Percentage rent is a rent in which a commercial tenant pays rent based on a percentage of their gross sales, either in addition to or instead of a minimum base rent. It’s a standard lease payment model in retail, particularly with large retailers, where landlords can collect more rent from businesses they expect to be successful.
In most scenarios, there are three main components of percentage rent, all of which can be negotiated to shift the burden of risk between the two parties and create more favorable terms:
- Minimum base rent
- Percentage of gross sales
Typically, tenants want a low minimum base rent and a higher percentage. While this means they’ll pay a larger share of gross sales to the landlord, it also means the breakpoint is higher, so gross sales have to reach a higher threshold for percentage rent terms to take effect.
Landlords are most motivated to have a higher minimum base rent, but the percentage can be a bit of a calculated gamble. A lower percentage means they start collecting percentage rent sooner, which can be worthwhile if a business isn’t particularly profitable, but a larger percentage could pay off big if the lease is in a prime location or the retailer is projected to have a good year.
In this article, we’ll look at how to calculate percentage rent and what businesses can do to minimize the time they spend performing these monthly calculations across their entire portfolios.
There are three different ways to calculate percentage rent payments, depending on the terms of the percentage lease agreement. The formula varies slightly based on the point at which gross sales trigger percentage rent charges. This is known as the breakpoint, and landlords and tenants can negotiate to use either a natural breakpoint or an artificial breakpoint. (They can also forego minimum base rent and use a flat percentage of gross sales, which is less common and most risky for the landlord.)
The formula for calculating percentage rent with a natural breakpoint is:
(Gross Sales – Natural Breakpoint) x Agreed-Upon Percentage = Percentage Rent
The natural breakpoint is where gross sales equal the annual minimum base rent divided by the agreed-upon percentage. So if your annual minimum base rent is $200,000, and the agreed-upon percentage of gross sales is 7%, then the natural breakpoint is $2,857,142.86 (200,000 ÷ 0.07 = 2,857,142.86).
Once your gross sales exceed that amount, you pay 7% of any gross sales beyond that natural breakpoint in addition to the minimum base rent. So if you have $5,000,000 in sales, then your percentage rent is $149,998.99 ((5,000,000 – 2,857,142.86) × 0.07).
The formula for calculating percentage rent with an artificial breakpoint is:
(Gross Sales – Artificial Breakpoint) x Agreed-Upon Percentage = Percentage Rent
An artificial breakpoint is a static threshold agreed upon by the landlord and tenant. It’s less common than using a natural breakpoint, but it can make the threshold more favorable to one party over the other. If the artificial breakpoint is higher than the natural breakpoint, it creates more favorable conditions for the tenant. If it’s lower, the terms are better for the landlord.
For example, in the same scenario above, let’s say the artificial breakpoint was $2,500,000. Assuming the same gross sales of $5,000,000, calculating the percentage rent would look like ($5,000,000 – $2,500,000) × 0.07 = $175,000.
With either breakpoint, the tenant would pay the percentage rent in addition to the minimum base rent (plus common area maintenance charges, etc.).
The formula for calculating percentage rent as total rent is:
Gross Sales x Agreed-Upon Percentage = Percentage Rent
In some cases, a landlord may be willing to forego a minimum base rent and simply charge a tenant rent as a flat percentage of gross sales. In this model, the landlord’s profits completely depend on the tenant’s success as a business, and may mean the landlord collects a larger percentage of gross sales. Unlike with a breakpoint, this model gives the landlord the agreed-upon percentage of all gross sales.
Brick-and-mortar store locations play a key role in retailers’ omnichannel strategies. Even when a physical location isn’t the point of sale, it often serves as an inventory source or order fulfillment center for nearby online sales. Modern percentage leases often account for this by requiring tenants to include in a location’s gross sales any transactions where customers used methods like curbside pickup, buy online pickup in store (BOPIS), or local delivery through the location.
This makes compiling gross sales more complicated, and demonstrates the broader shift in understanding how brick-and-mortar contributes to digital sales.
Calculating percentage rent can often take 30 minutes per location every month. Multiply that across dozens, hundreds, or thousands of locations, and how much time are these tedious, repetitive calculations costing you each month?
Tango Lease’s Percentage Rent feature can cut that time down to a few minutes per location, giving you hours to reinvest in work that demands more of your lease department’s expertise. Our software automatically calculates your percentage rent based on your breakpoints and makes adjustments for exclusions and offsets.
Want to see how it works?