How Semi-Gross Leases with CPI-Linked Increases are Transforming Shopping Centre Economics

In the dynamic landscape of Australian shopping centre leases, a notable shift from traditional net leases to semi-gross leases impacts retail property investments. Beginning around 2018, prominent centre managers initiated this change, integrating a portion of the outgoings into the rent, providing retailers with a more predictable expense structure.

Understanding the Semi-Gross Lease Structure

Semi-gross leases blend some outgoings with the rent, typically including management fees, salaries, security, and administrative costs, thereby reducing the variability of these expenses for the lessee. Below is a typical distribution of outgoings under this lease model:

  • Statutory charges: Fully recoverable, such as municipal/council rates, water and sewage rates, land tax, and other statutory fees.
  • Operating expenses: Partially recoverable. Costs like common area cleaning, centre supervision, and car parking are included in the rent, while insurance premiums and utilities like electricity and fire protection systems remain recoverable.

Approximately 60% of outgoings are embedded into the rent under this structure.

Comparative Analysis of Lease Structures

To understand the financial impact, consider these scenarios involving two fashion retailers:

  • Fashion Retailer in Centre A (Net Lease): Leases 100m² at a base rent of $150,000, with outgoings at $30,000, and a promotional levy of 5% of the base rent. The rent increases by a fixed 5% annually. At the end of five years, this results in a total occupancy cost of approximately $226,538, assuming outgoings grow at an inflation rate of 4%.
  • Fashion Retailer in Centre B (Semi-Gross Lease): Starts with a semi-gross rent of $168,000 (including 40% of outgoings), with similar promotional levies adjusted for the higher rent. The rent is indexed to CPI plus 2.5% annually. After five years, the total occupancy cost climbs to about $240,971, a 6% increase over Centre A.

This analysis shows that Centre B, under a semi-gross lease, imposes a higher initial cost but offers landlords more protection against inflation, translating to a slightly higher total occupancy cost by the end of the lease term compared to Centre A.

Implications for Capital Values

The shift to semi-gross leases significantly enhances property capital values. For instance, the 19% increase in capital values by year five in Centre B, when capitalised at a rate of 4.5%, leads to a substantial uplift in the property’s market value.

The Future of Lease Structures

While semi-gross leases with CPI-linked increases benefit retail landlords by generating more cash flow from rents and promotional levies in high inflation scenarios, they pose a higher financial burden on retailers due to unpredictable statutory outgoings and faster-rising rents. The prevailing economic conditions will likely dictate whether this trend continues or if there is a reversion to traditional net leases.

This evolution in leasing strategies mirrors broader economic shifts and could herald a new era in the management and valuation of shopping centres.

Around 2018, several centre managers started changing the way they recovered outgoings from their lessees from traditionally net leases to semi-gross, which means that partial outgoings are recoverable, and some are embedded in the rent.

The major shift was that controllable costs for the Landlord were embedded in the rent. These include management fees and salaries, security, and administration.

The table below shows the typical distribution of recoverable outgoings on a semi-gross basis.

Statutory ChargesR
Municipal / Council RatesR
Water & Sewerage RatesR
Land TaxR
Other StatutoryR
Operating Expenses
Insurance PremiumsR
Air Conditioning / VentilationR
Common Area CleaningI
Centre SupervisionI
Car ParkingI
Fire Protection / Public Address SystemR
Gas & OilI
Lifts & EscalatorsI
Pest ControlI
Repairs & MaintenanceI
Emergency GeneratorsR
Energy Mgmt / Bldg Automation SystemsI
Security / Access ControlI
Sewerage Disposal & SullageI
Public TelephoneI
Salaries & WagesI
Gardening / LandscapingI
Administration / Management FeeI
R= Recoverable Outgoings
I = Included in Semi–Gross Rent

This shift in lease structures presents a significant development for the Australian retail landscape. As the market adjusts to this new model, both landlords and tenants will need to carefully consider the long-term financial implications and strategically choose lease structures that align with their business goals. Whether the trend towards semi-gross leases continues or not, this evolution highlights the dynamic nature of shopping centre economics and the need for all stakeholders to remain adaptable in the face of changing economic conditions.