Rent in retail leases is usually calculated as a percentage of sales, but online sales are muddying the waters.
We are told that only two things are certain: death and taxes. But for retailers there is a third, and that's rent.
Rent has always been a significant operating expense for retailers - in Australia typically the second largest after labour. However, an increasing number of retailers are transacting sales in a manner that uses their bricks and mortar differently from the traditional sales process, wherein the customer walks into a store, inspects the merchandise, pays and takes it home.
Now, with omnichannel payment systems, retailers are gearing up to use their stores as pick-up points and fulfilment centres for sales made through e-commerce, making it very difficult for some kinds of transactions to be pinned unambiguously on a specific store location.
This is a spanner in the works if you're the rent collectors, who want to ensure that they are harvesting the true rental value of the physical stores they are leasing. The issue has the potential to become a major irritant between tenant and landlord, who are not exactly good buddies at the best times.
How exactly does the problem work?
Rent in retail leases is usually calculated as a percentage of sales, provided those sales exceed a particular level called the “break point” or “turnover threshold.” In the current Australian retail environment many retailers are not achieving the threshold level of sales, meaning that they just pay a fixed minimum or “base” rent.
However, as times get better the chances of exceeding the threshold improve and that is when sales made through non-traditional channels have an impact on rental income.
Take, for example, the retailer who is set up to allow a customer to buy from its e-commerce site and pick up the merchandise in the store. The financial transaction has occurred online but the store has still “touched” the sale because it is the place where the goods are actually collected by the customer. Even if the items are not originally held in the store itself but shipped there from a warehouse, which is common, the store is still integral to the sale process.
In another twist on the same theme, a retailer may hold a slim inventory in the store and essentially use it as a showroom in which merchandise is ordered online by, or on behalf of, the customer before he leaves the store. The merchandise is shipped directly to the customer's home and may never enter the store at all, but the sale is still initiated in the store and therefore fair game for percentage rent from the landlord's perspective.
Landlords face two challenges in keeping pace with how technology is changing transactional mediums. The first is getting language into leases that clearly defines a sale for which the store is responsible. Clarity must also be achieved about the accounting treatment of items that are purchased online but then returned to one of the retailer's stores for refund.
But even if they succeed in doing that a second problem rears its head: enforcement. Particularly with certain kinds of site-to-store transactions (buy online and pick up in the store) it is going to be difficult, if not impossible, for landlords to police retailers to ensure all sales are actually reported.
Enforcement of full disclosure even with conventional transactions is hard enough. With omnichannel retailing, the honour system will be sorely tested.
Michael Baker is principal of Baker Consulting and can be reached at email@example.com and www.mbaker-retail.com.