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Percentage Rent Leases Are Coming, With Lots of Questions

Posted by: | Posted on: October 1, 2020

COVID-19 has accelerated many dramatic trends in the retail industry. One thing has become clear: If many retailers are to survive, their rent structures may need to change.

One idea gaining traction is percentage-based leases, where the retailer pays a minimum rent and a percentage of its sales in rent.

Traditionally, landlords have been against percentage rents because they rely on the certainty of income, which affects their valuations, Tom Whittington, director, retail and leisure research at Savills, tells S&P Global Market Intelligence.

“The new agreements we have been seeing put in place over the last four months are not necessarily intended as a permanent fixture by landlords, but more of a way of navigating the current challenges in the sector,” Whittington told S&P.

But others think there need to be permanent changes in lease structures. “The pandemic has highlighted the need for many leases to have a greater degree of flexibility to accommodate significant business interruption better,” according to Omar Eltorai, market analyst at Reonomy.

If there is widespread adoption, some questions need to be answered, including which sales should be included in the retail calculation. Should it be the transactions in the brick-and-mortar store? Or should online sales also be included in the analysis?

As omnichannel sales strategies grow more popular, the breakdown between online and brick-and-mortar stores is becoming blurry. For instance, retailers let consumers return items bought online in their physical stores.

Nick Gardner, executive director, head of advisory and transactions, UK retail, at CBRE, tells S&P Global Market Intelligence that the retailer needs to “acknowledge what the role of the physical store is in rental terms alongside click-and-collect, online returns, brand enhancement and the halo effect on online sales.”

While retailers generally have thin margins on online sales, there is evidence that physical stores can increase that revenue, according to The Wall Street Journal.

The WSJ cites a study by the International Council of Shopping Centers that says a brick-and-mortar store in an area can increase traffic to the retailer’s website by 37%.

The effectiveness of percentage leases also depends upon the type of retailer. S&P’s Cathal McElroy writes that fashion retailers have been most likely to ask for adjustments to their lease. Additionally, she says leisure and food and beverage operations fit well into the percentage structure because the property’s relationship to the sales generated is more direct.

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