Percentage rent is a simple enough concept. It is additional rent paid (over the base rent) based on a percentage of gross sales.
Percentage rent is a common lease term for shopping centers and other multi-tenant retail properties. Tenants benefit from the overall draw of the shopping center and their various neighboring tenants. Retail landlords, moreso than any other real estate asset class, must pay special attention to their tenant mix. They do not want a Subway next to a Potbelly next to a Firehouse Subs. Through efficient and effective management of a center, landlords reduce competition amongst tenants thus increasing their likelihood of success and profitability. Percentage rent allows landlords to share in the profits they helped generate.
Percentage rent is generally charged on an annual basis and only applies after gross sales reach a certain amount. This amount is called the “breakpoint” and can be either artificial or natural. If the breakpoint is not met the tenant does not have to pay any percentage rent. An artificial breakpoint is simply a dollar amount (gross sales) agreed upon by the landlord and tenant after which percentage rent kicks in. The natural breakpoint is determined by dividing the annual base rent by the percentage rent. For example:
- Base Annual Rent: $100,000
- Percentage Rent: 5%
- Natural Breakpoint: $2,000,000 ($100,000 / 5%)
If the tenant has sales under $2,000,000 they pay no percentage rent; however, if they have gross sales of $2,200,000 the tenant would be required to pay $10,000 of additional/percentage rent ($2,200,000 – $2,000,000 = $200,000 x 5% = $10,000).
As stated previously, percentage rent is simply enough to understand; however, when negotiating specific terms governing the amount, breakpoint, etc. things can get complicated and require an in depth analysis and understanding of a particular tenant’s business.
I will cover percentage rent in greater depth in subsequent articles, but in the meantime, if you have any questions please contact me, Ryan Rauner, CCIM at Ryan@RealMarkets.com or 703.943.7079.