What lease issues should landlords be aware of with Clicks & Mortar tenants?

The recipe for retail growth used to be a simple concept. With one eye on the available customer market and retail location, it started with local high street shopping parades morphing into the out of town shopping mall behemoth experience that we are all familiar with.

This was the “build it, they will come” boom time model. When you combine advances in online shopping and a shift in consumer emphasis with the well documented economic turmoil, there has been a decline in the high street store that had only a physical presence before the advance of the internet, i.e. the bricks and mortar (BAM) model.

The economic downturn and some shock high street closures forced many out and out BAM retailers to re-evaluate their businesses, some realizing how unnecessarily bloated their offering had become, while others finally realised how ecommerce was taking a bigger piece of their pie. Some BAM retailers have chosen to ignore the impact of ecommerce on their business but many have seen this is as a “change or die” moment. Many retailers have reengineered their business to reduce fixed costs associated with the property, stock and staff and consolidated their property offering. Those retailers that have focused on understanding their customers have identified and reduced the markets, which are most vulnerable to online competition or have sought to develop new areas to exploit.

In recent years there has been a divergence between BAM businesses and online offerings. For years we have had mail order companies and the mass warehouse retail offering such as Argos, but now we are seeing the development of the “click and mortar” business, a business that sells products and services on the internet as well as from physical locations. Sometime this is by means of a simple “click and collect” service with products that may be collected from a physical location that may or may not be connected and branded like the internet seller.

From a legal perspective, this has thrown up a few issues that both landlords and investors (LAIs) need to consider when they are looking at new or existing property and letting them to tenants. Bearing in mind that tenants are now either seeking to adopt a new approach to their business or looking to build in the right level of flexibility to future-proof the lease, we consider below some lease elements that are likely to continue to change in the retail market:

Premises location and tenant consideration

A lower risk LAI strategy will focus on prime areas with historically lower tenant turnover/volatility. These are characterised by destination retail parks or centres with high-quality established retail occupiers i.e. those historic BAMs that specialise in customer experience or luxury goods that can command high pricing. Alternatively the tenant may be in a specialist market that is less exposed to competition from the internet.

A higher risk strategy embraces more fully the shift in consumer sentiment, but will require more intensive asset management and more flexible lease structures. At present these are more focused in secondary retail sites. Identifying and attracting good target tenants is harder but considering tenants from emerging technology markets , new concepts or those tenants that are looking to expand on a proven developed internet infrastructure with physical retail space may be a winning bet. This can include allowing part occupation of units by tenants to third parties operating click and collect services. If you consider Screwfix as an example, here was a predominately online building supplies company with limited retail outlets now expanding fast with a proven track record and strong covenant strength. Built on its online brand, it is now expanding physically. Many LAIs would have turned their nose up at this concept a few years ago.

Term length

Landlord and tenant relationships will come under increasing pressure as retailers rebalance their property portfolios with tenants seeking shorter leases or break options. As the “popup” or temporary experimental store formats become more common, there will be increasing demand for shorter and more flexible leases. For investors there is a balance to be struck between considering less certainty in tenant occupation length over voids in the current or short term.

Use

In circumstances where the landlord/investor is concerned about tenant mix or simply wishes to maintain a level of control, the use can be very tightly defined. In doing so, the landlord may restrict a tenant’s ability to adapt their business or restrict expansion by diversification. This may be considered short sighted. Permitting flexibility in use may permit tenants to expand into new fields or temporarily into the current “fad”. Initially “a fad” may not seem that attractive but if that short term approach in turn raises footfall at the physical location, this may be an approach that benefits a mall or shopping parade as a whole. Is it worth speaking with your tenants to see where they see their business going? A variation to an existing lease now may give them the scope they need to stay in business and keep paying the rent.

Turnover rent

Historically leases that reserve a base rent and top-up “turnover” rent have been a popular means in sharing in a tenant’s success. Leases with turnover rents may become less valuable to LAIs as multichannel retailers attempt to move sales online to adapt to new markets. LAIs need to consider their approach to new turnover rent leases to deal with technological sales. Poorly drafted turnover provisions may fail to capture online sales that are not physically located at the premises. Existing leases may be an issue for LAIs if they are old fashioned, do not account for the change in technology and therefore struggle to capture internet sales into the rent.

These lease elements are just some of the terms LAIs will need to consider in their approach and strategy in a changing retail market. It would seem flexibility is the key for both LAI and tenants alike. There are opportunities for both sides to take advantage of new concepts and opportunities but to do so may require a deviation from the tried and tested regime.

This article was written for, and first featured in Property News.