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Wharton Emeritus Professor Peter Linneman explains why percentage rent is justified.
BRUCE KIRSCH: It’s impossible to talk about the physical manifestations of properties without talking about leases. And so one of the things that we learn in the text is this notion of overage or percentage rent with respect to retail plazas. Can you just give a basic description of, why does it make sense for a landlord to essentially be able to take a tax on sales in a plaza?
PETER LINNEMAN: Well, it’s not a– it’s interesting. It’s more from the retailers point of view, namely, again, when I’m a retailer, and I’m renting from you– especially complex retail, highly interactive, highly spontaneous consumption retail– what I’m paying you for as a retailer is creating an environment that attracts customers. In other words, my Orange Julius stand or my little pizza stand is probably not going to attract a lot of people. Therefore, I need an environment that is quite rich.
And of course, every landlord is going to tell you, my retail environment attracts all these people, and everybody’s going to shop at your place. So you say, OK, fine, put your money where your mouth is. If you believe that people are going to come, then make some of the rent dependent on them coming, that is to say, on sales, because I believe I’ll get my sales if you can get people there. So to create a retail environment, to create those synergies, those positive spillovers between retailers, you make that rent.
Well, since– and if you think about, why aren’t there percentage rents in office? Well, everything’s internal. It’s not about, you created an environment where my business can occur. My business is occurring as Microsoft out there in the market somewhere, or if I’m an accounting firm, out there in the market. It’s not occurring because of your office space, whereas with retail, it is occurring because of the retail environment you create.
Similarly, my boxes are not being stored because you created a place where boxes can be stored. I got to store my boxes somewhere. So that’s why you’ll see percentage rents with the retailer basically telling the landlord, prove it to me. And that’s why the more complex the retailing is, the more I depend on a retail environment, the greater that there’s a reliance on percentage rents.
BRUCE KIRSCH: And so under that logic, in practice, do we see percentage rents ever in leases for the anchors, or is it just limited to the in-line tenants?
PETER LINNEMAN: It’s generally limited to the in-line tenants, because if I’m the anchor, I’m telling you, hey, I’m making the place. I’m the one bringing the customers with my sale advertisements, in particular. The anchor, yes, brings them, partly because I’m Macy’s or I’m a name that people recognize, but also partly because I’m the one who puts ads in the newspapers and on television and in stuffers saying, come shop, and our location is. I’m the one bringing them. So you don’t charge me percentage rents. You subsidize my rent, in fact.