Real Estate Blog
Maximizing Percentage Rent: Pointers for Landlords
In exchange for creating a retail environment that increases the revenues of a tenant’s store, a landlord often negotiates for “percentage rent” in addition to the fixed rent due under a lease. “Percentage Rent” is the tenant’s payment of a percentage of its gross sales from the premises over and above a specified annual dollar amount or breakpoint. While the percentage rental rate and breakpoint will vary depending on the type of business being operated by the tenant, the amount of fixed minimum rent will take the percentage rent formula into consideration.
The amount of actual percentage rent payable depends upon the tenant’s financial success at the premises. Therefore, a tenant under a percentage rent lease should be required to make all efforts to maximize gross sales at the store. Additionally, the lease should include tenant reporting requirements and landlord audit rights to ensure the accuracy of the reported gross sales.
In order to realize the benefits of a percentage rent lease, landlords should include the following lease provisions:
1. Retail Restriction Limit. During the term, the tenant shall not engage in any business within a certain geographical radius of the premises similar to or in competition with the tenant’s operations at the premises. The distance of the radius will depend on the location of the premises. For example, the radius may only be a few blocks in an urban location and several miles in a suburban location. If the tenant violates this provision, the gross sales from the violating store should be included in the tenant’s gross sales.
2. Continuous Operation by Tenant. Tenant shall operate 100% of the premises during the term with due diligence and efficiency to produce the maximum amount of gross sales. Minimum hours of operation should also be required. In the event the tenant is not open for business during the days and hours required under the lease, the percentage rent breakpoint should be proportionately reduced or tenant should be required to pay 150% of fixed rent for each day that it is not open, which increased amount shall be deemed to be in lieu of percentage rent.
3. Definition of Gross Sales. The definition of “gross sales” should include all sales by the tenant and any sub-tenants from the premises, whether by mail, telephone, or on-line. Exclusions from gross sales should be limited. Standard exclusions include returns and refunds upon transactions included in gross sales, the amount of actual fees paid to credit card companies and taxes paid to the taxing authority. A frequently negotiated item is whether sales of gift certificates are included in gross sales upon sale or redemption thereof.
4. Records and Statements. Tenant should be required to prepare and keep at the premises adequate books and record showing gross sales for each month during the term of the lease and report gross sales to landlord on a monthly and annual basis. The annual gross sales statement should be certified by an executive officer of the tenant or be an audited statement prepared by an independent certified public accountant.
5. Audit Rights. Landlord should have the right to audit the tenant’s records of gross sales. If landlord’s audit shall disclose an understatement in gross sales for such period of three percent (3%) or more, then the tenant should be required to immediately pay landlord any percentage rent due on such deficiency together with interest and the cost of such audit.
These types of landlord oriented provisions will give the landlord the rights and remedies necessary to maximize percentage rent.