For a long time, the muse of industrial property finance was stability. A landlord secured a 10-25-year full repairing and insuring lease, the tenant offered predictable cash-flow and lenders may comfortably underwrite loans towards a dependable hire roll.
That mannequin has been eroding, however the acceleration of flexible leasing constructions resembling turnover-based, hybrid and shorter-term agreements has introduced the problem to the fore. As tenant calls for have shifted, significantly in retail, the ‘conventional lease’ is not the default.
Tenants need affordability and agility, whereas landlords are more and more ready to share each threat and reward. This could also be serving to offers get completed, but it surely has additionally launched new complexities for valuers and lenders.
Turnover-based leases, as soon as a distinct segment instrument, are actually mainstream. Savills stories that UK turnover rents usually vary from 1% to fifteen% of gross sales, averaging round 7%. Deals are sometimes structured as a base hire at about 80% of open market ranges, with a turnover ‘top-up’ layered above that.
This aligns landlord and tenant pursuits. If the shop performs properly, the owner advantages; if gross sales falter, the hire burden eases. Post-pandemic, the mannequin turned a lifeline for struggling retailers, however surveys recommend it has lasting attraction.
Yet flexibility comes at a value. For valuers, revenue is not assured; it fluctuates with the broader financial system and shopper confidence. For lenders, the implications are starker: underwriting has all the time relied on predictable cashflows, and turnover leases problem that basis.
Instead of discounting a hard and fast hire, valuers should mannequin outcomes primarily based on previous gross sales, native footfall and sector resilience. Savills notes turnover hire valuations usually depend on the previous three years of turnover information – a precarious benchmark in unstable sectors, the place shopper behaviour shifts shortly.
This complexity is heightened by divergence throughout retail sub-sectors. Retail warehousing has confirmed strong. Savills stories that internet efficient rents within the sector grew by 7% in 2024, averaging £21 per sq ft, with void charges at simply 4.6%.
Investment volumes hit £2.2bn, up 35.9% year-on-year, with projected returns of 9.3% every year. By distinction, excessive avenue retail stays fragile, with slower rental progress and patchier demand. For lenders, this implies asset class and placement matter greater than ever.
The conventional lending mannequin assumes fastened rental revenue that may be stress-tested towards macroeconomic situations. With turnover leases, volatility undermines that certainty. Lenders are responding with stricter reporting necessities, adjusted loan-to-value ratios, and, in some instances, bespoke merchandise tailor-made to flexible leases.
At the identical time, 2024 introduced a shift in leasing patterns. According to Re-Leased’s UK State of CRE Leasing Report, common retail lease lengths elevated by 32% year-on-year in Q1 2024, from 37 to 49 months. Office leases additionally lengthened, rising 27% from 2.9 to three.7 years, with leases of three to 5 years surging 69%. This reversal of the ‘shorter lease’ development suggests tenants and landlords are looking for stability after years of upheaval.
Regulation
Overlaying these dynamics is the prospect of regulation. The authorities has proposed a ban on upward-only hire evaluations (UORRs), anticipated to take impact in late 2026. Their removing would mark a serious shift in landlord-tenant dynamics. While many SMEs already function on leases with out UORRs, the ban may speed up the transfer in direction of performance-linked and flexible agreements.
Despite the challenges, flexible leasing additionally presents alternatives. Linking revenue to efficiency permits data-driven threat evaluation. If lenders can entry real-time gross sales information via landlord reporting programs or direct tenant disclosure, they will construct extra correct fashions than these primarily based on static assumptions.
PropTech options are making this potential. Digital dashboards monitoring turnover, footfall and hire assortment are more and more frequent and will scale back opacity for lenders.
For essentially the most modern, it is a aggressive differentiator: lenders prepared to have interaction with flexible leases might seize high-quality alternatives that cautious rivals overlook.
The rise of flexible leasing indicators a profound shift in landlord, tenant, valuer and lender relationships. Income is much less predictable however extra reflective of actual efficiency. Lease lengths are lengthening once more, however with clauses that distribute threat in another way. And regulation is nudging the market additional in direction of flexibility.
For lenders, the query just isn’t whether or not to have interaction with these modifications, however how. A cautious strategy of decreasing LTVs and demanding extra reporting might defend towards draw back threat. A bolder technique of embracing data-driven underwriting and bespoke merchandise might seize new alternatives.
Either means, one factor is obvious: the standard 25-year lease with upward-only hire evaluations is turning into a relic. The future of industrial mortgage lending shall be written in an surroundings the place flexibility is the norm and the place lenders’ potential to adapt shall be as essential because the properties they finance.
Rebecca Sawyer is managing director of GRO Retail
