Understanding renewal rates in shopping centre leases in Australia

Retail leases in Australian shopping centres frequently do not include options, necessitating the renegotiation of lease terms between the retailer and landlord at the end of the lease term. Unlike a new lease, where the retailer first enters the centre, a renewal negotiation involves a “sitting tenant” that has established trading goodwill. This makes the retailer more captive in the negotiation than during the initial lease deal.

The renewal rate sometimes called a sitting tenant renewal or rollover spread, is a bellwether indicator of the strength of the shopping centre, retail category, and retailer’s performance.

What is a renewal rate?

In the context of retail leases, a renewal rate is the difference in rent payable when a lease term is renewed or ‘rolled over’ beyond its initial period. This typically occurs when the lease agreement needs to be renegotiated. Unlike new lease deals, sitting tenants are rarely offered incentives or inducements to lease. Essentially, the rent adjustment occurs when a lease is renewed, usually reflecting changes in the effective market rental rate after incentives have been considered.

How renewal rates work

When a lease term ends, tenants and landlords usually renegotiate new lease terms or terminate the agreement. If an agreement cannot be reached, both parties can choose to go on holdover, where either party can terminate the lease with one month’s notice.

In the negotiation, which typically commences well before the lease expires, the landlord benefits from access to the retailer’s sales data, other retailers’ data in the same category, and all the other rents in that centre. In contrast, the retailer is often limited to their lease and reported turnover unless they can access retail leasing data like Leaseinfo’s retail database. This information asymmetry can create a significant power imbalance in the negotiation process.

For example, if Retailer A leases Shop 1012 in Centre B starting 01/01/2018, with the lease expiring on 31/12/2023 at $100,000 per annum with 5% annual rental increases, and renews their lease on 01/01/2024 at $145,000 per annum, the renewal rate (rollover spread) is calculated as follows:

($145,000 / ($120,000 ^4)-1 = 3.5% as at 01/01/2024

Factors Influencing Renewal Rates

Several factors can influence the renewal spread applied to a retail lease, including:

  1. Market conditions: Fluctuations in the retail property market, such as changes in demand and supply, can affect rental rates and, consequently, renewal rates.
  2. Location: The shop’s location within the centre plays a significant role in determining market rents. Prime locations or areas with high foot traffic might see higher increases in rental rates compared to quieter areas in the centre.
  3. Economic factors: Broader economic conditions, including inflation rates, consumer sentiment, employment rates, interest rates, and economic growth, can impact retail rental rates and the associated renewal spreads.
  4. Retail category performance: Different retail categories within centres can perform in different cycles and can be countercyclical. For example, during the pandemic, JB Hi-Fi and Officeworks outperformed as workers rushed to buy “work-from-home” equipment.

Why is this data hard to get?

Landlords usually guard this information and only disclose it if required, such as when they are listed entities and must report it. Obtaining this data is challenging because it requires historical and current leasing data to calculate the renewal rate, necessitating a historical database of retail leasing data. One company that tracks renewal spreads is LeaseInfo.

Conclusion

Renewal rates or rollover spreads are a crucial element of shopping centre leases in Australia. Understanding how they work and their influencing factors can help landlords and tenants navigate lease renewals more effectively. Proper negotiation requires access to a comprehensive database of historical and current rental rates to negotiate confidently.

By staying informed and proactive, both landlords and tenants can better manage their retail renewal rates, ensuring a fair and beneficial arrangement for all involved.