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In addition to net rent, base rent, minimum rent, CAM and TMI, percentage rent in commercial leases is a common negotiable item that is negotiated between tenants and landlords.
Percentage rent in a commercial lease is a rental component in addition to the gross rent payable and is a percentage of the gross sales of the tenant.
Percentage rent is typically found in retail leases – more particularly in shopping mall leases as opposed to store front retail. It is not standard, but not uncommon either. We have found that 20% of shopping mall leases that we have reviewed contain the clause.
Percentage rent typically does not start at $1 of revenue. It is designed to kick in once the retail tenant is safely making a profit and the landlord participates in the upside of the tenant’s sales. This is called the breakpoint or natural breakpoint.
For example, the landlord may be entitled to percentage rent of 6% on sales over $800,000. If the tenant has $799,000 in sales, there is no percentage rent for the landlord.
No. Tenants in a shopping mall will have varying levels of revenue and each will have distinct Base Rent and inducements, and this is one of the negotiable items.
As a general rule, most landlords will either be in favor of a percentage rent clause or not, and will likely want to have all of their tenants to have this obligation, or none at all.
This can be a contentious issue among tenants in a mall that chat with each other. Discovering that you have to pay a percentage of your sales to the landlord and another tenant does not can be very upsetting.
The percentage rent clause is a bonus or the landlord, and every landlord will consider trade offs in the negotiation, such as whether the tenant is personally guaranteeing the lease, and the sum of all the wins and losses in the lease negotiation will dictate whether the percentage rent clause will remain in or be removed from the lease.
There will be a clause that will elaborate on their ability to inspect your sales records. It is typically monthly (some are quarterly).
If you are successful in deleting the percentage rent clause, then be sure to find the Access to Financial Information clause and delete that as well. If you do not the landlord may have the ability to request your financials, but the spirit of the clause was to support the percentage rent obligation.
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This is completely dependent upon the expected sales, the industry, nature of the property, vacancy rate within the property and the real estate market and the dynamics between the landlord and tenant.
If the tenant is successful in negotiating favorable inducements such as free rent, cash allowances, or has avoided a personal guarantee, the landlord may seek some victories in the form of a more landlord-friendly percentage rent clause that has a high percentage rent, or a low natural breakpoint.
As a general rule, we typically see percentages in the range of 4% - 8% and the natural breakpoint is in the $600,000 - $800,000 of gross sales for tenancies in the 1,000 – 3,000 square foot range.
Welp. It depends.
What does the lease say?
Most leases are silent on this issue, and instead refer to “Gross Sales”, and the definition of those gross receipts are typically not inclusive of online sales, but they are not specifically excluded either.
Unfortunately there are no clear guidelines on this. Online sales have exploded over the past decade, and most commercial leases for shopping centers have not kept up with the times.
Part of the reason for percentage rent is that the landlord has created an attractive environment for consumers to shop and therefore they should participate in the success of the lessee. It also provides them an incentive to keep the property appealing. A successful Shopify site that bolsters the tenant’s sales does not have anything to do with the landlord, unless the buyers browsed through the bricks and mortar store and made an online purchase at a later time.
Obviously a tenant would prefer to have a limited definition of what the gross sales are, and the landlord would want to have a broad definition to include all online channels.
Gross revenue shall include the sale of all goods, merchandise or services leased or sold at, in or from the Leased Premises (whether or not filled at the Leased Premises) including any sales on computers, tablets, electronic devices or other technology.
This is broad enough to capture a number of e-commerce and online transactions.
Gross Revenue shall exclude all telephone, computer, internet, online or electronic orders of merchandise regardless of where such orders are placed, delivered or received (except orders placed through registers within the Premises which shall be included in Gross Revenue).
Here is a more thorough and standard clause found in a shopping center lease:
Section 3.02 GROSS SALES REPORTING FOR PERCENTAGE RENT.
Showrooming – a customer tries a pair of shoes in at a shopping mall. Instead of purchasing, they discover in-store that there is an online special offered by the company and places an order while at home.
A customer orders a product online and picks it up in store. While there, they discover they prefer a different make or model, and they order a new product in store, which is sent directly to the customer’s home.
A consumer shops online while in a mall food court and orders a product to be picked up within the mall on the same day.
A customer cannot find a product in store and a store employee places an order for them online.
While all of the above examples touch the store, there is no clear and absolute attribution to exclusively the store, or online.
Things can get even trickier when a business has more than one location and may not be able to allocate sales to a particular store.
As the lines between the online and offline worlds blur, is there a place for percentage rent?
As tech and shopping continue to evolve, the concept of the landlord participating in the tenant’s success in online sales will be a tricky discussion to navigate. Negotiation power of the parties will always dictate whom the lease will favor, and a successful online retail strategy will put plenty of money on the table for negotiation.
Technology and buying patterns are changing at a much faster pace than lease templates and as landlords continue to wake up to the dollars they are leaving on the table new precedents will be set on what is normal for a percentage lease with respect to online sales.