Will the rise of online sales cut both ways in retail leasing?

(Editor's Note: Reposted with permission from LeaseInfo Group.)

The rise in permanent store closures across the Australian retail landscape coupled with the prodigious growth in online shopping is creating mounting pressure for landlords to restructure rental agreements and potentially introduce more retail business risk into leasing structures.

Welcome to LeaseInfo Group’s first blog post for 2021. This week we will be exploring the lasting implications for landlords and retailers caused by the Pandemic and the creative solutions they are finding during these turbulent times in the retail leasing landscape.

Prior to 2020, Landlords were in the business of collecting rents for retail space, which attracted a lower risk than rents purely based on turnover. Australia experienced significant impacts from the Pandemic when large retailers such as Zara and H&M together with a slew of permanent store closures across the apparel and travel industries occurred.

The physical space left behind by retailers is also becoming harder to fill as retailers become more cautious in the current economic climate. Furthermore, with the Government financial assistance in the final months, risks on both the tenant and landlord side have now increased considerably.

Moreover, the decreased mobility of potential shoppers during the Pandemic lead to a surge in online spending, accelerating a trend that the industry had gradually been experiencing, with almost 15% of sales being conducted online in Australia in June 20.

This shift to online retailing left landlords searching for ways to break into the online sector and maximise the profitability of their physical space.

The new leasing structures that are now being discussed, link rent to sales in a way that impacts the base rent. Prior to the Pandemic, most retail leasing agreements had a base or minimum rent which was increased annually in an upwards only direction and then a turnover rent component above a turnover threshold.

There are 3 broad structures that link rent to sales as shown below:

Capped Occupancy Leases
Although this is not new, under this structure a retailer’s rent is capped at a total occupancy cost (usually net or gross rent to total sales) which limits downside risk to the retailer. To confront the escalating pressures, certain landlords are revisiting this idea proposed by certain retailers that was largely dismissed prior to the Pandemic.

This structure is being increasingly discussed in CBD retail, as large sways of office workers are still working from home, which creates significant downside risk for retailers who are reluctant to commit to a minimum base rent, given the uncertainty of their cashflows.

Cap and Collar Rents
This is a structure where the rent is based on a retailer’s turnover, however there is a minimum rent that cannot go below or above a certain level. This limits risks for both landlord and retailers.

Hybrid Occupancy Leases
This is where there is an agreement between landlord and tenant to base the rents on a in tenant’s sales in state plus a percentage of online sales.

In the United Kingdom, where online sales can account for more than 20% of a retailer’s total sales, Hammersons, a major retail landlord have announced plans for flexible turnover based leases plus an “omni channel top up rent” based on store performance and omni channel returns including the click and collect performance at a store or footfall from showrooms.

So far in Australia, retailers have flatly rejected providing their online sales to Landlords, not to mention offering these as part of their rent. Time will tell whether these new types of structures will be adopted by the retail leasing sector.

One thing is for certain, change is inevitable.