As e-commerce sales have skyrocketed over the past year, with consumers shunning brick-and-mortar stores in light of the enduring consequences of the COVID-19 pandemic, there is a growing and largely “contentious” issue at play between landlords and their commercial tenants – one that brings the meaning of an in-store sale under the microscope. A seemingly straightforward inquiry, the issue is coming to the fore as a growing number of landlords aim to include contract provisions in new – or newly-renegotiated – leases that enable them to share in the sales that take place on their tenant retailers’ e-commerce sites on the basis that there is an important link between stores and online sales.
The inclusion of potential new contract terms that enable landlords to take a piece of retailers’ digital sales comes as the real estate industry is influx: landlords and tenants – operating in the midst of a starkly-changed, post-COVID retail landscape – are renegotiating lease terms, and in at least some circumstances, are facing off in court over lease-specific battles due to COVID complications. With enduring lockdown measures and a bigger shift away from brick-and-mortar stores at play, foot traffic to even the most esteemed shopping streets and centers in the world has fallen significantly, thereby, shifting the power in the leasor-lessee equation in many situations, and generally leading to a rise in the adoption of new contract terms. Among some of these changes are the adoption of COVID-19 clauses aimed at specifically addressing and mitigating new risks, the offering-up by landlords of shorter commercial leases, and the adoption of turnover-based leases, ones that link the revenue a company brings in from the space it leases and the rent it pays.
“Most commercial leases are structured in a way where tenants pay a fixed amount of rent throughout the term, subject to periodic upward-only rent reviews, either by reference to open market rent or to a [real estate] index,” according to DAC Beachcroft attorney Ricky Takhar. However, there has been a rise in the adoption of turnover-based rent over the past year as a result of the effect of the pandemic on the retail market.
Turnover-based rent is not a novel approach, and in fact, has proven to be a compelling option for landlords and commercial tenants in certain situations that pre-date the pandemic. At least some big-name tenants in Miami’s upscale Bal Harbour mall, for instance – which is home to the likes of Alexander McQueen, Chanel, Gucci, Stella McCartney, Oscar de la Renta, Prada, Neiman Marcus, and Saks Fifth Avenue, among others – maintain this type of rent arrangement, which “encourages and facilitates data sharing and collaboration as landlords work with tenants to promote the overall shopping experience” in a certain area, Takhar says.
“The use of turnover rent ultimately means that both parties to the lease have an interest in ensuring the success of the business operated from the premises,” Herrington Carmichael LLP’s Steph Richards states, an approach that makes particular sense in a shared space, such as a shopping center. But this model is increasingly moving beyond malls in the wake of the pandemic. The Wall Street Journal recently reported that Italian fashion retailer Pinko signed a yearlong sublease in New York’s SoHo neighborhood that will see it pay either $30,000 a month or 15 percent of sales, whichever is greater, in furtherance of a modified play on a traditional turnover-based rent deal.
While the turnover-based rent approach may be catching on, it is being modified – and not just in the way that the Pinko lease demonstrates. In the past, turnover rent operated in accordance with a strict church-and-state separation. The sales subject to the lease’s percentage rent terms consisted exclusively of ones that took place within the leased space. However, when the pandemic hit and e-commerce sales exploded (at the expense of brick-and-mortar sales), landlords went back to the drawing board. Now by some estimates, “up to 80 percent of leases being renegotiated or signed post-COVID include blanket online sales clauses,” the Sydney Morning Herald reported in March. The WSJ has since revealed that such terms are creeping into contracts in the U.S., with Simon Property Group Inc. CEO David Simon saying that in-store experiences are not exactly irrelevant when it comes to driving online sales. “If the store interaction is important” – and that is certainly the prevailing logic, “We don’t want our sales to be reduced because the store is providing a service,” Simon told analysts in February.
“The push to include online sales in lease agreements has loomed for some time,” per Sydney Morning Herald’s Simon Johanson, but it is “swiftly accelerating” now as brands are being forced to embrace an omnichannel retail model – and fast – in order to stay afloat.
E-commerce sales are expected to even out as vaccines become more readily available, and retailers clamor to provide consumers with new, in-store experiences in order to lure them back into brick-and-mortar stores. With that in mind, S&P Global asserted in March that “e-commerce has been moderating for a couple quarters now,” and post-pandemic retail is likely “going to be more balanced between physical store sales and e-commerce.” The publication notes that “nearly 50 percent of consumers surveyed by 451 Research in the first quarter [of this year] said they plan to ‘immediately’ start shopping at retail stores once COVID-19 restrictions are lifted, and another 22.7 percent said they will start spending in stores within three months after restrictions lift.”
Even amid a potential balancing of the marked spikes in e-commerce sales as the market moves to a “new normal” in the wake of COVID, the new push to consider digital sales in connection with a physical outpost inevitably raises a host of hard questions. For instance, the WSJ’s Suzanne Kapner and Esther Fung ponder, “If an order is placed online, but picked up at a store, should that count as an e-commerce sale or a store sale? Or if an item bought online is returned to a store? If online sales increase after a store opens, are landlords entitled to a portion of e-commerce sales within that store’s ZIP Code?” These are the things that landlords and tenants’ lawyers will be grappling over – if they are not going back and forth about them already.