Understanding Percentage Rent: Benefits for Landlords, Tenants, and How Mohr Partners Can Help

Percentage rent is a unique and flexible rental structure in commercial real estate, particularly popular in retail leasing. It allows landlords to benefit from the tenant’s success, while tenants have a more manageable rent based on their sales performance. This blog will break down what percentage rent is, how it’s calculated, the benefits for landlords and tenants, the different types of breakpoints, and how Mohr Partners can guide clients in structuring these agreements.

What is Percentage Rent?

Percentage rent is a leasing structure in which the tenant pays a base rent plus a percentage of their gross sales once those sales exceed a predetermined threshold, known as the “breakpoint.” This setup creates an aligned incentive where the landlord benefits from the tenant’s success while the tenant pays less base rent but shares a portion of their sales once they exceed the agreed breakpoint.

How is Percentage Rent Calculated?

1. Base Rent: This is the fixed amount the tenant agrees to pay, regardless of their sales performance.
2. Breakpoint: The breakpoint is the sales threshold above which the tenant begins paying a percentage of their gross sales as rent. It’s often calculated as the base rent divided by the agreed-upon percentage rate.

Example:
If a tenant’s base rent is $30,000 per year and the percentage rate is 6%, the breakpoint would be:

Breakpoint=30,0000.06=500,000

This means the tenant will start paying percentage rent only after sales exceed $500,000.Percentage Rent: Once the sales exceed the breakpoint, the tenant pays a percentage of the sales that exceed the breakpoint. For instance, if the tenant’s sales exceed $500,000 by $100,000, and the agreed-upon percentage rate is 6%, the tenant would pay $6,000 in additional rent.

Types of Breakpoints in Percentage Rent

Breakpoints are crucial in determining when percentage rent starts. There are several types of breakpoints, each with its own calculation method and implications for both landlords and tenants.

1. Natural Breakpoint

The natural breakpoint is the most common type, calculated by dividing the base rent by the percentage rate. It’s simple and ensures that the percentage of rent is directly tied to the tenant’s base rent.

Formula:

Natural Breakpoint=Base Rent\ Percentage Rate

Example:
If the base rent is $30,000 and the percentage rent rate is 6%, the natural breakpoint is $500,000 in sales. The tenant will only start paying a percentage of rent once their sales exceed this amount.

2. Artificial Breakpoint

An artificial breakpoint is a negotiated sales figure that is often higher than the natural breakpoint. It’s not based on the tenant’s base rent but is mutually agreed upon by the landlord and tenant.

Example:
If a tenant and landlord agree on an artificial breakpoint of $600,000 in sales, the tenant will only pay percentage rent once sales exceed that threshold, regardless of the base rent or the percentage rate.

3. Sliding Scale Breakpoint

A sliding scale breakpoint involves adjusting the percentage rate once the tenant’s sales surpass certain thresholds. As sales increase, the percentage of rent may decrease, making the arrangement more favorable to the tenant at higher sales levels.

Example:
The tenant may pay 6% on sales up to $500,000 and 4% on sales above $500,000. If the tenant’s sales reach $700,000, they would pay:

• 6% on the first $500,000 = $30,000
• 4% on the remaining $200,000 = $8,000

Total percentage rent: $38,000.

4. Breakpoint with Minimum Rent (Floor Rent)

This structure combines a traditional base rent with percentage rent. The breakpoint is calculated based on the minimum rent (floor rent), and the tenant only starts paying percentage rent after exceeding the breakpoint.

Example:
A tenant pays a base rent of $25,000 and a percentage rate of 5%. If the breakpoint is set at $500,000, the tenant would pay:

• $25,000 base rent + 5% of sales exceeding $500,000.

If sales reach $600,000, the tenant pays an additional 5% of the $100,000 excess, which equals $5,000 in percentage rent.

Benefits for the Landlord

1. Increased Rent Potential: The landlord benefits from the tenant’s success, as rent increases with higher sales, potentially leading to a higher return on investment.
2. Shared Risk: Percentage rent allows landlords to share the tenant’s risk, especially in volatile industries like retail.
3. Attracting Quality Tenants: Offering a percentage rent structure can attract tenants who prefer a lower base rent, especially those with variable revenue, such as startups or businesses scaling up.
4. Motivation for Tenant Success: Since the landlord’s income is tied to tenant sales, the landlord has an incentive to support the tenant’s success, fostering a more collaborative relationship.

Benefits for the Tenant

1. Lower Base Rent: Tenants benefit from a lower base rent, reducing fixed costs and improving cash flow, especially in slow sales periods or early in the business lifecycle.
2. Risk Mitigation: The tenant pays lower rent during slower sales periods, which reduces their financial risk.
3. Aligned Interests: The tenant and landlord share the incentive to increase sales, creating a mutually beneficial relationship where both parties have a stake in each other’s success.

How Mohr Partners Can Help

Mohr Partners is an experienced partner in the commercial real estate industry[RV1] , offering expert guidance to both landlords and tenants when negotiating and managing percentage rent leases. Here’s how we can assist:

1. Lease Abstraction Services: We provide comprehensive lease abstraction services, simplifying complex lease documents by summarizing key terms and clauses. This ensures that tenants understand their obligations and rights clearly, minimizing the risk of disputes and misunderstandings.
2. Lease Administration Services: Our team also offers lease administration services to help clients manage the ongoing complexities of their leases. This includes tracking important dates, ensuring compliance with lease terms, and providing regular updates, so both landlords and tenants can stay on top of lease obligations with ease.
3. Lease Structure Consultation: We help both parties understand whether a percentage rent lease is the right choice and provide advice on structuring the best possible terms.
4. Financial Analysis: Our experts conduct detailed financial modeling to ensure the percentage rent arrangement works for both parties, considering projected sales and market conditions.
5. Market Insights: With our extensive knowledge of the commercial real estate market, we help our clients secure competitive terms that are in line with current market trends.
6. Negotiation Support: Mohr Partners offers expert negotiation services, ensuring that both landlords and tenants achieve fair, balanced, and profitable lease terms.

Percentage rent is a flexible and mutually beneficial leasing structure that allows both landlords and tenants to adjust to changing business conditions. By aligning the rent with a tenant’s sales performance, both parties share in the risk and reward of the tenant’s success. Whether you’re a landlord looking for a better return on your property or a tenant seeking flexibility, Mohr Partners can help guide you through the process, ensuring you get the best terms for your situation.

Are you considering entering into a percentage rent agreement or looking to renegotiate an existing lease? [RV1] Contact Mohr Partners today to speak with one of our experienced real estate professionals. Let us help you structure a deal that maximizes your benefits.