A percentage lease is a lease that requires a commercial space tenant to pay a "base rent" and, on top of that, to pay the landlord a percentage that is based on the business owner's monthly sales volumes. Percentage leases are commonly executed in retail mall outlets.
This type of lease agreement is most common for businesses with notoriously large sales volumes, but even a small business that wants to set up shop in a mall—to take advantage of the high volume of foot traffic—may be subject to it.
Percentage of Sales Taken
Percentage leases don't take a percentage of all sales. They include a percentage paid to the landlord or lessor only when a tenant has made a certain amount and exceeded a certain sales threshold in any given month. For example, a percentage lease might require a tenant to pay 7% of all sales that exceed more than $25,000 in sales in any given month. Seven percent is a common percentage lease figure, so if a landlord wants to charge you 10% or 12%, be leery.
Your breakpoint is the point at which a landlord will typically require that you begin paying percentage rent. The breakpoint in sales is the point at which your percentage rent equals your base rent. You can calculate your store's breakpoint by dividing your base rent by the percentage your landlord wants to charge you. For example, let's say your base rent is $4,000 a month. If you divide that number by 7%, it comes out to $57,142. This is the point at which you would begin paying percentage rent—when your gross receipts surpass this benchmark. At this point, you must pay 7% of each and every dollar in sales over the $57,142.
It's important to note that your gross receipts are really what counts when it comes to percentage rent—your revenues before you pay other expenses. In all likelihood, any potential landlord you deal with will ask for your minimum yearly sales and then she or he will calculate your base rent based on this information.
Negotiating the Percentage
There usually is not be much wiggle room when it comes to negotiating the percentage amount your landlord has in mind—unless of course they are being unscrupulous and want to charge a 10 percent or higher percentage. However, that doesn't mean you can't negotiate. You might find that a landlord is somewhat open to discussing the sales threshold after which the percentage rate kicks in. Obviously, the higher it is, the lower your total rent for the year will be.
Despite what seems like a non-negotiable way of leasing commercial property, no savvy business person should ever sign a lease without first attempting to negotiate better terms. Also, when you know your fixed rate for the year you can better adjust your expenditures if, let's say, you have an unusually slow sales period. This can happen to the most prepared business owner. For example, if you sell high-quality bed linens and a popular competitor opens a shop near you, your sales may unexpectedly suffer. You could counter by cutting back on non-essentials like your public relations campaign. Also, percentage leases are more complex than straightforward leases and could cost you a lot of money down the road. It always pays to have an attorney review any agreement before you sign and, if need be, negotiate on your behalf.