Welcome to a world of the à la carte retail lease

In sickness and in health, till short-term, revenue-adjusted leases do us part.

One of the U.K.’s biggest retail landlords is moving away from a traditional lease structure across its multibillion-dollar portfolio, opting to give tenants a basket of leasing options with adjustments based on in-store revenue. It’s one of the most significant reevaluations of the relationship between landlord and tenant and is likely to be watched closely by property owners across the pond.

Legal & General Investment Management Real Assets, which has a U.K. retail and leisure destination portfolio valued at about $5.9 billion, will offer tenants various lease structures with rents tied to revenue, according to the Times of London.

Fledgling brands can sign leases as short as three months with revenue-adjusted rents, while more established stores can sign leases of between three and five years, also with revenue-adjusted rents and performance-based clauses that would allow for lease terminations. Tenants will still have the option of a traditional lease of five-plus years, with fixed rents and built-in escalations.

“Retail is not only changing through market forces but also culturally,” Denz Ibrahim, Legal & General Investment Management Real Assets’ head of retail, told the newspaper. “Our role as owner is shifting from what was solely ‘the librarian’ — collecting rent, renting shops and cleaning spaces — to becoming an ‘editor’ of the space.”

Ibrahim acknowledged that the coronavirus was a “catalyst” for the shift. “We think this is what the market needs to better serve investors, occupiers and consumers,” he added.

After hospitality, retail has been the industry sector most battered by the pandemic in the U.S., with Covid-related shutdowns and subsequent precautionary measures gutting foot traffic and in-store sales and ushering in a wave of defaults.

Unibail-Rodamco-Westfield’s U.S. malls saw a 15.3 percent year-over-year decline in net rental income for the first half of the year. Rent payments are piling up, and many formerly blue-chip tenants such as H&M and the Gap are being dragged to court by their landlords. Neiman Marcus said last week that it would shutter its much-hyped location at Hudson Yards, which its landlord, Related Companies, had touted as “the future” of retail. (Neiman Marcus did have a revenue-sharing agreement in lieu of a fixed rent in place at the complex, but seems there was little revenue to be had.)

And there’s likely more pain on the horizon: CMBS delinquency rates for retail properties jumped to 7.86 percent in June, according to ratings agency Fitch, more than twice the rates seen in May.

Legal & General’s gambit is what many industry observers have been advocating for with increased urgency since the pandemic struck: a closer tie of fortunes between landlord and tenant. Jamestown’s Michael Phillips told the Wall Street Journal in May that he expects to see shorter leases and more revenue-sharing agreements as the retail sector reopens.

“The days of being the landlord as an overlord to collect rent are over,” he said.