Like so much else in the retail sector, the pandemic has accelerated existing trends in the retail property market. Retail Week looks at the actions taken by landlords Hammerson and the Crown Estate, and what they mean for the future of the industry

  • Coronavirus crisis could mean the end of upwards-only rent reviews
  • Turnover-based lease agreements on the table for more retailers
  • Landlords such as Hammerson want to rebase rents to a more affordable level
  • Retail property values will be lower in the short term but bounce back

When the UK was plunged into lockdown and non-essential retailers were forced to shutter stores, the blow did not just fall on the brands. 

With the majority of their occupants losing store revenues, landlords were lucky if occupants agreed to quarterly rent deferrals. Due to the government’s moratorium on forced evictions, many occupants simply refused to pay rents at all. 

Combined with the structural changes that were already sweeping the sector pre-coronavirus, and a fresh wave of closures and estate rationalising spurred by the pandemic, landlords are increasingly realising that existing rental models are no longer fit for purpose.

This dawning realisation has been best highlighted by decisions in recent weeks from two different landlords: the Crown Estate and Hammerson. 

Both have made moves to offer struggling tenants more flexible leasing agreements to keep their sites and stores occupied. However, while both have taken progressive steps as a result of the pandemic, neither have done so out of pure altruism.

Hammerson, like many shopping centre landlords, has been badly hit by falling rental incomes. As a result, it announced this week it would be looking to raise £825m through fundraising and selling assets to offset its spiralling losses. 

What do these landlords tell the sector about the future of retail property? 

Union Square Aberdeen

Hammerson is trialling a performance-based top-up system at Union Square in Aberdeen

1. Death of upwards-only rent reviews

The coronavirus may finally herald the beginning of the end for upwards-only rent reviews, driven by a mixture of market forces and an understanding that the dated method no longer properly reflects store values. 

Traditional leasing practices for shopping centres were based on comparative models. If retailer A has been paying £100 per square foot for the duration of a lease and, during that time, retailer B moves in next door at £120 per square foot, at the next review retailer A would be compelled to match that. 

Hammerson managing director of the UK and Ireland Mark Bourgeois says upwards-only rent reviews have been a key reason for the relationship between landlords and occupiers becoming ever more adversarial. 

“We want rents being rebased to an affordable level… historically, many shopping centre landlords will set the rents at the highest level that an occupier can pay”

Mark Bourgeois, Hammerson

Following a bruising last 12 months and more, Hammerson announced it would scrap upwards-only rent reviews to focus instead on what Bourgeois says will be base rents. 

“We want rents being rebased to an affordable level. It sounds pretty obvious but historically, many shopping centre landlords will set the rents at the highest level that an occupier can pay,” he says. 

“Instead, we’ll have a base rent. It’s affordable and index-linked to give an element of growth for us but on a predictable element, both for us and for the occupier.”

A number of other institutional landlords, including giants Landsec and British Land, have also said since the coronavirus pandemic and even before, they have been renegotiating and reviewing rents on a case-by-case basis to better support occupants. 

Upwards-only rent review clauses have also been kiboshed by retailers such as JD Sports and Zara, which have looked to remove such stipulations in renegotiations. 

2. Turnover-based rents and beyond

The Crown Estate last week wrote to tenants across its properties in London’s West End, offering to share the pain with its struggling retail and hospitality occupants, by agreeing to accept lower rents while trade remains at pre-coronavirus levels. 

In one letter, the landlord asked for 9% of turnover as a percentage of what it would normally receive in quarterly rent. This was based on a sliding scale starting at 0% for the current period and rising to 75% by next March.

Turnover-based rents have long been desired by many retailers given the growing penetration of ecommerce and declining footfall. 

While turnover-based lease agreements have long been in the arsenal of stronger retailers such as H&M and the Inditex brands, they have historically been beyond the bargaining power of smaller names. 

What is clear is that many landlords are changing with the times. Where they lead, others will follow

Bourgeois says this is changing and some landlords will go even further. 

“We’re looking to introduce top-up payments based on performance. So there will be an element of turnover but what retailers want from us as landlords is to drive footfall. So we’re exploring rents based on footfall,” he says.

Hammerson has launched a pilot scheme including this performance-based top-up system, at its Union Square scheme in Aberdeen. 

With its sprawling continental portfolio, Unibail-Rodamco-Westfield has been ahead of its UK landlord competitors when it comes to turnover-based leases. This model offers Westfield more opportunities to monitor occupants performance and gives it freer rein to remove tenants who are not performing as they should. 

London’s Covent Garden owner CapCo has also been offering occupants flexible leases tied to store turnover as a result of the coronavirus with such agreements set to last until at least the end of the year. 

St James London

The Crown Estate agreed to lower rents while trade remains at pre-coronavirus levels

3. Rental rebasing

Connected to all this is the overall rebasing of rents. Again, with the issues that beset the high street prior to coronavirus that have been exacerbated since, landlords say rents have been falling organically for years. 

However, for Bourgeois, there is still further for them to come down. He says rents have fallen 42% in UK shopping centres from their peak to the present trough and those can still come down by as much as 15%. 

Ultimately, Bourgeois says Hammerson wants to rebase rents to a more affordable level. “By gearing a base rent and reducing that base rent to affordable levels, down about 15% from where they are now, we can clearly hold a base rent that’s sustainable which works for us and the retailer,” he says. 

Instead of one set rent for every occupant in a centre, Hammerson wants to move to a system where different retailers on the same scheme pay different base rents. This would be predicated on a host of factors such as store performance, brand awareness, click-and-collect sales and even wider online catchment area sales. 

He uses Peloton as an example. “It sells bikes from our locations but it’s also a real brand builder for it. Some operators may rely more on sales in-store and their operating margins will be different,” he says. 

“We want to get underneath every retailers’ models and match the true value of that store to that occupier.”

Bicester Village 2020

Prime locations such as Bicester Village have been hit by the lack of tourists to the UK

4. Impact on property valuations

Historically, one of the main reasons given by landlords for not adopting turnover-based rents is the effect it would have on property valuations. 

To put it simply, historically, retail property valuations have been set based on income projections in terms of what they will generate from rents, versus the cost of the property, which is called yield. 

When the fixed income becomes harder to project, because of a move to turnover rather than set quarterly base rents, for example, valuations come down. 

While the changes discussed above will all serve to no doubt lower retail property values in the short term, Bourgeois is confident that in the medium-to-long term, valuations will not only recover but become stronger. 

“What we see going forward is that we’ll have established a base of affordable, sustainable and growing income linked to the success of our occupiers,” he says. “The fact you have six-year breaks is not something our valuers would say is a disadvantage. It’s already a model in place in continental Europe and premium outlets.”

While more flexible leasing structures, no upwards-only rent reviews and lower base rents coupled with performance-based top-up payments may be music to the ears of retailers, the question remains how long will the sector take to readjust? 

The steps being taken by the likes of Hammerson and the Crown Estate stem, at least in part, from desperation due to tumbling rental incomes and shattered property valuations. They also fly in the face of decades, if not centuries, of previous leasing best practice. 

Bourgeois says while it would not make economic sense for the landlord to restart all existing agreements on day one, he says Hammerson’s portfolio will have moved across to its new leasing structure entirely by 2023. 

The Crown Estate has extended its offer of turnover-based rents until next March. But, once agreed, it seems unlikely it will completely reverse course.

What is clear is that many landlords are changing with the times. Where they lead, others will follow. Perhaps only a few at first, but as occupiers begin to grow more accustomed to such flexible deals, demand will only grow.