Village) and airports stores, raises a certain number of questions including: how to calculate the turnover? Is in store click and collect included? What if the item is tried on in the store but bought online? What if the store is only a showroom? To what extent can one include online sales in a turnover rate?
Finding a balance between fixed rent and flexible turnover is thus crucial for both parties. By the exact nature of the transaction, the landlord’s assets are unsure and will certainly contribute to some discomfort on the landlord’s investor’s side. Therefore, negotiating a substantial base minimum will be key. On the tenant’s side, installing segments of an open market rent (approx. 6 times during the lease currently) where the rent is re-negotiated will be requested.
In addition to this, being open about the retailer’s financial health and accounting will be at core of the negotiation. The landlord must be able to trust the tenant’s income disclosure and on the landlord’s side, keeping strict confidentiality and commercially sensitive information undisclosed. In a nutshell, much will depend on the landlords and tenants being open and willing to make this form of relationship work.
In addition to retail, we can see turn over rent being transposed in the future to restaurants, hotels and office spaces as other sectors of real estate market reflect that changing demand.