The Impact of Occupancy Costs on Physical Retail Start-ups

For the retail start-up, there is a multitude of considerations that must be analyzed before making a commitment, especially when the decision is to open a physical store.

One such consideration is occupancy costs and the significant changes that are beginning to occur in both the UK and further afield, due to a groundswell against high rental costs and a very slow take-up on vacant units in high streets and towns.

What are occupancy costs?

Occupancy costs – also often referred to as fixed costs - are made up of rent, business rates and service charges and will become the biggest fixed cost by far for new retailers, in excess of salaries. Certainly, for a retail start-up, salary costs will be limited to the minimum before the business develops.

Because of this, any new start-up owner needs to become very familiar with what is happening in the retail rental market and why landlords are struggling to rent their spaces, as well as fully understanding the business rate structures and bands.

Rents and service charges have become too high and have consequently dragged up business rates. Business rates are revalued every five years and are largely a percentage of rent, so the higher the rent, the higher the business rate becomes.

Only recently in 2019, the UK government stepped in to arrest this business rate rise - but only to the lowest payers. For a new retail business, who will probably take a small space, this is good news. However, it is vital that new business owners fully understand the rateable value of the property and the rates payable. (Rates payable tend to be about 45% of the rateable value).

Should you go for a lease or license?

Landlords are struggling to find tenants but are reluctant to drop their asking rent for fear of the banks (from who they borrowed money to buy the freehold) asking for a significant amount of the sum borrowed to be repaid. Banks will have lent money based on the landlord achieving a certain rent. If that rent falls, the landlord will have to write down the value of the property, which will inevitably lead to the landlord repaying part of the capital sum borrowed.

This is where you, as a new retail start-up, must be tread carefully. It is essential to be fully briefed on what is happening in this rapidly changing area of rent and do not simply ‘sign up’ an onerous lease that will be a permanent millstone.

There have been an increasing number of very experienced professionals in the retail industry and beyond, demanding a change in the Landlord and Tenant Act, (the legal act that governs the rental contract), known as the lease.

For decades shopkeepers have signed leases, often for twenty years with five year upward only rent reviews built in. This is now dying out fast all over the UK. It is no secret how many retail groups are declaring a CVA (creditor voluntary arrangement) in order to renegotiate their leases.

Rents are currently too high for a low inflation retail climate, so many new start-up owners would be best to not sign a lease but instead go for a licence. The landlord will prefer a tenant on a licence deal rather than an empty property. You will have less security of tenure, but this is a risk worth taking because it will allow the flexibility to gauge the consumer response to your business without committing yourself to a long lease.

How can you get started?

Becoming fully aquatinted with the legal aspects of the Landlord and Tenant act (and the business rates bands) is essential, rather than fully relying on professional advice, no matter how good their intentions. Otherwise, the danger of burdening your business at the outset, with unnecessary fixed overheads, will destroy your plan before it even has a chance to develop.

For more information on this crucial area, you can find a full analysis detailed in  The Retail Start-Up Book .