What Is a Percentage Lease?
A percentage lease is a type of lease where the tenant pays a base rent plus a percentage of any revenue earned while doing business on the rental premises. It is a term used in commercial real estate. A percentage lease agreement generally decreases the base rate for lessees and offers the lessor additional upside potential.
Key Takeaways
- A percentage lease requires commercial tenants to pay to the landlord a set percentage of gross revenue earned from business conducted at the leased premises.
- This percentage is added on top of a base rent, but the base will be set lower than it would be on a standard lease, making it attractive to tenants.
- Often, the percentage of revenue portion of the lease will not kick in until a negotiated sales breakpoint is first reached.
Percentage Leases Explained
A percentage lease has two components — base rent (or minimum rent) and a percentage of the monthly or annual gross sales made on the premises. The lessee could find this arrangement attractive, as it lowers this fixed cost, which normally accounts for a large proportion of operating costs, and the lessor obtains some upside potential beyond what a standard lease (i.e., no percentage of sales component) could yield. Additionally, the percentage lease aligns the interests of lessee and lessor.
By providing a desired location and upkeep services to the tenant, the lessor enhances the presence of the retailer to capture more foot traffic and hence, the possibility of greater sales, part of which would go to the lessor under the percentage lease agreement.
Negotiating a Percentage Lease Contract
The landlord and tenant negotiate a "breakpoint," the level of sales where percentage lease payments kick in, in conjunction with the base rent. If a landlord agrees to a lower base rent, it would want a lower breakpoint as well. The lessee is interested in a low base rent and high breakpoint. After back and forth and settling on those two figures, the two parties must determine exclusions to the sales figure (sales to employees of the store, for example), operating hours of the store, rights to amend the breakpoint, and procedures for auditing store sales, among other details.
Accounting for Percentage Leases
Let's take a look at the financial statements of Tapestry, Inc., owner of Coach and Kate Spade brands, which calls their percentage portion of its overall lease payments "contingent rentals." The company recognizes contingent rentals on its income statement when "the achievement of target (i.e., sale levels) ... is considered probable and estimable." In its fiscal year 2019, Tapestry paid approximately 30% of its total rent in the form of contingent rent (i.e. through a percentage lease). Contrast that with Signet Jewelers Limited, whose percentage lease payments were less than 2% of the total rent for the same year.
FAQs
A percentage lease requires commercial tenants to pay to the landlord a set percentage of gross revenue earned from business conducted at the leased premises. This percentage is added on top of a base rent, but the base will be set lower than it would be on a standard lease, making it attractive to tenants.
How does a percentage lease work? ›
A percentage lease is a lease arrangement where the tenant pays a predetermined rent plus a percentage of sales made. Percentage leases are common with retail businesses. The three components of a percentage lease are the base rent, the break-even point, and the percentage rent.
Who benefits most from a percentage lease? ›
Key Points. Lease benefits both landlord (extra income from tenant's performance) and tenant (potential for lower payments if sales slow). Percentage leases are commonly used in shopping malls and other retail spaces where sales can vary significantly throughout the year.
What is a percentage lease most suitable for? ›
Percentage leases are most often used with retail tenants. Multi-tenant retail properties, such as malls and shopping centers, use this type of lease because it benefits both parties involved.
How do you calculate percentage leased? ›
Here's how to calculate the leased percentage: current number of units occupied + (number of units with signed leases yet to move in) / total number of units * 100%.
Why does a landlord want a percentage lease with a retail tenant? ›
It serves as a strategic rental model that allows tenants to pay a percentage of their sales, typically gross sales, in addition to a base rent. By connecting rental income to a percentage of the tenant's sales revenue, it motivates both parties to work together for a successful retail operation while minimizing risks.
How to negotiate percentage rent? ›
You may want to take the lead in suggesting a percentage greater than 7%. You may, for example, offer to pay a higher percentage of rent if you think that your income will not be rising rapidly and when it does, it will be sufficient to cover the extra expense (remember, up to that point the income is all yours).
What are the advantages of percentage rent? ›
The advantage of paying percentage rent is that your rent can reflect the change in sales when your business has a month of low revenues. Then, when your company has a profitable season, both you and your landlord do better because of increased profits.
What is the percentage rent clause? ›
In a commercial leasing context, an amount payable by a tenant in addition to the base rent. Percentage rent is typically based on a percentage of the tenant's sales in excess of a fixed base dollar amount, which is often referred to as the breakpoint.
What is the effective rate of a lease? ›
Net effective rent is calculated when you multiply the gross rent (actual rent) by the length of the lease and then subtract the discounted months you give the tenant. Then, you can divide that actual amount by the length of your lease to get the net effective rate.
The lower the money factor, the less interest you'll pay over your lease term. Generally, a money factor of 0.0025 and below (the equivalent of 6% APR) is considered a good rate.
What is the 90% rule for leases? ›
The lessee has the option to buy the asset at the end of the lease term at a bargain purchase price that is below the fair market value. The lessee gains ownership at the end of the lease period. The present value of lease payments must be greater than 90% of the asset's fair market value.
What percentage of people lease vs buy? ›
Share of all new U.S. vehicles that are leased 2017-2023
Over one-fifth of new vehicles in the United States were leased in 2023, with the rest being sold outright. The percentage found in the third quarter of 2021 was even higher, with 26 percent of new vehicles in the U.S being leased that year.
How do percentage leases work? ›
A percentage lease is a type of lease where the tenant pays a base rent plus a percentage of any revenue earned while doing business on the rental premises. It is a term used in commercial real estate.
What is the formula for lease payment? ›
Monthly Payment = Depreciation + Rent Charge + Taxes
All of these values can change from vehicle to vehicle, and again from year to year.
What does 100% leased mean? ›
100% Lease-up means that all Rental Units have been leased to income certified tenants and that leases have been completed and executed on or before a date to be agreed upon by the Owner and the Agent and specified in the Property Management Plan as set forth in Exhibit F.
What is a good lease rate percentage? ›
A good lease deal will have a money factor less than 0.001 (2.4%), an average lease factor will be between 0.0025 (6%) and 0.0035 (8.4%), and a high interest rate is anything above the average.
What is the 90% rule in leasing? ›
The lessee has the option to buy the asset at the end of the lease term at a bargain purchase price that is below the fair market value. The lessee gains ownership at the end of the lease period. The present value of lease payments must be greater than 90% of the asset's fair market value.
What is the 90% lease rule? ›
What is the 90% threshold for net present value for determining whether a lease is finance or operating? If the net present value of lease payments is greater than 90% of the fair market value, then it should be classified as a finance lease and not an operating lease.
What do the terms of a percentage lease state? ›
The terms of a percentage lease state that rent is 4% of sales up to $100,000 and 2.5% of sales over $100,000. Your business plan projects monthly sales to average $270,000 per month. There is a $250 per month maintenance fee.
