Real Estate Blog
Percentage Rent: How it’s Calculated
Percentage Rent is intended to reward the Landlord for creating a successful retail environment wherein the Tenant exceeded a sales benchmark (“breakpoint”) establishing a level of profitability. The Tenant, on the other hand, is given a lesser base rent than it would otherwise pay in exchange for making the Landlord a stakeholder in the Tenant’s business at that location. If the gross sales exceed the breakpoint (which may be calculated in different ways), the Tenant pays the Landlord the stated percentage on every dollar of gross sales in excess of the breakpoint.
The breakpoint may be a fixed amount that Landlord and Tenant have determined is the appropriate level of gross sales after which landlord is entitled to share in the Tenant’s bounty by receiving a percentage of each dollar after the breakpoint as a reward for having created such a robust sales environment for the Tenant.
The breakpoint may be a function of the base rent and, as such, is expressed as a “natural” breakpoint, and is determined by dividing the annual base rent payable by the percentage that Landlord and Tenant have agreed is the appropriate percentage, given the base rent and the nature of Tenant’s business. By way of example, if the base rent is $50,000 per annum, and the percentage rent number is 4%, the “natural” breakpoint is determined by dividing 50,000 by 4% = $1,250,000. For every dollar of sale after $1,250,000 Landlord will receive 4% of that dollar as percentage rent.
Gross sales may be reported monthly, quarterly, or annually; and percentage rent may be payable when the breakpoint is exceeded. The breakpoint may also be established as a quarterly breakpoint or annual breakpoint.
In most instances, the true up is done at the end of the calendar year upon delivery of the gross sales statement for the entire year. Monthly and quarterly statements are typically certified to be true and correct by an officer of the Tenant, and annual statements generally require a certification from an independent certified public accountant. The Tenant should require that the gross sales statements be kept confidential.
The Landlord should have the right to audit Tenant’s gross sales to ensure the veracity of the statements. The Tenant, on the other hand, wants to ensure that it is given an entire year of sales before being assessed percentage rent so that the quiet shopping months (generally the summer months) are counted together with the busy shopping months (typically Thanksgiving through Christmas).
The last part of the percentage rent analysis is to determine what is included, and what is excluded, from percentage rent. Typical exclusions are the amounts of all discounts, refunds, credits, allowances and adjustments made to customers, and the amounts of all retail sales taxes which are charged specially to customers as retail sales taxes. The sales price of both cash sales and credit sales are generally included upon the delivery of the merchandise or the laying away of the merchandise for the customer or the rendering of the service, the risk of collection in the case of credit sales being upon the Tenant.
An example of a typical percentage rent clause is below.
(A) Tenant agrees to pay to Landlord as rent in addition to the foregoing minimum rent such sums as Landlord may become entitled to under the provisions of this Article 4, such sums being sometimes called “percentage rent”.
(B) The first (1st) lease year shall be a period commencing upon the commencement date of the term of this lease and terminating on the last day of that January next following said commencement date. The second (2nd) and succeeding lease years shall be periods of exactly twelve (12) months following successively thereafter, except, however, if the term of this lease shall terminate on a day other than the last day of a lease year determined as above provided, then the last lease year shall be a period of less than twelve (12) months commencing upon the first day of a lease year determined as above provided and terminating upon the day the term of this lease shall terminate.
(C) (1) The “gross sales of the demised premises” for any lease year shall be the total amount of all sales of merchandise or services made in, upon or from the demised premises during said lease year, whether the same shall be made by Tenant or by any other person, at wholesale or at retail, whether for cash or on credit, whether delivered from the demised premises or elsewhere, including, but without limitation, telephone orders and mail orders, except that the following shall not be included in gross sales of the demised premises for said lease year, or if previously included in gross sales of the demised premises for any lease year, the same shall be deducted from gross sales of the demised premises for said lease year: (a) the amounts of all discounts, refunds, credits, allowances and adjustments made to customers and (b) the amounts of all retail sales taxes, which are charged specially to customers as retail sales taxes. The sales price of both cash sales and credit sales shall be included in gross sales of the demised premises upon the delivery of the merchandise to the customers or the laying away of the merchandise for the customers or the rendering of the service, the risk of collection in the case of credit sales being upon Tenant. The percentage rent payable for each lease year shall be a sum equal to the amount, if any, by which ____ percent (__%) of the gross sales of the demised premises for said lease year exceeds the minimum rent paid for said lease year. Minimum rent for any period of time shall be deemed to mean the minimum rent provided in Article 3 to be paid for said period of time less amounts suspended or abated therefrom in accordance with the provisions of this lease.
(2) On or before the fifteenth (15th) day after the expiration of each month during the term of this lease, Tenant shall submit to Landlord a monthly statement showing the gross sales of the demised premises for said month. Commencing with the month in any lease year in which any Sales Base shall be reached and for each month thereafter during said lease year, Tenant shall pay to Landlord the amount of percentage rent then due as shown by the monthly statement for said month, which percentage rent shall be paid by Tenant to Landlord at the time said monthly statement shall be submitted as aforesaid. On or before the thirtieth (30th) day after the expiration of each lease year, Tenant shall submit to Landlord an annual statement showing the gross sales of the demised premises for said lease year, and at such time there shall be an adjustment between Landlord and Tenant, with payment to or repayment by Landlord, as the case may be, to the end that Landlord shall receive the entire amount of percentage rent payable hereunder for said lease year, and no more. Monthly and annual statements shall be signed by a principal executive of Tenant, and annual statements shall be certified by a certified public accountant. Tenant agrees to keep in the demised premises full and complete records of all sales and services, in, upon or from the demised premises (including deductions or exclusions therefrom), whether made or rendered by Tenant or by any other person. Such records will be retained by Tenant for not less than three (3) years after the expiration of the lease year to which they relate, and such records will be kept in accordance with sound and generally accepted principles of retail store accounting, and without limiting the generality of the foregoing, such records shall include daily records of cash and credit sales and copies of all reports filed with any governmental body in connection with the collection of sales taxes and/or taxes in the nature of sales taxes. Landlord or its agents may at reasonable times inspect and audit such records. The receipt by Landlord of any statement or any payment of percentage rent for any period or the failure of Landlord to make an inspection or audit for said period shall not bind Landlord as to the correctness of the statement or the payment, nor bar Landlord from collecting at any time thereafter the percentage rent due for said period. If any inspection or audit by Landlord or its agents of Tenant’s records shall reveal a deficiency in any payment of percentage rent, Tenant shall forthwith pay to Landlord the amount of the deficiency together with interest at the Lease Interest Rate from the date when said payment should have been made. If the gross sales of the demised premises reported by Tenant for any lease year shall be understated by more than one percent, Tenant shall pay to Landlord, in addition to all other payments, the cost of Landlord’s inspection and audit.