A percentage rent clause is a provision in a commercial real estate lease that requires a tenant to pay a portion of their gross sales revenue to their landlord as rent if their revenue exceeds a set amount. This percentage rent is typically accompanied by a fixed amount of rent that is paid every billing period, regardless of the business’s performance. This can lead to rent costing more or less for the tenant, depending on the success of their business. This is most common in shopping malls or in other rented business spaces.
Components of Percentage Rent Structure
- Base rent: This is typically a fixed amount that must be paid every billing period. This will not change and is not based on the performance of the leasing business.
- Breakpoint: This is typically a dollar amount threshold of gross sales revenue that must be met for the additional performance-based portion to be applicable. The breakpoints can be one of two ways:
- Natural Breakpoint: This is calculated by dividing the yearly base rent by the agreed-upon percentage rate.
- Artificial Breakpoint: This is any breakpoint that differs from the natural breakpoint described above. This artificial breakpoint can be based on projected performance, market conditions, or any other relevant factor. This can be negotiated between the landlord and tenant.
- Percentage Rent: This is a variable amount of rent that is based on a percentage of all sales that exceed the breakpoint.
How Percentage Rent Clauses Work
In most cases where percentage rent clauses are utilized, the tenant pays a base rent each billing cycle (usually once per month). Each billing cycle, the tenant reports their gross sales revenue to their landlord. If this amount is above the agreed-upon breakpoint, then the tenant is responsible for paying the landlord a set percentage of that exceeding sales revenue. If the breakpoint was not reached, then the tenant does not have to pay anything additional.
Benefits of Percentage Rent:
- Aligned interests: Percentage rent clauses are a great way to align interests between landlords and tenants. If a tenant’s business succeeds, both landlord and tenant will share in that success.
- Mutual protection when there is lower productivity: In the event a tenant’s business does not succeed past the breakpoint, the landlord will still get their base rent, but the tenant will not have to pay anything more.
Downfalls of Percentage Rent:
- Fluctuating rent: Operating under a percentage rent structure means that a tenant might owe the landlord a vastly different amount in rent each billing cycle. This can be difficult for the landlord and tenant alike to plan their income/expenses each billing cycle.
- More reporting: The tenant will have to keep highly accurate and transparent records, and the landlord will have to verify these records on a regular basis. Each party will have to devote a significant amount of time to ensure the rent has been calculated properly each month, which can increase administrative costs.
Is A Percentage Rent Clause Right For Me?
To determine if a percentage rent clause is right for you, whether you are a landlord or tenant, it is important to discuss it with an attorney. Contact one of our real estate attorneys today by calling 608-784-8310 or reach us via email.