Different Kinds of Commercial Lease Types Focus: Percentage Leases
By LeeAssociatesApril 26, 2018
Different Kinds of Commercial Lease Types
Focus: Percentage Leases
When you are finally ready to lease space for your business, it’s always a good idea to fully understand the different kinds of leases available to you. Commercial leases are not one size fits all, therefore it’s important to find the lease option that works best for you and your business.
Looking at commercial leases may seem overwhelming, but this basic guide will give you a head start on what you should be looking for and how to find the right space for your business’ bottom line.
Rent Basis: Base rent + taxes, insurance & maintenance (utilities)
Commonly used in: Majority of commercial leases
Rent Basis: Base rent + percentage of monthly sales
Commonly used in: Retail businesses
In this last article on Commercial Leases, we are going to talk about Percentage Leases, their benefits and disadvantages.
A percentage lease is a lease where the tenant pays a base rent and a percentage on top of that based on monthly gross sales. These types of leases are commonly used in multi-tenant retail spaces, such as shopping malls. The argument for percentage leases is that shopping malls attract an ongoing flow of traffic, ensuring a natural draw for businesses located within the mall.
Typically, your base rent would be based on a dollar amount per square foot and the percentage rent would kick in after a certain amount of sales are made. This is called the ‘breakpoint’. If the breakpoint is never met, the tenant would only be responsible for the base rent.
The breakpoint in a percentage lease is most commonly a percentage (agreed upon by both the parties) of gross sales. This breakpoint is often established by dividing the base rent by the established percentage.
Let’s look at an example:
Base Rent: $2000/month or $24,000/year
Percentage Agreed Upon: 5%
Breakpoint: 24,000 divided by .05 equals $480,000/year
In this example, the tenant would have to pay 5% of sales after hitting that $40,000 breakpoint.
Please note: This is sometimes adjusted to a monthly basis.
Advantages to Tenant:
Strategically placed in a high traffic location
Seasonal business enjoy paying less when during their down months
Disadvantages to Tenant:
Unpredictable monthly payments
Must share revenue with landlord after breaking point (which if you have a large business with a lot of sales, may not be a huge factor)
Things to consider:
What types of revenue are included or excluded? For example, are employee sales counted toward revenue? What about returns? These are all very important aspects of a percentage lease that must be established before the contract is signed.
Some landlords require regular sales audits, so you will need to make sure those are readily available and accurate.
Advantages to Landlord:
Can decide which business to place where
Receive a percentage of all tenants sales
Commercial leases with percentage provisions have both up and down sides, however it is always important to understand the contract in full to avoid being caught off-guard with any massive payments down the road. Most percentage leases are in the 5% to 8% range, so if you have the option to negotiate, it’s always a plus to secure a higher breakpoint if possible. Some negotiating tactics might include paying a higher base rent with a higher breakpoint. This will allow you to profit at a lower sales level before having to pay the percentage rent.
There are many ways to negotiate a lease and you should always utilize the expertise of a broker to ensure that you are getting the best fit for your business, or if you’re a landlord, your property.