Struggling businesses target rents to ‘turn over a new lease’

GENERATION RENT: Jonathan Amor, a restructuring and insolvency partner at UK top 10 accountancy firm Azets in Yorkshire, says more businesses in retail and hospitality may seek alternative rental models

GENERATION RENTS: Jonathan Amor, a restructuring and insolvency partner at UK top 10 accountancy firm Azets in Yorkshire, says more businesses in retail and hospitality may seek alternative rental models

Deteriorating high street trading may spark greater calls for ‘turnover rents’ from hard-pressed retailers faced with cutting costs or shutting up shop.

Jonathan Amor, an insolvency and restructuring partner at UK top 10 accountancy firm Azets, said: “Retailers and restaurateurs, especially SMEs, are running out of options for survival.

“Poor trading in December capped another challenging year for the sector. Recently released figures from the Office for National Statistics made grim reading with a record fall in the sales volumes of goods sold over Christmas, down by 3.2% month on month, the largest monthly fall since January 2021, and 2.4% year on year.

“Meanwhile, latest statistics from The Insolvency Service showed that in 2023 registered company insolvencies stood at 25,158, the highest annual number since 1993.

“The structural shift in retail from bricks and mortar to online has accelerated post pandemic while costs have soared, fuelled by record high inflation last year and rock-bottom consumer confidence. This has resulted in greater financial distress for retailers as well as for those in hospitality.”

According to the British Retail Consortium, the total value of retail sales is £436bn annually, of which 26.6% is online. It says that retail accounts for three million jobs, about 8-10% of the working population. It estimates that there are approximately 400,000 wholesale and retail registered businesses in the UK.

“Retail is more vulnerable than many sectors, especially for SMEs, where 11 months of the year can be loss-making with the business reliant on a buoyant Christmas. If they have suffered a challenging December then they can pay the price for the rest of the year, and especially in the traditionally quiet first quarter,” Jonathan added.

“Pressure is now growing amongst some retailers for so-called turnover rents or revenue leases to ease their fixed costs and overheads while providing much-needed financial headroom.

“As its name suggests, this type of alternative rent model is calculated by reference to turnover generated at a property rather than on the traditional agreement where a fixed or monthly sum is paid to a landlord.”

Typically, a tenant will pay a discounted base rent below market prices plus a turnover rent on top, calculated as a percentage of gross turnover although exact agreements can vary.

Turnover rents have also been increasingly adopted as instruments in the restructuring of business, especially within company voluntary arrangements (CVAs) and more recently Restructuring Plans.

The Restructuring Plan was introduced by the Corporate Insolvency and Governance Act 2020, legislation accelerated as a result of the COVID-19 pandemic.

A Restructuring Plan is similar to a CVA but with the advantage of the ability to ‘cram down’ dissenting creditors of the process.

Seventy-five per cent of creditors need to agree to a CVA and often the creditors with the least economic interest in the process can frustrate the implementation of a CVA.

A Restructuring Plan on the other hand can be approved by the Court even if a class of creditor votes against the plan provided at least one class of creditor that has an economic interest in the process approves the plan.

This ability to cram down is potentially an extremely powerful process for restructuring viable companies.

There are recent examples of the use of both of these processes.  Retail giant New Look proposed the introduction of turnover rents for more than 400 stores in its CVA of 2020 and the Virgin Active Restructuring Plan of 2021 approved by stakeholders amended existing leases to move them to a combination of turnover based rent, reduced rent or in some cases rent free depending upon the strength of the trading from each site.

Jonathan said: “In the face of diminishing cash flow, the mounting up of historic debt and continued costs pressures or even the risk of an insolvency or restructuring process, a turnover rents arrangement may seem the obvious answer to many in retail and hospitality.

“In theory, it provides the opportunity to create a symbiotic relationship with a shared risk and reward model for landlord and tenant.

“It can reduce one of a tenant’s most significant overheads and allow it continue trading, while for the landlord it can mean that a property remains occupied with at least some rental return and the prospect of an uplift in future if revenues rise.

“Clearly some landlords, particularly institutional investors, may be reluctant to commit or unable to do so under agreements with their own lenders.

“Agreements need to be watertight to avoid potential disputes but they do give hard-pressed retailers and restaurateurs greater scope to keep trading rather than shut up shop.

“I expect to see such alternative rent models adopted even more frequently, including within CVAs and Restructuring Plans, in the future as the high street continues to transition and face an uncertain future.

“Other issues clearly need to be addressed to ease the pressure on the sector, especially in relation to fundamental reform of the business rates system which is no longer fit for purpose.”

Jonathan also urged businesses in retail and hospitality to keep a forensic watch on cash flow.

“Cash is king, especially for SMEs or boutique traders which specialise in certain sectors or product lines rather than the leading national chains which sell across the board.

“SMEs are more likely to struggle as they do not have the cash reserves when bumps in the road come along, especially during the first quarter of the year.

“If a business hasn’t already, it is critical to put cash flow forecasts and monitoring in place or instruct an accountant to provide support. Keep an eye on what is going out of the door and what the creditor position is. Holding on to cash as much as possible is the number one message.”

Jonathan added: “The threat of a winding-up petition from HMRC is often the trigger for businesses to get to grips with their finances or seek help.

“By then it can be too late, so gaining advice or support as early as possible when financial distress appears is absolutely key.

“This means there will be more options available. Initial conversations are always free of charge with a reputable and qualified insolvency and restructuring professional.”

ONS said the volume of overall retail sales volumes fell by 2.8% in 2023, putting them at their lowest level since before the pandemic.

Azets newly published January business Barometer for the UK shows that economic uncertainty is a significant worry while individual firms are cautious about their own financial performance. .