Why Percentage Rent Works (for Both Landlords and Tenants)

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Percentage rent can be an extremely useful tool in customizing lease terms to fit a tenant’s specific needs and business model. The percentage, breakpoint, and base rent can all be negotiated until a deal is reached that benefits both landlord and tenant. For tenants it is crucial to understand their expense-to-sales ratio so that they can negotiate terms that minimize their fixed expenses (rent) all while maintaining a minimum level of gross profit. For landlords it is important to manage their properties efficiently and effectively to maximize the profitability of all their tenants and to understand enough about the prospective tenant’s business to accurately estimate gross sales potential. In this article, I will explain why percentage rent can be mutually beneficial to both tenants and landlords.

Percentage rent is unique to retail, particularly shopping centers and multi-tenant properties. Leases for free-standing retail properties are less likely to have percentage rent clauses because the concept behind it is that tenants benefit from the overall draw of the shopping center and their neighboring tenants. Landlords have an interest in cultivating a diverse tenant mix. The idea being to reduce competition among the various businesses thus increasing their likelihood for success. By maximizing the number of products and services offered by their tenants, landlords maximize the number of visitors to the center who may then patronize other businesses in the center. This provides a significant benefit to tenants and percentage rent is a way for landlords to share in the success promoted by their effective management. This is one part of the “why” percentage rent works.

It may seem that percentage rent only benefits the landlord, but this is not the case. Percentage rent only kicks in after a certain point in gross sales, and if the tenant does not hit the natural or artificial breakpoint they pay nothing (in percentage rent). Tenants benefit from percentage rent because it allows them to negotiate a lower base rent in return for a percentage of gross sales. Many retail businesses are seasonal and can experience periods of both feast and famine. A lower base rent coupled with percentage rent makes it easier for such tenants to succeed by reducing their fixed monthly expenses while setting a minimum level of profit (as it relates to gross sales). When the tenant wins the landlord wins. The landlord has every incentive to help the tenant reach and exceed the negotiated breakpoint so that percentage rent kicks in and they make up the difference from the base rent and market rent (if any). This is the 2nd part of “why” percentage rent works.

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