Percentage Lease: Meaning and Example

Percentage Lease

As a landlord or tenant in commercial real estate, you can choose from various lease arrangements. One kind of lease is called a percentage lease. This page explains the percentage leases, including their operation, and other important information that commercial landlords should know. 

A Percentage Lease, Then, Is What?

In commercial real estate, a percentage lease is one kind of lease. A percentage rent lease, unlike net or gross leases, involves paying the landlord a proportion of the renter’s profits.

A percentage lease is most frequently utilized because of its structure when negotiating with a retail tenant, particularly if the tenant will be joining a multi-tenant retail space like a mall or shopping center.

This kind of lease has the advantage of potentially benefiting both the landlord and the renter. On the one hand, by carefully choosing companies that complement each other effectively in the space, the landlord assists the tenant in drawing in more customers. If a retail complex houses a restaurant, clothes store, nail salon, and tailor, for instance, it may entice clients to move between the stores, thus increasing foot traffic for all tenants.

However, an increase in rent from tenants helps the landlord, who is entitled to a higher rent payment. Once more, a percentage lease is designed to give the landlord a cut of the renter’s earnings. Under this kind of lease, the tenant will be required to provide the landlord with a share of their higher sales if there is an increase in foot traffic.

A Percentage Lease Is Used by Who?

Retail renters are the ones who use percentage leases the most. This lease type is frequently utilized by multi-tenant retail complexes like malls and shopping centers due to its mutually beneficial benefits.

Component of a Percentage Lease

1. Base Rent 

The predetermined monthly fee that the renter must pay the landlord to use the space is referred to as the base rent. Usually, it is calculated using a fixed dollar value per square foot (e.g., $6).

2. The Point of Break-Even

The break-even point denotes the monthly sales threshold that, if exceeded, will result in a portion of the sales being paid to the landlord in the form of additional rent. A break-even point of $500,000, for instance, indicates that the landlord will receive a portion of sales above $500,000.

3. The percentage of rent

The extra sales above the break-even mark are subject to a flat percentage charge known as percentage rent.

Who Gains the Most from a Lease That Is Prorated?

Leases with a percentage are intended to be advantageous to the landlord and the tenant.

With the help of this lease, landlords may choose exactly which companies to put in their multi-tenant building. Selecting companies that work well together will encourage clients to visit several locations.

Examples Of  percentage lease

You are aware of the concept of a percentage lease, but how do they operate?

Let’s examine an illustration:

A tenant pays $3 per square foot per month in fixed base rent while renting a 1,000-square-foot apartment. Thus, the total of their base rent is $3,000. The tenant and landlord decided on a variable rent of five percent and a break-even point of $25,000. The tenant will be responsible for paying 5% of any sales exceeding $25,000 to the landlord.

Percentage Lease Has Benefits for Both Landlords and Tenants.

A percentage lease presents a special chance for landlords to profit from their tenants’ commercial success. Landlords might profit from their shop tenants’ expansion in addition to their fixed monthly payments.

Some landlords have an immediate interest in the success of the retail business since they link rental income to the tenant’s sales revenue. This arrangement encourages landlords to actively support their tenants’ businesses, thereby fostering optimal conditions for their success.

However, tenants profit greatly from the percentage leasing arrangement as well. Tenants find the lower upfront costs to be among the most alluring features. Tenants can devote more funds to other crucial areas of their business, including marketing, customer service, and inventory if their base rent is reduced. This cash infusion can be extremely valuable for startups or businesses facing difficult financial times. 

Furthermore, after they reach a certain sales benchmark, tenants only have to pay a portion of their sales. This implies that leasing expenses rise in proportion to the company’s success when it performs well and surpasses expectations. This special feature helps tenants and landlords align their objectives as they collaborate to increase sales and profitability and lower risk for tenants during lean times. 

A Percentage Lease’s Drawbacks

One major drawback for the renter is that if they go beyond the break-even point, they have to give the landlord a portion of their sales. Additionally, the renter has the responsibility of providing their landlord with correct sales data and reporting any discrepancies.

The reduced base rent and the requirement to verify the veracity and integrity of the sales information supplied by the tenant are the primary drawbacks for the landlord.

To put it briefly, the landlord has asymmetric information when a percentage lease is in place. They run the danger of the renter faking lower sales figures to stay below break-even.

FAQs

Who Gains the Most from a Lease That Is Prorated?

Who gains the most from a lease that is prorated? Leases with a percentage are intended to be advantageous to the landlord and the tenant. With the help of this lease, landlords may choose exactly which companies to put in their multi-tenant building. Selecting companies that work well together will encourage clients to visit several locations.

For What Reason Is Effective Rent Calculated?

Net effective rent is the amount tenants pay for their lease after any concessions, discounts, or other incentives arranged with the landlord are subtracted. By calculating it, landlords can have a fair and sustainable return in the commercial real estate market while also giving tenants predictability in planning their spending.

How Much Will Rent Cost Overall for the Term?

A lease requires you to pay a set amount every month; your annual gross rent is the total of all your monthly rental payments. For example, suppose you have a one-year lease and your monthly rent is $2,000. Your gross rent for the year would be $24,000.

Bottom Line

To attract the best renters, landlords can make great use of a percentage lease. In a percentage lease, a portion of their total sales is added to the base monthly rent, which is smaller. When used carefully, a percentage lease can benefit all parties.

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