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.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s