Percentage Rent, also known as “overage”, is a characteristic of many retail leases that allows the landlord to participate in the sales of the retail tenant at the property. The Percentage Rent is additional rent above the otherwise base fixed rent. The rationale behind this unique lease term, which is seen only in retail leases (and most prominently in multi-tenant properties for the in-line tenants), is that the landlord adds value by creating sales synergies from selecting the mix of retail tenants in a multi-tenant retail property.
For example, let’s assume there are 5 tenants in a strip center. On one extreme, those 5 tenants could have highly complementary natures for the customer of the center (e.g., there is a coffee shop, dry cleaner, drug store, hair salon, and a package shipping store), or on the other extreme, the tenants could have 100% overlap in what they offer the customers (e.g., all of the tenants are shoe repair shops).
Percentage rent calculations are typically driven off what is known as a “breakpoint”, which is a dollar amount of annual sales volume specific to the location above which a negotiated percentage of sales are paid to the landlord. For example, if the breakpoint is $600,000 in annual sales at the property, and the leased premises generate $5,000,000 in sales in a particular year, and the Percentage Rent percentage is 5.00%, then the Percentage Rent paid to the landlord would be (.05)*($5,000,000-$600,000), or $220,000.
Let’s take a look at two ways in which the percentage rent could be structured in a lease, and therefore calculated mathematically:
1. Using a “Natural” breakpoint
The “natural” breakpoint is solved for by dividing the annual fixed rent by the assumed percentage rent percentage. In our example from above, if the fixed rent were to be $500,000 per year, the natural breakpoint would be $500,000/.05, or $10,000,000. The percentage rent would then be 5% of all annual sales above the $10,000,000 breakpoint.
2. Using a Stipulated breakpoint
Instead of a natural breakpoint, sometimes the percentage rent is based off of a stated annual sales dollar value breakpoint. An example of this is if the stated breakpoint is $10,000,000, then the Percentage Rent paid in dollars is simply (.05)*([Annual Sales] – $10MM). (This assumes that the breakpoint is exceeded in that year’s sales. If it is not, then no percentage rent would be paid.)