PERCENTAGE LEASE

Contact Neufeld Legal for commercial leasing legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A Percentage Lease is a somewhat infrequent form commercial real estate leasing arrangement, almost exclusively utilized in retail properties such as shopping centers, malls, and high-street retail locations. Unlike fixed-rent agreements like the Gross Lease, the Percentage Lease ties a portion of the tenant's rental obligation directly to the performance of their business. This aligns the financial interests of the landlord and the tenant.

A Percentage Lease typically consists of two main financial components:

• Base Rent (or Minimum Rent): A fixed, predetermined monthly or annual payment, paid regardless of the tenant's sales performance. The Base Rent is often set lower than what would be required under a standard fixed-rate lease. This provides the tenant with a reduced financial burden during slow periods or when starting up.

• Percentage Rent (or Overage Rent): A variable payment calculated as an agreed-upon percentage of the tenant's Gross Sales that exceed a specified threshold.

The calculation of the variable rent component relies on three critical negotiated terms:

1. Gross Sales

This is the total revenue generated by the tenant's business from the leased premises. The lease document must meticulously define what is included in "Gross Sales."

• Inclusions: Typically includes all sales (cash, credit, checks), services rendered, and sometimes revenue from online sales fulfilled via the store (e.g., "buy online, pick up in store" or BOPIS).

• Exclusions (Negotiable): Often excludes sales tax, returns and allowances, bulk sales to employees, and sometimes revenue from vending machines or non-core business activities.

2. The Breakpoint

The Breakpoint is the annual (or sometimes monthly) dollar amount of Gross Sales a tenant must achieve before the obligation to pay Percentage Rent kicks in. There are two primary ways to establish this threshold:

• Natural Breakpoint: This is calculated by dividing the Base Rent by the agreed-upon Percentage Rate. For example, if the Base Rent is $180,000 per year and the Percentage Rate is 8%, the Natural Breakpoint is $2,250,000. The tenant pays 8% of sales only above this amount.

• Artificial Breakpoint (or Fixed Breakpoint): This is a specific dollar amount that is negotiated between the landlord and tenant, independent of the Base Rent.

3. The Percentage Rate

This is the negotiated rate (e.g., 5%, 6%, 8%) applied to the amount of Gross Sales that exceeds the Breakpoint. This rate varies significantly based on the tenant's industry.

Formula and Calculation

The Total Rent owed by the tenant is calculated as follows:

Total Rent = Base Rent + [(Gross Sales - Breakpoint) x Percentage Rate]

 (Recognizing that the lease agreement generally requires that the Percentage Rent component is only paid if Gross Sales exceed the Breakpoint).

Strategic Implications associated with Percentage Leases

For the Tenant (Lessee): The Percentage Lease provides cash flow flexibility. By accepting a lower Base Rent, the tenant reduces their fixed monthly overhead, making it easier to survive slow seasons or initial setup periods. However, when the business is highly successful, their total occupancy cost (rent) increases. This structure incentivizes landlords to properly maintain the property and drive foot traffic, directly aiding the tenant's success.

For the Landlord (Lessor): This structure grants the landlord a stake in the tenant's prosperity, offering uncapped upside potential during economic booms. It incentivizes the landlord to invest in the property and secure a desirable tenant mix (anchors, unique brands) to maximize shopper traffic and, consequently, Percentage Rent revenue. The main disadvantages are the administrative burden of auditing tenant sales and the risk of lower returns if the retail business performs poorly.

For knowledgeable and experienced legal representation in negotiating, reviewing and drafting lease agreements, and protecting your business’ legal rights thereunder, contact lease lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.