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A percentage lease is an excellent option for landlords who want to entice ideal tenants. A percentage lease is a lower base monthly rent with an added percentage of their gross sales. A percentage lease can be a win-win for everyone involved when utilized strategically.
This article defines percentage leases as well as how they work, negotiable terms, and other vital details commercial landlords should understand.
What is a Percentage Lease?
A percentage lease is a real estate legal document for a commercial lease where the tenant pays a percentage of revenue in addition to their base rent amount. The tenant usually pays a lower base rent, which can become a selling point of the lease. After a specific sales threshold or breakpoint, the landlord can begin charging them a gross revenue percentage to offset the low base rent.
This web page also defines percentage leases.
How Does a Percentage Lease Work in Real Estate?
Percentage leases are often used with multi-tenant retail properties.
Here’s an example of how a percentage lease works in real estate for greater clarity and understanding :
- MacKenzie Flynn is a real estate entrepreneur
- She sees an opportunity to purchase a vacant outlet center
- Flynn believes that if she attracts the right tenants, she could profit considerably using percentage leases long-term
- All tenants receive a low initial base rate of $20 per square foot plus 7 percent of gross sales above the natural breakpoint
- Flynn drafts her percentage lease agreements to account for these terms with complementary businesses
- Over five years, she fills the outlet center with high-end retailers and makes property improvements
- Not only is Ms. Flynn’s rental business booming, but her clients are enjoying heavy foot traffic
- Each year, her tenants’ sales increase by 15 percent each year, which means that Ms. Flynn saw an increase in commercial rental income as well
- Flynn’s percentage lease strategy was the right decision
This example shows that the strategic use of percentage leases can help aligned parties make a considerable profit while strengthening the local commerce ecosystem. However, these types of lease agreements are not suitable for every landlord, tenant, business, or industry, meaning that you should carefully consider your options before offering them to prospective tenants.
Who Benefits from a Percentage Lease?
A percentage lease can benefit either the tenant or landlord. Certain tenants may enjoy percentage leases due to the lower monthly fixed rental costs. Their use often applies to high traffic areas such as shopping malls, outlets, and shopping centers since percentage leases can benefit tenants with high and low sales volumes.
Percentage leases benefit the property owner as they allow for the strategic selection of the businesses that will occupy the retail space. As a result, strategic leasing can increase customer traffic to the space, allowing the landlord to negotiate a percentage of sales over time. However, not all businesses may be willing to agree to a percentage lease, which may limit the landlord’s options.
A percentage lease is not appropriate for every commercial rental situation. Always seek legal advice if you have questions about how to structure and negotiate your lease terms. For example, you may want to consider gross leases for commercial office lease rentals or modified gross leases for entire building leases.
Terms to Negotiation in a Percentage Lease
When negotiating a percentage lease, it’s essential to discuss the lease term and who will be responsible for operating expenses. You will also want to discuss base rent amounts, breakpoints, and percentage rents.
Let’s take a closer look at the terms to negotiate in a percentage lease :
Term 1. Base Rent
A commercial lease agreement that offers a percentage rent clause will also include a specified amount of base rent. Typically, this minimum rental cost is calculated on a per-square-foot basis.
Regardless of the tenant’s revenue, the base rent of a percentage lease agreement must be remitted to the landlord. It is the bare minimum amount that the property owner can expect to earn from each tenant in this leasing situation.
Term 2. Breakpoint
The landlord will not begin collecting a percentage of the tenant’s income until a certain level of gross sales is reached. This amount is typically expressed in dollars and is referred to as the break-even point, defined as an article or natural breakpoint. Many small business owners prefer a natural break-even point over an artificial one because it ensures that the break-even point is greater than the gross sales revenue required to pay the base rent.
Term 3. Percentage Rent
Finally, both parties must agree on a percentage rent. This figure is typically a flat percentage representing the income amount above the breakpoint. For example, landlords and tenants may agree that percentage rent will apply to seven percent of gross sales above the breakpoint.
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Percentage Lease vs. Net Lease
Percentage and net leases are common leasing models in commercial real estate, but they have some essential distinctions. Percentage leases require commercial tenants to pay a base rent plus a percentage of gross sales once they reach a specified revenue level. On the other hand, net leases do not include gross sales, and the tenant is responsible for base rent, maintenance, insurance, and taxes.
Let’s take a closer look at net leases for a better understanding of their fundamental differences :
What is a Net Lease?
Net leases are commercial lease agreements in which the tenant pays a portion or all of the property’s taxes, insurance, and maintenance costs in addition to the base rent. In commercial real estate, net leases are common and often come in the form of single net leases, double net leases, and triple net leases . Keep in mind there are different net leases and the costs the tenant is responsible for will vary.
How is a Percentage Lease Calculated?
You calculate percentage leases using a straightforward equation representing the total rent a tenant must pay in place of base minimum rent. The tenant is responsible for the landlord’s triple net costs and expenses along with percentage rent.
Start with the following three variables:
- Variable 1. Percentage rent
- Variable 2. Gross sales
- Variable 3. Rental square footage
Insert these variables into the following equation:
(Negotiated Percentage X Gross Sales) / 12 = Price Per Square Foot
If the landlord’s target rent is above the price per square foot, they fell short of their objectives. However, if this number is higher than the target, the landlord’s strategy pays off.
We should also note that lease vs. rent differ. The former connotes long-term limits, whereas the latter signifies a monthly agreement.
What is the Percentage in Retail?
The percentage in retail under percentage leases is about seven percent. Businesses most frequently use this type of lease agreement with high sales volumes. However, it may also apply to a small business looking to establish a high foot traffic presence.
The terms are often more affordable for the retailer since they don’t have to pay more for rent if sales are slow for a given period.
Get Legal Help with Percentage Leases
Commercial lease lawyers can help you with percentage leases. They offer insight on drafting the documents you need and how to negotiate a commercial lease. Get in touch with a commercial lease lawyer from your state today.
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Meet some of our Percentage Lease Lawyers
Craig M.
I have been practicing law for more than 7 years in Maine and have owned my law practice, Dirigo Law LLC, since 2020. My practice focuses mostly on Real Estate / Corporate transactions, Wills, Trusts, and Probate matters.
Melissa G.
My name is Melissa “Mel” Green and I provide legal counsel to entrepreneurs, start-ups, and small businesses that is clear, concise, and focused on the practical impact of decisions. As trusted legal counsel, I proactively identify risks, and develop effective, practical solutions that protect my clients businesses, create positive outcomes, and help mitigate legal exposure. My areas of expertise include business formation, contract law/commercial transactions, healthcare law, and intellectual property. I also provide services as an outside general counsel or “fractional general counsel”. Prior to starting my own law firm, I spent the majority of my career in-house at large and small corporations, both for profit and not-for-profit, working with senior and executive management, in addition to other stakeholders at a variety of management levels. to proactively identify and address risks, mitigate legal exposure, streamline processes, lead persuasive negotiations that are integral to ensuring positive outcomes for the organization, and deliver hands-on, spectacular client service. There came a time when I realized that individuals and smaller entities were not receiving the same level of legal support and guidance as mid-size to large companies and as a result, individuals and small businesses were not growing and sustaining on the same level. I wanted to use my expertise to provide those that were underserved by the legal market with competent counsel at an affordable price. With the increasing number of new businesses, I knew that I could make a difference to those that needed legal guidance but were putting it off in fear of “Big Law” prices. I love to “partner” with my clients, get a deep understanding of their business, develop lasting professional relationships and watch them prosper. I want to find a way to help my clients maximize the reach, value and impact of their business. Services that I have provided over the course of my career: (i) reviewing, drafting and negotiating commercial agreements (leases, MSAs and SOWs, consulting services agreements, confidentiality agreements, SaaS agreements, coaching agreements, independent contractor agreements, coaching agreements, photographer agreements, waivers and releases, licensing agreements, etc.), (ii) business formation (operating agreements, written consents, bylaws, etc.), (iii) preparing policies and procedures for businesses in highly regulated industries, (iv) conducting federal trademark searches and filing trademark applications/preparing trademark opinion letters after conducting appropriate legal research, and (v) general business counsel.
Robert Jay H.
My Legal career hasfocused on representing businesses (corporations and limited liability companies) as general outside counsel. In this capacity, I have drafted a broad range of legal documents as well as analyzed proposed agreements drafted by the other party's attorney to the agreement for the pupose of determining the risks to which my client would be exposed. I maintained the client's minute book if no one in-house was available for that task. Additionally, if rquested, I served as a general advisor to the client's executive offers and to its Board of Directors.
July 29, 2021
Stanley K.
Stan provides legal services to small to medium-sized clients in the New England region, and throughout the U.S. and abroad. His clients are involved in a variety of business sectors, including software development, e-commerce, investment management and advising, health care, manufacturing, biotechnology, telecommunications, retailing, and consulting and other services. Stan focuses on the unique needs of each of his clients, and seeks to establish long term relationships with them by providing timely, highly professional services and practical business judgment. Each client's objectives, business and management styles are carefully considered to help him provide more focused and relevant services. Stan also acts as an outsourced general counsel for some of his clients for the general management of their legal function, including the establishment of budgets, creation of internal compliance procedures, and the oversight of litigation or other outside legal services.
July 30, 2021
Sam W.
Sam Widdoes has practiced law in California since 2014. He began his career as a litigation associate at a boutique firm in Los Angeles, and founded a production development company with a partner in 2017. Since then, Sam has served as the head of business and legal affairs at District 33, while working hand-in-hand with writers, directors and actors to develop, pitch and produce scripted and unscripted content. In that role, Sam produced the documentary series BLACKBALLED for Quibi/Roku, and will produce the upcoming documentary feature AS WE SPEAK directed by J.M. Harper for Paramount+/MTV, and the doc series THE BLACK BOX for MRC and XYZ Films. He is also the executive producer of an upcoming limited series with CBS TV starring Judith Light and Noah Wyle called SHADOWS IN THE VINEYARD, and a feature comedy for Spyglass Entertainment, among other projects. In early 2022, Sam opened WIDDOES LAW, APC, after recognizing a need for experienced legal services in the unscripted and documentary spaces. Since opening his own practice, Sam has advised producers, editors, directors and rights holders on a variety of agreement negotiations, including option purchase contracts, collaboration agreements and documentary producer deals. Sam also serves as production counsel for several documentary features, series and short films, and will draft, negotiate and advise on all legal aspects of the projects, including financing, production and distribution. Sam earned his Juris Doctor from The Catholic University of America, Columbus School of Law in 2013, where he graduated on the Dean's List and as a member of the Society of Trial Advocates. He holds a BA in journalism from the University of Richmond, and sits on the Board of Trustees at Turning Point School in Culver City, California. Sam is passionate about quality storytelling, and supporting those with the vision and drive to share their stories with the world.
August 3, 2021
Robert D.
Robert is a skilled corporate lawyer, licensed to practice law in NY and DC. He has over 25 years of experience, with a focus on Venture Capital, Private Equity, M&A, General Business Law and Company Formation. Robert brings business side experience to every legal transactions. This allows him to shape a client's legal needs around its business goals to drive success in an effective and efficient manner.
August 4, 2021
Spencer W.
I’m a New York based attorney with substantial experience in media and art law, corporate structuring and commercial contracts. For the past several years, I have been advising startups and new business on their legal needs, with a special focus on tech and entertainment.
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