The Share Lease Idea is Poised to Unfold

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The Percentage Lease Concept is Poised to Spread

The pandemic has opened the door to a whole host of negotiations on rent reductions, other concessions and lease adjustments between retail landlords and their tenants.

"The pandemic has shown that many leases need to be more flexible in order to better cope with significant business interruptions," says Omar Eltorai, market analyst at Reonomy.

According to Eltorai, the pandemic has sparked greater interest in more flexible rental terms. Now he expects the percentage leasing concept to become increasingly popular. "The percentage leasing concept is not new, but it is likely to spread further – especially in retail," he says.

According to Eltorai, the percentage was generally only available for large retailers. “The way the rental agreements work is that they have a fixed rental component and a variable rental component,” he says. "The fixed component is the base rent, which is generally below the market price, and the variable component is a percentage of the sales this retailer makes in that property."

The lease protects the tenant, but gives the landlord the potential to collect more than the market rent. And if the turnover is worse than expected, the tenant pays below the market rent. "The tenant likes this arrangement because it has set lower fixed rental costs, and the owner likes it because it has filled the space and has upside potential if the retailer is doing well," says Eltorai.

Eltorai expects rental terms to change more dramatically as the economic problems caused by COVID emerge. However, some changes to existing leases were immediate measures to address the initial shock and may not apply to future tenants.

"The first changes we will see are tailor-made in nature – and unique between lessor and lessee – as property owners negotiate with tenants who have had a significant business interruption in order to find terms that allow for some leniency during these times." says Eltorai. "After that, there may be broader changes in rental terms as there is a better understanding of what seems to work well for both lessors and lessees in different companies."

Eltorai anticipates that some of the changes made to existing leases will eventually be applied to new leases. However, the takeover depends on tenant-specific scenarios. "New lease negotiations will be affected by the pandemic as both the owner and tenant will consider a pandemic scenario – even if they don't make it the focus of the negotiations," he says.

While Eltorai does not anticipate a drastic revision or re-evaluation of all leases, it does believe it is reasonable to expect that there will be a greater variety of leases after the COVID crisis. "Much of the diversity that is being added will come in the form of greater flexibility based on the tenant's perceived business interruption risk and the owner's willingness to share that risk," he says.

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