John is the CEO of XYZ, a real estate company specialized in retail properties. John is sharp and, to maximize both XYZ’s and the tenants’ revenues, had for many years deployed turnover-based lease contracts (1). This way, everybody had the right incentives to work hard and generate great revenue. Bankruptcies hit historic lows.
Problems with variable leases started a few years ago. The cause? E-commerce. The shopping centers were crowded as always, but online-generated revenue was not recognized in John’s lease contracts. XYZ started to lose money and John’s lawyers wrote tons of clauses to tackle the issue, but the remedy was not effective and led to even more legal problems. Tired and despairing, John made a drastic decision: no more revenue sharing, only fixed contracts. But John is all but happy with the result. He is smart and knows well the importance of risk-sharing, to attract the best brands and maximize profits.
Unsolvable problem? Maybe not, technology can help. XYZ’s shopping centers have sensors installed virtually everywhere. Irrespectively of the used technology (heating cameras, laser scanners or smart phone detectors), XYZ and its tenants have an accurate picture of the customers’ position at all times. The data is very valuable not only to implement optimal sale strategies, evaluate the tenants’ performance and optimize the tenant mix, but also to implement rental leases!
An ad-hoc footfall-based model for setting commercial retail leases has already been developed at WSP. With such a model, property owner and tenant incentives are perfectly aligned. The model takes into account the tenants’ standard revenue, operating margins, pedestrian flow, etc. to always set the right contract. Through big data analysis it is possible to assign a value to the time spent by customers in the mall or in a single store and, from that value, calculate the rent of a commercial property.
The underpinning algorithm is a complex combination of number of visitors and cumulative shopping time that links historical and real-time data, making it nearly impossible to misrepresent reality. Despite being variable, the model meets the standard requirements of financial stability, vital for publicly-listed property owners. To avoid excessive variance in the rental income and enable earnings predictability, data-smoothing is effectively performed.
From a property valuation perspective, the lease structure of footfall-based contracts is sufficiently similar to classic turnover-based contracts to create no valuation issue. From a legal perspective, real estate lawyers have analyzed the legal feasibility of footfall-based contracts and written a draft proposal for deploying these contracts in the Swedish market. The initial idea of a footfall-based commercial lease was granted the prize as the Swedish Best Master Thesis to the author and the refined model is here to revolutionize real estate leases.
If only John knew that…
(1) A turnover lease is a lease where the rent payable by the tenant is calculated either wholly, or partly, by the actual turnover achieved by the tenant’s business operated out of the premises