A Percentage Lease is a lease agreement in which the tenant (lessee) pays a base rent plus a percentage of their gross sales made on the leased premises. This type of lease commonly includes a minimum base rent to ensure the landlord (lessor) receives a steady income despite fluctuations in the tenant’s sales. Percentage leases are primarily used in retail settings where sales can significantly vary.
Components of a Percentage Lease
Base Rent
The base rent is the fixed minimum amount that the tenant agrees to pay each period (e.g., monthly). This ensures that the landlord receives a consistent rental income regardless of the tenant’s sales performance.
Percentage Rent
In addition to base rent, the tenant pays percentage rent, which is a predetermined percentage of their gross sales. The formula for calculating it is:
Structure and Types
Pure Percentage Lease
In a pure percentage lease, the tenant pays solely based on a percentage of their sales. This type isn’t common as it doesn’t guarantee any fixed income for the landlord.
Percentage Lease with Minimum Rent
Most percentage leases include a minimum base rent, which guarantees that the landlord receives at least a certain amount of rent each period. The tenant pays the base rent plus a percentage of their sales above a certain breakpoint.
Breakpoints in Percentage Leases
A breakpoint is the sales threshold above which the tenant starts paying the percentage rent. There are two types:
Natural Breakpoint
Calculated by dividing the base rent by the percentage rate. For example, if the base rent is $10,000, and the percentage rate is 5%, the natural breakpoint is:
If the tenant’s annual sales exceed $200,000, they will start paying additional rent based on the percentage rate on sales above this point.
Artificial Breakpoint
An arbitrarily set sales figure that triggers the additional percentage rent. It can be either higher or lower than the natural breakpoint, depending on lease negotiations.
Special Considerations
Overage Rent
Overage Rent refers to the additional rent paid by tenants when their sales surpass the breakpoint. It’s synonymous with the concept of percentage rent.
Percentage Rent Clauses
Lease agreements often include detailed clauses about how gross sales are defined, periods for sales reporting, and methods for audit and verification to prevent discrepancies.
Historical Context
The concept of percentage leases gained popularity with the rise of shopping centers and malls. They provide landlords with potential income growth aligned with the success of their tenants, promoting a symbiotic relationship.
Applicability
Retail Settings
Percentage leases are most commonly used in retail industries where sales can vary significantly based on location, economic conditions, and tenant performance.
Landlord and Tenant Relationship
This lease structure incentivizes landlords to foster tenant success since their income is a direct percentage of tenant sales. Shopping centers often prefer percentage leases to ensure tenants remain motivated to enhance their sales performance.
Comparisons and Related Terms
Net Lease
A Net Lease requires the tenant to pay not only rent but also a portion of common associated costs, such as property taxes, insurance, and maintenance. In contrast, a percentage lease focuses on tying rent to sales performance.
Percentage Rent
Percentage Rent is the portion of rent under a percentage lease derived from the tenant’s sales figures, rather than a fixed amount.
FAQs
What is a Percentage Lease?
Why are Percentage Leases used in retail?
How is the breakpoint determined?
References
- “Essentials of Real Estate Finance,” David Sirota, 13th Edition.
- “Real Estate Principles,” Charles F. Floyd & Marcus T. Allen.
Summary
A Percentage Lease aligns the interests of landlords and retail tenants by linking rental payments to sales performance. This lease structure includes both a base rent and a percentage rent, commonly activates at a specified sales breakpoint. It fosters a cooperative relationship aimed at maximizing tenant sales and, consequently, the landlord’s rental income. Understanding the nuances of percentage leases is crucial for both landlords and tenants in retail property arrangements.
