Percentage rent: Overview, definition, and example
What is percentage rent?
Percentage rent refers to a type of rental agreement commonly used in commercial real estate, where the rent is determined as a percentage of the tenant's gross sales or revenue, rather than a fixed amount. This arrangement is often used in retail leases, where the tenant’s business performance can influence the rent payments. The tenant pays a base rent (which is usually a fixed amount) plus an additional percentage of their sales that exceed a specified threshold, known as the "breakpoint." This type of lease benefits landlords by aligning their income with the tenant’s business performance, while it offers tenants the opportunity to pay rent based on their success.
Why is percentage rent important?
Percentage rent is important because it allows landlords to share in the financial success of their tenants, particularly in industries where sales can fluctuate, like retail. It can offer landlords a greater return if the tenant's business performs well. For tenants, percentage rent provides flexibility, as their rent payments are tied to their sales performance. If the business performs poorly, the tenant pays lower rent, which helps reduce financial strain. The structure also encourages landlords to support tenants in achieving high sales, creating a mutually beneficial arrangement.
Understanding percentage rent through an example
Let’s say a retail store leases space in a shopping mall under a percentage rent agreement. The base rent for the store is $2,000 per month, but there is also a percentage rent clause, stating that the tenant will pay an additional 5% of their gross sales over $50,000 per month. If the store generates $80,000 in sales during the month, the additional rent would be calculated as 5% of the $30,000 in sales above the $50,000 threshold, resulting in an additional $1,500 in rent for that month. Therefore, the total rent for that month would be $3,500 ($2,000 base rent + $1,500 percentage rent).
In another example, a fast food chain signs a lease agreement in a prime location with percentage rent terms. The base rent is $5,000 per month, with an additional 4% of sales over $100,000. If the restaurant makes $120,000 in sales during the month, the percentage rent would be 4% of the $20,000 in excess sales, amounting to $800 in additional rent. The total rent due for the month would be $5,800.
An example of a percentage rent clause
Here’s how a percentage rent clause might look in a commercial lease:
“In addition to the base rent of $3,000 per month, Tenant agrees to pay as additional rent 6% of the Tenant's gross sales exceeding $100,000 per month. The percentage rent shall be payable on the 10th day of each month for the preceding month’s sales. The base rent is due regardless of the Tenant's sales.”
Conclusion
Percentage rent provides a flexible and dynamic rental structure that can benefit both landlords and tenants, particularly in commercial leases. For landlords, it offers a potential for higher rent based on the tenant’s performance, while for tenants, it ties rent payments to their ability to generate sales, offering a cushion during slower periods. This type of lease is commonly used in retail environments, such as shopping centers and malls, where sales can directly impact the space's value. By understanding percentage rent, both parties can better navigate lease agreements and align their interests for mutual success.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.