What is a Percentage Lease?

In commercial property management, crafting lease agreements that align with landlord and tenant goals is crucial for long-term success. One creative approach is the percentage lease, which benefits both parties by tying the tenant’s rent to their revenue.

Keep reading for a detailed look at the benefits of these commercial lease agreements and how property managers use them.

What is a Percentage Lease?

A percentage lease is a type of commercial lease typically used in retail businesses. In this type of lease, the tenant pays a base rent, which is typically lower than the market rate, plus a percentage of their monthly sales revenue.

The arrangement creates a partnership-like scenario between landlords and tenants, with the property’s success directly influencing the rent a tenant pays.

Key Components:

• Base rent: A fixed minimum rent ensures landlords receive a guaranteed income.
• Percentage rent: An additional rent amount calculated as a percentage of the tenant’s gross sales over a certain threshold, called a breakpoint.
• Breakpoint: The sales level at which percentage rent kicks in.

Benefits of Percentage Leases

For Landlords:

• Aligned interests: Landlords share in the success of their tenants’ businesses, potentially earning more than with a fixed rent arrangement.
• Attractive to tenants: Lower base rent makes spaces more appealing to startups and businesses looking to minimize fixed costs.
• Market responsiveness: Rent adjusts with the tenant’s sales, reflecting current market conditions more accurately than a fixed lease.

For Tenants:

• Reduced risk: The lower base rent reduces financial pressure during slow periods.
• Flexibility: The lease cost adjusts with sales, offering a more sustainable model during economic fluctuations.
• Incentivized landlords: Landlords may invest more in the tenant’s success, contributing to marketing or property improvements.

Implementation

To effectively implement a percentage lease, property managers should consider the following:

• Thorough tenant screening: Since the landlord’s income partially depends on the tenant’s success, it is crucial to assess the tenant’s business model and financial health.
• Clear agreement details: The lease should clearly define terms for calculating percentage rent, sales reporting requirements, and audit rights to ensure transparency and trust.
• Fair breakpoint calculation: Establishing a fair breakpoint is essential for balancing risk and reward between the landlord and tenant. The natural breakpoint formula or an agreed-upon artificial breakpoint can be used.

Managing Percentage Leases

Effective management of percentage leases requires ongoing communication and collaboration between landlords and tenants:

• Regular sales Reporting: Tenants should provide regular, verified sales reports to calculate percentage rent accurately.
• Marketing collaboration: Landlords and tenants can work together on marketing efforts to boost sales, benefiting both parties.
• Periodic review: Lease terms, including the percentage rate and breakpoint, should be periodically reviewed and adjusted if necessary to reflect changes in the market or the tenant’s business.

Conclusion

Percentage leases offer a dynamic and mutually beneficial leasing arrangement for landlords and tenants in the commercial sector. By aligning the interests of both parties, these leases create a partnership that can adapt to market changes and promote shared success.

For property managers, understanding how to structure, implement, and manage percentage leases is crucial for maximizing property revenue while supporting tenant businesses. With careful planning and open communication, percentage leases can be an effective tool in the commercial property management toolkit.