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Buy-Online, Pick-Up-In-Store Turns Into Sell-Online, Pay-Rent-In-Store.

A landlord went on a mountain retreat to contemplate the meaning of omnichannel. Om Om Om Om. Suddenly, she had an aha! moment: Why don’t I charge tenants turnover rent for those Buy-Online, Pick-Up-In-Store transactions? Brilliant! So I speak. And so it is.

Though the story may not be true, there is a growing trend that tenancy agreements now include a clause stipulating that sales generated by a tenant online and picked up in a physical store are deemed part of the store’s Gross Turnover. This increases the Turnover Rent that the tenant has to pay.

Setting Sales Target Using Store’s Occupancy Cost

For the past nine years since 2011, we have been using occupancy cost to determine a store’s sales target. If a store achieves the sales target in a particular month, every team member of that store will receive a sales incentive that month in addition to his or her base salary and sales commission.

Occupancy cost refers to the ratio of sales to rent, usually expressed as a percentage:

Occupancy Cost = Gross Rent ÷ Gross Turnover

For example, if your rent is $7,000 and your sales is $30,000, your occupancy cost is about 23.3%.

For our business, we think that an occupancy cost of 13% and below is desirable. Here’s how you calculate the sales you need to generate to achieve an occupancy cost of 13%:

Sales Target = Gross Rent ÷ % Occupancy Cost

So with rent of $7,000, you will need to generate sales of about $53,846 ($7,000 ÷ 13%) to achieve an occupancy cost of 13%.

If your gross rent includes turnover rent, you will need to take that into consideration in your computation:

Sales Target = Gross Rent ÷ [% Occupancy Cost – % Variable Rent]

For example, if your gross rent is $7,000 + 1% of Gross Turnover, you will need to generate sales of about $58,333 [$7,000 ÷ (13% – 1%)] to achieve an occupancy cost of 13%.

In our case, our store manager gets 0.5% of the store sales and our store associate gets 1% of his or her individual sales as sales incentive if the store’s occupancy cost is below 13%. We have a tiered structure – 11% & below, our manager gets 0.75% and our associate gets 1.5%; 9% & below, our manager gets 1% and our associate gets 2%.

It’s important to highlight that base salary still makes up the bulk of our compensation and it is designed intentionally as such. There’s a lot of talk of pay-for-performance in retail – about how a significant portion of a retail staff’s salary should vary with performance. My own view is that pay-for-performance is perhaps relevant when a company is paying an executive a high base salary and is looking to incentivise her further if she meets certain targets. Take the case of an executive whose monthly base salary is $100,000, and let’s say she stands to receive another $50,000 as sales bonus if she meets certain revenue or profit goals. So two-thirds of her compensation is fixed and one-third is variable.

Retail, however, remains a low-wage sector. Imagine if a retail associate’s base salary is $1,000, and she will only receive another $500 as commission if she hits her sales target. I guess, in theory, this retail associate should be more motivated to achieve her sales target. She needs that $500! But in reality, she’s probably too stressed trying to make ends meet and I am more inclined to believe that the stress leads to poorer performance. And it’s not even about the performance. It’s simply not a conscionable thing to do.

How Turnover Rent Killed Black Friday

It is common for retailers to make around 40% of our turnover in the last quarter of the year. For 3/4 of a year, we retailers try very hard to ride out the offseason and stay afloat. Black Friday, the day after Thanksgiving, perfectly describes this reality: it was the day when retailers went from being in the red to being in the black.

So what is turnover rent and how does it kill Black Friday? Turnover rent is that portion of rent that’s calculated as a percentage of a tenant’s retail sales. Nowadays it’s very common for a landlord to charge turnover rent on top of base rent. Here’s how rent is typically calculated:

$20.00 psf/month + 1% OR 11% of Gross Turnover, whichever is higher

The base rent ($20 psf/month) serves to minimise the landlord’s downside risks while the turnover rent (1% OR 11% of gross turnover) serves to provide the landlord with upside potential. It all works out well for the landlord. But if your business is highly seasonal, this way of calculating rent makes it even harder for you to be in the black. Why is that so? The OR GTO is designed to kick in in months when your business experiences high sales. Hence if you are in a business that relies on a few months of extremely high sales to make up for many months of loss-making low sales, you need to take into consideration the additional rent you have to pay the landlord in your profit and/or cash projections.

Many of us who are responsible for negotiating leases tend to focus on the first part of the offer, that is, the base rent portion, and we often ignore the OR GTO portion. It may seem inconsequential at the time of signing the lease agreement but it may come back to bite you in the butt.

So what can you do?

Negotiate a low OR GTO or no OR GTO

Just as many tenants tend to focus on base rent, many leasing officers also tend to focus on base rent. A bird in the hand is worth two in the bush. This makes negotiating OR GTO easier. You can start your counter-offer by removing the OR GTO.

So instead of your counter-offer looking like this…

$20.00 psf/month + 1% OR 11% of Gross Turnover, whichever is higher

…your counter-offer will look like this:

$20.00 psf/month + 1% of Gross Turnover

If the landlord insists on having OR GTO, you do stand a good chance of getting it lowered as long as they are happy with your base rent. In determining the OR GTO you should pay, you should ask yourself the question: What is the maximum occupancy cost (rent as a percentage of sales) that will make my business highly profitable? Remember those offseason months that you may be losing money while the landlord is still collecting their base rent? You need to take that into consideration. Landlords usually anchor a high OR GTO at say, 20%, and as a result, you may frame the question quite differently without you even realising it. You may end up asking yourself: What is the maximum occupancy cost that will make my business break even? This will lead to you offering and accepting a higher OR GTO than you can afford.

Avoid having high-sales event in a store with OR GTO

Every year, on Boxing Day, we hold a member event in one of our stores. This one-day event typically generates additional sales of about $25,000. To us, it’s considered high sales.

Knowing that in December, we’ll pay OR GTO rent for stores that have that component, we always choose a store without an OR GTO component to hold the event. Having the event in a store that has an OR GTO of 11% would cost us $2,750 ($25,000 x 11%) more rent.

There’s also a likelihood that you trigger the OR GTO rent as a result of the sales event.

Assume we are talking about a store that has a base rent of $7,000 per month and an OR GTO of 11%. When sales exceed $63,636.36 ($7,000 ÷ 11%), the OR GTO of 11% kicks in. Let’s say you would have achieved sales of $55,000 for the month if you didn’t hold the sales event. If you did, you would have achieved $80,000. As a result of having the sales event, sales exceed $63,636.36 and the OR GTO kicks in. Instead of paying $7,000 in rent, you now pay $8,800.

It is now common for gross turnover to include sales from buy-online-pick-up-in-store transactions (read your lease agreement). If you sell your products online and get one of your stores to ship out that order, the sales from that order is also included in the computation of gross turnover. Some may argue that we as tenants can simply choose not to report those buy-online-pick-up-in-store transactions and there’s no way for the landlord to find out. Yes, I guess you can hide it from the landlord. You will also need to hide it from the auditors as a sales audit is usually a requirement that comes with turnover rent. It’s harder to hide it from your frontline colleagues so they either do not know the details of the lease agreement or they know you’re underreporting the gross turnover. If you, as the business owner, are dishonest, it’s somewhat hypocritical to expect your staff to be honest, right?

Am I saying that you should give up making those sales just to avoid the turnover rent? Absolutely not. But if you have the option of directing sales to any store, direct it to a store that has low or no turnover rent.

Avoid having products and services with gross margin lower than OR GTO

If your store’s OR GTO is 11%, you need to avoid selling products and services with gross margin below 11%. For example, if you make a gross profit of $1 from selling a calculator at $10, your profit of $1 cannot even cover the $1.10 ($10 x 11%) of incremental rent that you have to pay. The more you sell, the more you lose.

Black Friday is now synonymous with unbelievable deals and deep price cuts. While you are busy chasing sales, make sure you are also contributing to your business staying in the black.

What Is Gross Turnover (GTO) Rent?

If you are venturing into retail and looking to rent a premise in a shopping mall, you are likely to come across an offer from the landlord that looks something like this:

$20.00 psf/month + 1% OR 11% of Gross Turnover, whichever is higher

The + 1% or 11% of Gross Turnover is commonly referred to as GTO Rent. What this means is that on top of the Base Rent ($20 per square feet per month in the example above), you will also need to pay rent calculated as a percentage of the sales generated at the premise.

Assume you are a GST-registered business and you are looking to rent a premise that’s 350sf.

If a month’s sales, inclusive of 7% GST,  is $30,000:

  • Your Gross Turnover is $28,037.38 ($30,000 ÷ 107%);
  • You will have to pay Base Rent of $7,000 ($20 x 350sf);
  • In addition to the base rent, you will have to pay Turnover Rent of $280.37 (1% of $28,037.38);
  • Hence, the Gross Rent payable is $7,280.37 ($7,000 + $280.37).

What about the OR 11% of Gross Turnover? This OR GTO kicks in in those months when the Gross Rent as a percentage of Gross Turnover is lower than 11%.

If a month’s sales, inclusive of 7% GST, is $75,000:

  • Your Gross Turnover is $70,093.46 ($75,000 ÷ 107%);
  • Your Base Rent is $7,000 ($20 x 350sf);
  • In addition to the base rent, you will have to pay Turnover Rent of $700.93 (1% of $70,093.46);
  • The Gross Rent payable is $7,700.93 ($7,000 + $280.37).
  • However the Gross Rent payable of $7,700.93 is lower than the OR GTO rent of of $7,710.28 ($70,093.46 x 11%).
  • Hence, you will need to pay whichever is higher. In this case, you need to pay $7,710.28 as rent.

Reciprocity, not Conscionable Conduct, will better guide the Fair Tenancy Framework

A long-overdue review of the Fair Tenancy Framework begins by revisiting its guiding principles of fairness.

The recent tussles over the disbursement of IRAS property tax rebates and the rollout of rent relief packages in light of the COVID-19 downturn has once again brought the disproportionate power landlords have over their tenants into the spotlight.    

The retailers and restaurateurs in Singapore are suffering badly, and for many; the sudden and severe downturn brought on by COVID-19 could be the death knell for their businesses.

We know that cash is the lifeblood of every business. Onerous clauses in commercial tenancy agreements result in retailers and restaurateurs struggling to generate and retain cash for their business. This makes many of them extremely vulnerable to shocks in their business.

More than 5 years ago, I was one of many entrepreneurs and business owners who witnessed the launch of the voluntary Fair Tenancy Framework by the Singapore Business Federation (SBF) in January 2015.

Since then, year after year, my hopes of a pro-business, pro-competition environment in commercial leasing turned more and more into despair. The situation has only gotten worse.

For instance, the introduction of turnover rent as a component of gross rent has created a legitimate reason for landlords to collect tenants’ sales data systematically. Sadly, it is often used against the tenants. It is common to see a landlord asking for higher rents upon lease renewal even as the tenant’s brick-and-mortar sales are falling. With information asymmetry, landlords are able to demand higher rents while generating lesser value. What ends up happening is, with every renewal, rent is negotiated closer and closer to a point where the tenant will be slightly worse off if they do not renew and only slightly better off if they do. Near breakeven, that is.

It begs the question: “Is the landlord’s conduct conscionable?”

Conscionable conduct, as defined in the framework, means “conduct done in good conscience i.e. not unfair, harsh, or oppressive and beyond hard commercial bargaining.

The tenant may argue that the information asymmetry is unfair, hence unconscionable; the landlord may defend their action by saying that their goal is to maximise profits for their shareholders and they simply drive a hard bargain. Both can be right, and both can be wrong. This is a classic case of relativity in which the observers – both landlord and tenant – cannot truly understand a system that they themselves are a part of. This is where the limitation of applying a value judgement like “conscionable conduct” lies.

In such situations, the principle of reciprocity may prove useful.

Reciprocity is defined as one individual selectively providing helpful acts to another individual that will provide benefits in return.

What if we apply reciprocity to the introduction of gross turnover rent and the collection of the tenant’s sales data by the landlord?

In return for the tenant’s daily or monthly sales data, as a quid pro quo, it may be mandatory for a landlord to provide to the tenant the mall’s gross turnover and average occupancy cost (rents collected as a percentage of gross turnover) on a monthly basis.

The mall’s gross turnover will provide a feedback loop to the tenant, indicating if a rise or fall in their store sales is in tandem with the mall’s overall rise or fall in gross turnover. This will help both the landlord and the tenant determine if the store is the problem or if the mall is the problem.

If a tenant has access to the average occupancy cost of different shopping malls, they are able to ascertain the “value for money” of each mall. This will definitely guide their decision around which mall they want to be in and how much they should be paying for rent.

Providing such aggregate data to tenants will heightened the mall managers’ level of accountability. They will be incentivised to provide more and more value to their tenants to justify higher and higher rents.

What if the landlord is unable or unwilling to provide such aggregate data? Then the landlord should content with just collecting a fixed base rent with no gross turnover component. The landlord then does not need to provide the aggregate sales data because the tenant will not need to submit her sales data.

Reciprocity takes away morality and adds in flexibility to ensure that the contract is not one-sided. Ultimately, reciprocity is the approach of a pragmatist.

For years, landowners’ monopolistic powers and unfair practices have existed in many countries, including Singapore. We will be naïve to believe that the playing field will ever be levelled. Hence it is no surprise that a completely voluntary Fair Tenancy Framework will be ineffective in protecting tenants’ rights.

It is often said that insanity is doing the same thing over and over again but expecting different results. Five years ago, then-Minister of State for Trade and Industry Teo Ser Luck called the framework “the first step towards fairer leasing practices”. We are now ready for the second step – an updated fair tenancy framework with some guidelines that are mandatory based on the principle of reciprocity.