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Property Special: Fighting back against occupancy costs

As occupancy expenses continue to rise, retailers are calling for greater flexibility.

When celebrity Dragon and Boux Avenue lingerie chain owner Theo Paphitis demanded a revolution in the business rates system last year, retailers rallied en masse. They argued that the tax no longer reflected true rental values and had proved to be the final straw for many faltering businesses.

British Property Federation head of communications Patrick Clift agrees, and says that while business rates are around 40% of rent, they can often be higher because they are based on pre-crash 2008 rental values and won’t be re-evaluated until 2017.

He adds: “It’s worth noting business rates are higher than property taxes anywhere else in Europe and are the second highest in the OECD [the Organisation for Economic Co-operation and Development, which comprises 34 high-income countries]. A recent survey highlighted that 93% of MPs agree that the fundamental reform of business rates would revitalise our high streets and town centres but this is far from being just a retail problem; it is a problem for all businesses.”

There is increasing awareness that rates are just part of a gamut of occupancy costs that retailers have to contend with. The combined effect on stores already experiencing lower demand, tighter margins and a diminishing bottom line is devastating - and deters new investment.

“The UK has some of the highest property costs in the world matching some of the most productive trading locations. One of the most emotive issues for UK retailers is business rates and change continues to be championed with government,” says Tony Devlin, head of high street retail for commercial property consultant CBRE.

The most obvious and unpalatable occupancy cost that retailers face is rent. Upward-only rent reviews, quarterly advance payments and difficult lease negotiations cause the most resentment.

“I don’t understand why there are ever-increasing rents,” complains Julian Blades, director of designer boutique Jules B, which has nine stores in the Northeast. He claims some landlords have tried to increase his rent by 10% because new entrants have agreed to pay that level - but, as he points out, some of these newcomers have subsequently gone out of business because they could not afford the rent in the first place.

If someone takes a similar unit nearby and agrees to pay 10% more than you, chances are your rent will go up by 10% at the next review, due to what is called ‘comparable evidence’ in the valuation process. Blades is frustrated and annoyed that valuation surveyors use shorter leases as comparable evidence and then foist rises onto long-term tenants like himself.

Often retailers find themselves bogged down in lengthy and confusing lease negotiations, where they feel strong-armed due to the financial disruption that relocating would cause.

Charles Clinkard, managing director of the eponymous independent footwear chain, spoke of one landlord who would not negotiate at a 15-year break clause on a 25-year lease, despite Clinkard being a long-term, stable tenant. The unit was subsequently let to a string of pop-ups, and Clinkard questions why this was seen as preferable to the security of 10 years stable income from a quality retailer.

Clinkard says: “Institutional landlords play hard-ball. We are not a key player and it is not a level playing field. But had they come to the table and treated us fairly, we would have probably stayed.”

The British Retail Consortium and the Royal Institution of Chartered Surveyors have designed a standardised and easily digestible lease for small- and medium-sized retail enterprises, which is supported by landlords due to the vacant property rates they might otherwise face. It is designed to get retailers into empty premises “quickly, conveniently and, most importantly, cost effectively”, says John Munro, external affairs adviser at the BRC. He adds: “Clarity is what’s needed. They need to be in a property as soon as possible, not wading through pages and pages of a lease to see if there is an upward-only rent clause.”

Advance quarterly rents are also difficult for many - particularly towards the end of the year, when inventories are being stocked for Christmas and cash flow is tight. Property experts don’t think there will ever be a wholesale move away from quarterly rents, although some landlords, such as the Duke of Westminster’s property company Grosvenor, will switch to monthly advance rents for a 1% or 2% levy. Retailers such as New Look and Monsoon have been moving towards this arrangement.

Clinkard believes the problem is the financial model that institutional landlords adopt. Arguably, reducing the rent impacts the investment value of a property, whereas improving the internal rate of return through rising rents is more likely to keep the property well maintained and attractive to shoppers.

These rising costs come as bricks-and-mortar sales continue to be hit by etail, which has lower overheads, and again this deters investment.

Clinkard comments: “The cake is not getting bigger. Online retail is taking 15% of total sales and is projected to get to 20%. I cannot see that improving for physical retailers.”

Any business - including landlords - expects to get full market value for its products and services. Most retailers accept this, but would like a bit more give and less take.

Richard Bradbury, retail consultant and former chief executive of River Island, lauds the greater use of turnover rents, which are based on a percentage of turnover or bottom line. “Some sanity has returned to the market,” he believes.

Such an option would appear to be a solution to falling turnover, but is not without cost. Mark Jacobs, director with property consultant CBRE’s corporate occupier services, says: “Landlords are increasingly wanting more control of tenant mix while retailers are seeking more flexibility. If retailers get more occupancy flexibility, they will have to balance this with a higher risk of losing representation on lease expiry, particularly as the UK sees strong demand from international retailers looking to enter the market.”

‘SMEs need to be in a property as soon as possible, not wading through a lease to see if there is an upward-only rent clause’
John Munro, external affairs adviser, British Retail Consortium

His colleague Devlin adds: “Over the past few years we have seen a change. While not prevalent, in a number of instances when advising retailers in some markets we have agreed deals with upwards and downward rent reviews, as well as turnover-based rents with no rent reviews.”

Above-inflation rises on service charges have also become a bugbear for some retailers. Westfield London in White City quoted a service fee of £14.50 per sq ft prior to the shopping centre’s opening in 2008, yet the subsequent introduction of a £14 charge still led to a revolt by incensed retailers, who said the fee was too high. By contrast, British Land’s average charge across its portfolio is £5 to £7.

However, retailers in Westfield London recognise that Australian owner Westfield has high standards in running and maintaining the centre, alongside the high charges. Bradbury says: “You do not have a choice with service charges. But you have to be pragmatic - if you want high standards, you have to pay for them.”

Landlords maintain that minimum wages for security guards and cleaning staff, and rising utility costs, are to blame for the high service charges. In addition, maintaining plant and machinery in older units is another rising cost for landlords. But retailers point out that some of these increases, such as minimum wages, affect them as well.

In addition, retailers are struggling with rising energy costs. Although utility bills have stabilised, additional taxes, such as the climate change levy, are peeling margins ever closer to the core.

Ultimately, the ability of retailers to improve profitability is the best solution. That partly comes down to environment and the successful management of the change that retail locations are undergoing.

BRC’s Munro says: “Central government needs to empower local authorities to provide certainty that the areas retailers invest in will develop and improve. Local authorities need to understand that one of the most significant challenges facing them is the ability to retain businesses in their area.”

Property is a hard-nosed business and decisions always come down to money. If landlords can make more money by reducing occupancy costs, to secure a longer lease for example, they will. But if there’s nothing in it for them, obviously they won’t.

Bradbury concludes: “The issue is about stimulating the bottom end of the market and getting new retailers to take a risk. Occupancy costs have to be affordable, then you will see new entrants trying out different concepts. But at the moment there are just too many barriers.”

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