Percentage rent allows a retail landlord to benefit from a tenant’s success. In addition to the base rent, tenants will pay an additional rent based on some percentage of the tenant’s gross sales typically triggered by what is termed a “breakpoint”. New tenants asked to pay percentage rent are typically troubled by the idea mostly because they see it as a way of being penalized for success. Clearly, landlords benefit significantly from percentage rent reaping additional profits in times of economic boom while losing nothing during downturns. However, there is a synergistic effect that can benefit tenants. Most landlords aggressively seek to maximize profits and creating the right tenant mix and shopping center atmosphere aids in increasing the revenue stream for all tenants thereby increasing the landlords rent. In such cases, the landlord at least arguably is creating something of value for tenants. The value of a landlord’s labors in this scenario is of course difficult to measure, but with an earnest effort it can unquestionably have a dramatic impact on shopping center sales.
Percentage rent is typically set at five percent (5%) of gross revenue but usually doesn’t trigger until some “breakpoint”. The breakpoint can be arbitrarily set by the parties as a stipulated breakpoint (for instance at $1,000,000). In this case, a tenant would be obligated to pay 5% of all gross sales in excess of $1,000,000. If gross sales were $1,500,000, the tenant would owe as additional rent of $25,000 (5% of $500,000). Many retail leases set the breakpoint at what is termed the “natural breakpoint”. For the natural breakpoint, you divide the base rent by the set percentage (the typical 5%). The natural breakpoint results in a percentage rent applicable to sales over and above the point in which the base rent would equal 5% of gross revenue. In other words, the tenant is paying 5% of gross sales or the base rent whichever is higher. If the breakpoint is not reached, the base rent is higher than 5% of gross sales. If the base rent in the above example was $120,000 ($10,000 a month), the breakpoint would be $2,400,000 resulting in no additional rent due. The landlord is then guaranteed a minimum rent no matter how bad sales are, but benefits when sales are good. Tenants benefit if the stipulated breakpoint is above the natural breakpoint but not if it is below the natural breakpoint. In the above example, if the stipulated breakpoint is $4,000,000, the additional rent would be zero. If the stipulated breakpoint is $500,000, the tenant would pay the base rent ($120,000) plus a percentage rent of $50,000 (5% of $1,000,000).