What Is A Percentage Lease?

There are a few types of commercial leases that a tenant could enter when looking for a place to house their business. One of those types of commercial lease agreements is a percentage lease, where the tenant pays a base rent plus a percentage of their gross sales revenue. 

Unlike a gross lease or net lease, percentage leases give the landlord and tenant unique benefits like lower base rent for the tenant and an opportunity for the landlord to be paid a portion of the tenant’s revenue. 

In this article, we’ll discuss the basic components of percentage leases in commercial real estate, including base rent, the breakpoint calculation, and negotiation strategies, empowering you to navigate financial dynamics in lease agreements and make informed real estate decisions. 

Overview of a Percentage Lease  

Percentage lease arrangements are commonly used in commercial real estate, especially in multi-tenant retail spaces, where tenants pay a base rent along with a percentage of their gross sales once a predetermined revenue threshold is met. This type of lease is particularly common when negotiating with a retail tenant in multi-tenant retail spaces like malls or shopping centers. This arrangement benefits both parties by encouraging revenue growth and determining the total rent based on the tenant’s performance. 

Percentage lease structures typically include two components: Base rent and percentage rent, which is calculated based on a break-even point. Negotiating considerations such as base rent, break-even points, and the revenue subject to percentage rent are up for negotiation between a property owner and potential commercial tenant. 

Percentage leases can be advantageous to the tenant because they allow the tenant to pay a lower-than-average base rent, while enjoying increased foot traffic to their business. This is because percentage leases are popular among multi-tenant retail spaces, which increases potential sales since that business gets walk-by interest from those visiting the neighboring stores. 

However, in order to enjoy the full benefits of percentage leases, it’s crucial that you understand and negotiate an advantageous agreement with your landlord. 

Break Even Point Calculation in Percentage Leases  

What are break-even points, and how are they calculated? 

First, you should figure out what your base rent will be. Base rent is the minimum amount that the tenant must pay each month. Typically, base rent is calculated by a per-square-foot model. To be clear, this base rent must be paid no matter how much the business makes in revenue or what their monthly sales figures are. 

Next, you’ll need to agree on the breakpoint amount. The breakpoint is the level of gross sales at which percentage rent kicks in, typically when sales surpass a predetermined threshold. There are two types of commonly used break even point formulas: 

• An artificial breakpoint is a predetermined flat amount after which percentage rent will kick in. For example, a business may decide that any revenue made past $400,000 will be subject to percentage rent. 

• A natural breakpoint is when the base rent is divided by the percentage rent amount and given to the landlord. This is popular for businesses that are worried about meeting the base rent amount, as a natural breakpoint ensures that the break even point is above whatever gross revenue is required to meet the base rent. 

Landlords and tenants may negotiate the breakpoint, providing an opportunity for strategic discussions. Adjusting the breakpoint can influence when tenants commence sharing income with landlords and impact financial obligations. 

Understanding this calculation is crucial for tenants navigating lease agreements, offering flexibility and potential benefits in the negotiation process. 

Negotiation Strategies for Percentage Rent  

There are a few things that tenants and landlords should consider when negotiating for percentage rent. Percentage rent leases require careful negotiation to balance the interests of both parties. This process can take time, since the tenant is interested in a low base rent and high break-even amount, and the landlord wants the opposite. 

Generally, when entering discussions, the tenant should consider suggesting a flat percentage higher than the industry standard of 7% to potentially secure a more favorable deal. 

Proposing a higher minimum rent plus a percentage can delay sharing income with the landlord, providing you with more financial flexibility initially. 

In percentage leases, the tenant pays a base rent along with a percentage of their gross sales revenue. Tenants and landlords can also trade concessions on percentage rent for other lease benefits, creating a win-win situation for both parties. 

When negotiating a percentage lease and using a break point formula in a percentage lease agreement, both parties will propose adjustments that align with their financial goals and other financial obligations. However, keep in mind that what may be advantageous to your tenant may also be advantageous to you. More revenue and business success for your tenant means more rental income for you, especially if your lease has a natural breakpoint. 

On the tenant’s side, if income growth is slower than expected, suggesting to pay a higher percentage after surpassing the breakpoint could be advantageous. Negotiating the breakpoint not only affects the timing of income sharing but also influences your financial responsibilities as a tenant. 

Conclusion  

Percentage leases in commercial real estate offer a unique opportunity for both landlords and tenants to benefit from increased foot traffic and revenue growth.  

By understanding the concepts of base rent, breakpoint calculation, and negotiation strategies for percentage rent, you can make informed decisions that impact the financial dynamics of lease agreements.