Fashion giant H&M is reported to have challenged the status quo last year with a hefty set of lease demands. How will landlords respond?

H&M wants UK lease terms similar to those it has in mainland Europe

Retailers have been on the front foot in terms of lease negotiations for some time, but Swedish fashion giant H&M is understood to be taking this to a new level with a list of tough new demands for UK landlords.

The fashion retailer is asking for terms similar to those it obtains in mainland Europe, a push that is understood to be driven by a sense at H&M’s head office that compared with its continental counterparts, UK shopping centres are inefficiently managed.

H&M’s new demands include reducing the amount of rent it would pay if 15% of a shopping centre it occupies falls vacant. If this were to happen H&M would immediately cease paying the base rent and would revert to simply paying the landlord a turnover-linked “top-up” fee.

The fashion retailer is also stipulating that if the vacancy rate of a centre remained at 15% or rose over a set period, it could further reduce its rent, regardless of whether its turnover stays the same or increases.

Ultimately, H&M could then terminate the lease if it still wasn’t happy.

Another clause states that H&M wants the option to abandon a lease immediately if other footfall drivers, such as Next and Topshop or an anchor department store such as Debenhams, leave a shopping centre.

There is no doubt that H&M’s demands have put the cat among the pigeons around the property sector, but they need to be seen in context. The UK has always adopted a different lease structure to mainland Europe, with much longer lengths of up to 25 years.

The relatively short 10-year leases that are now commonplace in the UK have been in operation at such durations, or even shorter, for many years in Europe.

As a global operator, H&M is already able to secure leases containing such clauses in other markets and it now wants to impose the same strictures on its UK store portfolio. But for UK landlords, the demands may prove hard to swallow.

Patrick Keenan, director and head of retail representation at property consultancy Lunson Mitchenall, describes H&M’s proposal as “interesting” but he doubts that other retailers will make similar demands. “My concern would be that the terms are so complex that the retailer may find itself not getting access to the best sites,” he explains.

“That said, across the board heads of terms have become far longer and more exhaustive in recent years, with most of the innovation coming from the fashion industry.”

For landlords the bugbear is risk - H&M’s demands skew risk heavily back towards shopping centre operators - but there is also concern about the more technical aspect of valuation. If a centre’s income is viewed as unstable or uncertain then its valuation will be lowered, and that has big implications for the centre.

More movement

All parties are looking for increased flexibility in terms of shorter leases and more break clauses, says Dominic Rodbourne, head of out-of-town retail at property agent Savills. “At the moment, we are seeing few clauses being enacted but for landlords it is difficult as it has an impact on valuations. Those break clauses involve different types of timings and each retailer tends to have a tactic.”

Rodbourne also points out that covenants can change dramatically over relatively short periods. “The strength of a retail covenant can be leveraged by retailers but it is worth considering that is not set in stone,” he says.

“A few years ago many landlords were probably concerned about Dixons but Comet - as part of Kesa - looked rock solid. Just look at how that has turned around. So retailers need to keep in mind that their negotiating position will not necessarily improve over time.”

Mark Bourgeois, managing director of developer Capital & Regional, warns that increased uncertainty is no good for landlords of shopping centres or the retailers that occupy them. He maintains that “unreasonable demands”, and particularly the strictures of the Landlord and Tenant Act, under which many leases fall, are now hampering the ability of shopping centre landlords to make the sorts of decisions that will keep a centre vibrant.

Leases do not have to adhere to the Landlord and Tenant Act - most shopping centres include a mix of tenant leases inside and outside the Act and the preference often comes down to individual negotiating positions.

However, more protection is afforded to tenants whose leases do fall under the Act. For example, if a landlord offers a deal to bring a new retailer into a scheme, incumbent retailers at lease end could use that to force a reduction.

Bourgeois adds: “There are two themes that come out of this: one is flexibility and the other is whether a lease is inside or outside the Landlord and Tenant Act. I think on the latter we are at a tipping point because of the way it is impacting landlords and their ability to be creative to keep shopping centres buoyant.”

For Dan Simms, partner at property consultant Briant Champion Long, there is far more flexibility in shopping centres than on the high street. For example, he says, a large multi-let shopping centre in single ownership has more “elbow room” to grant shorter leases because it has less of an impact on the centre’s overall lease expiry profile.

“Shopping centre landlords are able to put bigger incentives together to attract the right retailers and they can be more strategic, with typical incentive packages running at 12 or 13 months,” he explains.

He observes that the continued use of turnover leases, in which the rent payable is linked to a retailer’s turnover, as a further sign of the flexibility open to shopping centre landlords. He says: “They are rarely granted on the high street or on retail parks, but they continue to feature in more than a third of the shopping centre lease transactions analysed by research we have carried out.”

Right place, right store

The location of a centre also has an impact on what retailers can and will demand. Miles Dunnett, head of the Grosvenor Liverpool Fund, says: “Going into 2013, I feel there is a little more realism in the market, especially for the stronger locations. Ultimately retailers want to be in the best locations and they are pragmatic about what they need to do to achieve that. They want the best deal but they also know which sites they really want.”

With a lack of a pipeline of new shopping centres, CBRE research director Jonathan De Mello warns that retailers need to continue focusing on location. “It is a delicate balance,” he admits. “Obviously retailers want the best deal but there is also the issue of brand equity. Retailers need to focus on securing the right locations and the right stores - especially as there are less markets they want to trade from now.”

The current climate favours shopping centres that are able to offer retailers large flagships, but Bill Giouroukos, director of operations at Westfield, notes that requirements are constantly evolving. He says: “We see cycles come and go and as a landlord it’s about being reactive and trying to provide the retailer with the space they want in the location they want, so that’s about creating strong fundamentals and then building in flexibility.”

At Westfield centres, leases are staggered, varying in length and deals are a mix of inside and outside the Landlord and Tenant Act. Pop-ups shops are used as part of the marketing strategy. “It’s about balance,” Giouroukos says. “A landlord wants to keep their centre fully-let but it’s vital to focus on the tenant mix, even if that is changing all the time. Pop-ups don’t have to be stores, they can be in common areas and used as incubators for emerging, cutting-edge retailers.”

Bourgeois maintains that good landlords have been providing a higher degree of flexibility since the downturn in 2009, when a lot of retailers went into administration. “The most important thing for a shopping centre is to keep as many stores trading as possible and if that means doing deals to let a retailer trial a location then, as landlords, we have to be proactive and pragmatic, because it helps everyone,” he adds.

“We’ve also used pop-ups as part of that flexibility and where units have been regularly and consistently rotated we are now seeing valuers recognising that consistency, albeit that the leases are temporary, and valuing it as income, which is a strong step in the right direction.”

The Landlord and Tenant Act is believed by some to stifle such creativity. Bourgeois says: “Under the Act, retailers have security of tenure and at the end of term the rents have to be proven if there is disagreement between landlord and retailer. Ultimately, this is decided by the court and the court’s decision bears no relation to rent affordability.”

For retailers, being able to renew a highly profitable store at “market rent” while retaining the right to offload underperforming shops is clearly a bonus - it provides much needed flexibility. But whether it does much to help declining town centres is yet to be seen.

Shorter leases boost flexibility for retailers

The UK’s long leases have always been seen as an anomaly by the rest of Europe, especially when 25-year leases were the norm.

In dropping down to a more typical 10 years, the UK has aligned itself more closely with mainland Europe, although UK leases remainat the longer end of the continental benchmark. However, for the first time there are signs that the 10-year median is being breached.

Dan Simms, partner at Briant Champion Long, notes: “According to our analysis, for the first time average lease lengths have dipped below 10 years to 9.9 years. We will have to wait and see whether it stabilises or continues to fall but 10 years has been the benchmark for a number of years.

“Within that, the number of break clauses, typically at five years but with some variation, have also become commonplace.”

He adds that a five-year break clause was in included in 46% of leases in 2009 but that shot up to 62% in 2010. It dropped back to 50% in 2011, where Simms thinks it will remain. Similarly, turnover rents peaked at 39% of transactions in 2009 but have declined to 31% for 2012.

Patrick Keenan, director and head of retail representation at Lunson Mitchenall, adds: “The lease length had been drifting downwards even before the 2008 crisis and the general assumption now is 10 years, with an increasing number of retailers requiring break clauses at five years, which normally come with a six-month rent penalty if exercised. A huge variety remains, and what can be achieved depends on the location and the retailer.”

He points to River Island in Leeds as an example. “It wanted a break clause to provide it with options, given the number schemes being developed there.”