Shopping centers rely on a unique mix of tenants to draw customers. Who doesn’t enjoy grabbing a bite to eat after purchasing a pair of tennis shoes? Malls and other multi-tenant spaces allow visitors to dine, browse and receive services in one location. With multiple restaurants and retailers, these spaces expect to see more foot traffic—and more sales.
Retailers in shopping centers are often bound to percentage leases and pay what’s called percentage rent (or turnover rent). Typically, only lease agreements for larger retailers in strip malls and shopping centers include percentage rent clauses.
What is Percentage Rent?
What is a percentage rent clause in a lease? And how do you calculate percentage rent? Many multi-tenant retail and mall lease agreements operate under the percentage lease system, which is where tenants pay two rent types: a base rent and an additional percentage rent.
A tenant’s base rent is a fixed number that’s agreed upon in the lease. Base rent is the set amount a tenant pays in rent each month. Landlords usually determine rent by the dollar amount per square foot of the space. Often, base rent will be lower if a percentage rent clause is included, reducing a tenant’s fixed operating costs.
Percentage rent starts once a tenant exceeds a certain amount in sales. When gross sales pass this amount, the tenant pays a percentage of every dollar to the landlord as rent. While tenants may benefit from lower base rent, landlords can profit from their tenants’ sales when sales are good.
What Percentage of Sales Should Rent Be?
The percentage of sales is up to the landlord and tenant. Most commercial landlords offer 7% on every dollar, which is the industry standard. However, there’s always room for negotiation. For example, retailers may request higher base rent payments to hold off when percentage rent would begin.
How to Calculate Percentage Rent
When percentage rent kicks in is based on a breakpoint, or the amount of gross sales tenants must meet each month before the landlord takes a percentage. You can calculate the natural breakpoint using a tenant’s gross sales and a percentage multiplier.
Natural Breakpoint Formula
Base Rent / Percentage = Gross Sales for Natural Breakpoint
To calculate the natural breakpoint in retail leases, take the base rent and divide it by the agreed upon percentage. The resulting number is the gross sales amount the retailer must reach before they start paying a portion of sales as additional rent.
Let’s say you have a base rent of $12,000 a month with a 7% multiplier. Your natural breakpoint would be $12,000 divided by 7%, which is $171,428 in gross sales. You would pay a percentage of any sales above this amount to your landlord.
With a natural breakpoint, the base rent and percentage are dependent on one another. Artificial breakpoints are based on agreed upon dollar amounts and percentages. In these scenarios, the artificial breakpoint may be higher or lower than the natural breakpoint.
Here’s an example. Your base rent is $45,000 a month, and 5% of your sales over $800,000 are to be paid as additional rent. If you make $1,000,000 in gross sales, you pay 5% of $200,000 as additional rent. Depending on the agreement, you could end up paying more or less in additional rent with an artificial breakpoint.
The higher the breakpoint, the less likely a tenant will hit the mark. Tenants who negotiate for higher breakpoints should expect increased base rents in exchange for the landlord’s potential lost rent from sales.
Percentage Rent Exclusions
Not every sale counts toward a tenant’s gross sales when percentage rent is concerned. Landlords and tenants must agree on what types of revenue count toward the tenant’s gross sales. Often, profit made from sources other than a retailer’s main inventory is not included in gross sales. Any exclusions concerning gross sales and percentage rent need to be added to the lease.
Common exclusions include:
- Discounted employee sales
- Charges paid directly to credit card companies
- Charges for extra services (like gift wrapping)
- Credits for customer returns
- Sales from gift cards before redeemed
- Sales made on equipment, fixtures or decor that are not the tenant’s regular merchandise
Tenants should make sure they understand their lease terms before signing, especially when it comes to percentage rent. Once you and your landlord agree on terms, it’s time to open your doors and focus on your retail shop’s success.
Are you looking for commercial real estate? Come see us in Branson!
With more than 120,000 visitors a day, Branson is the perfect place for retailers of all kinds! Our team at Commercial One Brokers would be more than happy to answer any questions you may have and guide you in your commercial real estate journey.