Market Know-how: Bets are Made

You give me, I give you

There are two ways of charging rent in the retail real estate market: a fixed sum and a percentage of the turnover of a trading operator. As vice-president of Torgovy Kvartal Elza Rosental notes, in the West rent is paid under a mixed scheme: if the percentage of turnover is less than a certain sum then the tenant pays a “surcharge" in view of the percentage.

According to Antonina Denisenko, director of the retail real estate department at NAI Russia, in such a way favorable conditions of business dealing are created for both the tenant and the proprietor of a shopping center. "The system means a certain flexibility: the more successful a tenant is, the more its rent rate. And in case of a crisis the proprietor is protected from losses as it has a fixed sum any way,” she explains. In Europe the majority of tenants operate under such a system. "When the payment is a percentage of turnover, the income of the developer directly depends on the sales volume of the trading operator,” says Kira Butba, head of the department of commercial real estate at Vesco Consulting. “The more successful a trading operator is, the more profitable a developer is. And the strengthened work of a developer in the marketing policy of a shopping center raises the sales of the tenant, and so the income from rental payments for the developer."

"With fixed payments, the proprietor and tenant do not participate in each others risks or profit: even if the tenant makes super profit, the proprietor won’t get any of it. And with payments as a percentage of the turnover of a tenant, the proprietor becomes a direct participant in the risks of the tenant, and in cases of "success" can count on its super profit," Rosental adds.

Not only the developer is interested in this form of rental payment. "For a tenant, payment as a percentage of turnover, is undoubtedly more favorable,” assures Butba. “First of all, the developer of a successful shopping center which charges rant at a fixed rent will be constantly increasing it, referring to the unique positioning and advantages of the shopping center. Secondly, the turnover of tenants is subject to seasonal fluctuations, which are taken into account when a percentage of turnover is paid. One of the main arguments in favor of payment as a percentage of the turnover is that it induces the developer to be more concerned about the requirements and needs of the tenants. And problems in attracting visitors becomes a common cause for the developer and the tenant in such a scheme of interaction."

According to Vitaly Efimkin, vice president of Tashir, practice shows that if a shopping center is successful, for 2-3 years such a system of rental rates becomes the most favorable to both parties. "Both the developer and the tenant are interested in forming a high stream of visitors and increased sales volume. It positively affects the work of both the individual shops and the parameters of activity of the shopping center as a whole," summarizes Mikhail Golomb, president of Promsvyaznedvizhemost.

Fixed for life

Unfortunately Russia has not yet become accustomed to this system and its introduction has difficulties. "The majority of our contracts with developers are on fixed rental rates," says Alexander Astreiko, general director of the Vester chain. His words are confirmed by other retailers questioned by Vedomosti. Introduction of the western way of mutual relations between the developer and tenant collides with a set of difficulties. "Practically all operators of Russian shopping centers pay fixed rent," says Butba. "By virtue of the backwardness of the market of quality retail premises in Russia until recently the market has been a proprietor’s market, rather than a tenant’s. Therefore payment as a percentage of turnover made no sense: it is more profitable for the proprietor to have a high fixed income, than to share risks with the tenant," believes Ilya Shershnev, director for development at Swiss Realty Group. Efimkin has a similar opinion: "The shopping and entertainment center market in Russia is not saturated yet, and therefore proprietors dictate the rules. And with a fixed system of income, the future is much more predictable for the proprietor."

Many developers are interested in stable financial streams, but are not sure of their own strength. Having established a fixed rate, the owners of shopping complexes expect that payments will come even if it becomes less competitive compared with other premises. If rates are charged as a percentage of turnover, the developer will lose money from a decrease in attendance to the premises, which will be negatively reflected in the capitalization of the project as a whole and will result in lost profit.

"If a percentage of turnover is paid then the fixed rate should be less than if there was no such percentage,” Rosental explains. And many owners are not all right with that: what if the turnover of the tenant doesn’t even reach the minimum?

"The Russian market has got used to paying a fixed rental rate because it is more interesting for the proprietor,” considers Natalia Burtseva, top manager for projects in the retail real estate department at Penny Lane Realty. “Now the majority of entertainment center projects under construction are for sale. And for western buyers fixed rental rates are more interesting as they guarantee income from the bought premises. And according to a member of the board of directors and a leading adviser of Magazin Magazinov Marina Markova, having taken loans from a bank, developers, accordingly, count on a certain monthly sum of money to repay these loans. "When a developer goes to a bank for refinancing, it has to provide a guaranteed sum which it will receive from tenants,” Vadim Prikhodko, vice director of RTM-development agrees. “Let’s say it will be only $300 per sq.m, instead of 5 per cent from rent as a percentage of turnover. For the bank it’s unimportant, of that I am sure: that this 5 per cent will be no less than $700, it will only refinance the loan if it has guarantees that it will be repaid."

However, there is also a specific Russian reason preventing the use of payment of rent from a percentage of turnover. The problem is, Russian operators often don’t absolutely fairly show their turnover, Yulia Nikulicheva, deputy director for the strategic consulting department at Jones Lang LaSalle, says. "Developers repeatedly complain that tenants never – no matter how they are checked – make more than the minimum turnover, so they don’t get charged a percentage, but the base rental rate," she says. In such a situation the developer can only charge a percentage to those operators it certainly trusts.

In Russia fixed rental rates have a number of advantages. "For a hypermarket or supermarket that rents a premises at a low fixed rate and works with high parameters, this model of payment is much more profitable. It allows to save, and also precisely calculate rental costs for some years in advance,” Astreiko explains. “And the given model is interesting to the developer as it will definitely receive income irrespective of the success or failure of retailers. The establishment of a fixed rate provides no risks for the proprietor." And many tenants simply do not want mess about with daily reports, which they should provide the managing company.

Mixed rent

But in Russia we gradually starts to become accustomed to the system of collecting rent as a percentage of turnover. The locomotive for this, strangely enough, is in the regions. "It is difficult to predict the trade turnover in an unfamiliar city. And where the trade turnover is unpredictable, it is more profitable to pay a percentage of turnover. When a company knows that it is possible to earn more and sees promise in the given premises it is prepared to pay stable rent," Markova says. And Efimkin considers that during the process of saturation of the market in Russia, tenants will dictate the conditions of rent in shopping centers, choosing the most optimum model for themselves.

According to Nikulicheva, anchor tenants - supermarkets, some clothes shops and restaurants - more often now pay rent as a percentage of turnover. And developers are prepared to give them concessions. However, there are conditions. "The gradual transition from a fixed rental rate to a percentage of turnover began in 2004, and this trend has considerably increased in connection with the increased transparency of carrying out financial reporting by retailers,” Golomb is assured. “First of all anchor tenants and known chain operators have moved to such a system of rental payments. This format of rental relationships will come onto the market in the next few years." According to him, at Gorizont shopping center (developer - PSN) in Rostov-on-Don over 20 operators work under the system of "minimum rent and a percentage of turnover."

"For a long time already we have used a similar system of charging rent whereby retailers and the developer have become partners. And frequently it is more profitable," notes Ivan Sitnikov, general director of RosEvroDevelopment.

"In one project we were interested in, when attracting operators, the brand Zara, from the very beginning, wanted to rent the premises only under the system of a percentage of turnover, and we agreed,” says Efimkin.

And Prikhodko says that RTM-Development takes a percentage of the turnover only when working with western tenants or their large known franchises: "Such companies monitor their financial systems and have a better accounting system, which does not give them the opportunity to manipulate figures. Russian companies still do not follow such practices, and equipment for online accounting is expensive.”

Anna Rudakov, a real estate consultant at Russian Research Group on the other hand believes that it is a forced measure: "For example, some western operators (McDonalds, etc.) generally refuse to participate in a project under other conditions. All large Russian companies, applying for the status of representatives of transparent business, also try to move to this system. X5 Retail Group, M.Video, Tekhnosila and other anchors more often work under this scheme." MediaMarkt also operates under this system.

But the Carrefour chain, which intends to open its first Russian hypermarket in 2008, has chosen another scheme: Fix differs within the limits of one project, i.е. There are minimum and maximum fixed rental rates. "If the percentage of turnover exceeds a certain sum, then the “fix” is used. The French operator works exactly to this model,” Rosental says.