Omni-channel retailers and lease contracts: A new era

By Emilio Gómez Delgado, partner Real Estate Hogan Lovells.-

What is omni-channel and why is this so important?
The concept is easy to understand. However, the complexity lays down in analyzing and predicting all the impacts that this new approach will produce in the retail industry in the future. There is consensus about the distinction between multi-channel and omni-channel concepts. This new wave –omni-channel– is the consequence (or the reason why) the consumer behavior is no longer binary. Technology has been fully integrated into the buying process in the way that consumers browse and compare online and buy in-store and vice-versa, in a complex practice expanded worldwide.

Is the retail industry changing?
No doubt. Consumer behavior is no longer binary either. Most important, a sale is important but nowadays the relevant factor is that customers’ experience is positive. That obliges retailers to invest considerable amounts of money to change their organizations, integrating different platforms (logistics, warehouse, digital presence and retail shops), combining display shop proposition and space, stock availability, tracking inventory, merchandising and marketing strategies.

What is this all about with lease contracts?
Traditionally, lease contracts were implemented to capture the value of the store by reference to a rent level per square meter. Location and size were the key aspects to fix the base rent values, and subsequently this was complemented by a variable income calculated as a percentage of sales achieved by the retailer (tenant) above a certain threshold. This is referred to as turnover rent and the structure is known as «turnover rent model».

This rental model has remained broadly unchanged in the last decades. However, in the omni-channel world the in-store sales are no longer an accurate measure for the contribution of a store to total sales of the retailer. The role of the store is changing in the retailer strategy and has abandoned the pure buy-in design. In some cases the stores are not only a delivery path for sales transacted beyond their four walls, but are also equipped with devices that facilitate online orders from within the store.

Is the omni-channel strategy a new driver for lease contracts?
In my view this is unquestionable. There is consensus in the shopping centre industry about the fact that the turnover rent model fails to reflect the true contribution of a store to total sales generated because this does not fully capture the contribution of the store to the sales that occurred online.

What are the challenges for the landlord/tenant relationship?
As I mentioned above, the role of the store is changing. Sometimes they are visited by customers but the sale is completed online some days after, and also onsite deliveries are captured using devices whereby the transaction is not accounted for in the store.

To address this issue, some real estate owners are increasingly proposing geo-fence turnover models. The lease contract would be drafted so that the turnover includes all sales within an agreed catchment area, using postal or other locational codes of the consumers, and this determines the turnover rent of the store. It is clear that retailers are reluctant to share the turnover data on non-store sales in a particular region, and this creates an obstacle in landlord-tenant negotiations. In any event this is in my view a scrappy approach and against the digitalisation era.

Omni-channel shakes the foundations of the landlord-tenant relationship in the retail industry. Until now there is a relative bargaining power of some actors (tenants) when negotiating terms and conditions with retail investors (landlords) for new locations.

The complexity of this new retail model shows that both parties should collaborate and work together in order to innovate and capture the value that the digitalisation of the retail chain presents for businesses in both sides of the table. The public authorities are also looking into this issue to avoid legislative gaps which may distort fair competition. The solution is not yet in place but this should be a win-win situation.