May 31st, 2013, By Don Catalano
Common in regional shopping centers, percentage rent clauses in leases are not limited to that venue. While a percentage lease can help to motivate a landlord to promote his property, increasing your sales and his rent collections, it also carries the potential for wild swings in your rent that accrueto your landlord’s favor instead of yours.
In a lease with a percentage rent clause, you are required to report your sales to your landlord and to pay rent based on your sales. For instance, if your lease is based on a flat eight percent of your sales and one of your locations does $4,000,000 in business, you will have to pay an annual rent of $320,000. If your sales go up, your rent goes up, and if the sales go down, your rent should go down.
Some lease calculations are more elaborate and assign rent to different categories of sales. For example, one large drug store chain wrote some percentage leases that broke out front of store sales from prescription sales. Depending on the specific document, they either excluded prescriptions completely or assigned them a very low percentage. This allowed them to pursue increases their prescription sales more easily without having to worry about having to pay percentage rents.
While your rent should go down if your sales decrease, this doesn’t always happen. Many percentage leases have a minimum rent that you must pay. For instance, if the store that did $4,000,000 had a $340,000 break point, your rent would be $340,000, since that would be more than eight percent of the total sales. When your sales increase and the percentage rent is more than the minimum rent at the break point, you pay percentage sales, but when they drop, your rent can only drop so far.
As a landlord, a percentage rent clause is a relatively sweet thing to have. If it hits, it’s essentially free money, and this is one of the two problems with percentage rent for your business. When you sign a lease with a percentage rent clause and a break point, you’re taking all of the risk of inflation and of increasing rents while your landlord has the protection of a guaranteed floor below which the rent cannot drop. As such, if you must sign a lease with percentage rents, try to negotiate a break point that is as low as possible.
The other problem with a percentage lease is that it requires you to disclose your sales to your landlord. While it’s reasonable to insert language into the lease that protects the security of your information, you’re still going to have a copy of your sales data floating around. If your business is in an industry where per-store sales data needs to be kept confidential, this is a real risk.
Ultimately, unless you can negotiate a percentage rent structure that is unlikely to ever impact your business, there’s no reason to include percentage rent in your lease. In just about every case, it protects your landlord without taking care of you and, in some cases, compromises the security of your information. It’s a lease term to only accept if you have no other choice.