Percentage Rent in Commercial Real Estate Leases
In the world of commercial real estate, navigating through various lease types and their terms can be a complex task. One aspect that often puzzles tenants and landlords alike is the concept of ‘percentage rent’. This blog post aims to demystify percentage rent and explain how it’s calculated.
What is Percentage Rent?
Percentage rent is a common term in retail property leases. It’s an additional rent amount paid by the tenant, based on a percentage of the tenant’s gross sales. This model is particularly prevalent in shopping centers and malls, where the landlord’s income is in part directly tied to the success of the tenant’s business.
Why Percentage Rent?
The rationale behind using a percentage rent clause in a commercial lease is twofold. First, it aligns the interests of the landlord and tenant – as the tenant’s sales increase, both parties benefit. Second, it in part ties rent to actual sales rather than a flat rate, although leases are commonly structures such that tenent pays base rent and percentage rent only to the extent sales are above a cretain threshold.
Calculating Percentage Rent
The calculation of percentage rent involves several key components:
- Breakpoint: This is the sales threshold beyond which percentage rent is due. It can be a natural or artificial breakpoint. A natural breakpoint is determined by dividing the annual base rent by the agreed-upon percentage. For example, if the base rent is $120,000 per year and the percentage rate is 6%, the breakpoint is $2,000,000 ($120,000 / 6%). An artificial breakpoint is a predetermined sales figure, irrespective of the base rent.
- Percentage Rate: This is the agreed-upon percentage of gross sales that constitutes the percentage rent. It’s typically negotiated between the landlord and tenant and varies based on the type of business and location.
- Gross Sales: This includes all revenue from the business conducted on the premises, sometimes with specific exclusions agreed upon in the lease.
Example Calculation
Let’s say a tenant has an annual base rent of $100,000, and the agreed percentage rate is 5%. If the annual gross sales are $1,500,000:
- Calculate the natural breakpoint: $100,000 / 5% = $2,000,000.
- Since the gross sales ($1,500,000) did not exceed the breakpoint, the tenant would not pay any percentage rent.
However, if the gross sales were $2,500,000:
- Sales exceeding the breakpoint: $2,500,000 – $2,000,000 = $500,000.
- Percentage rent: 5% of $500,000 = $25,000.
In this scenario, the tenant would pay the base rent of $100,000 plus the percentage rent of $25,000, totaling $125,000 for that year.
Final Thoughts
Percentage rent offers a flexible arrangement that can benefit both landlords and tenants, especially in fluctuating market conditions. However, it’s crucial for both parties to understand the terms and calculations involved. Always consult with a real estate professional or legal advisor to navigate these agreements effectively.
