Commercial lease structures come in many forms, but one of the more dynamic ones is the percentage lease.
A percentage lease ties rent payments directly to a tenant’s revenue. This means that landlords share in a tenant’s financial success, which can align incentives in high-traffic commercial environments.
These leases are most commonly found in retail and restaurant spaces, particularly in malls, shopping centers, and entertainment districts, where foot traffic can heavily influence business performance. For landlords, it creates an opportunity to earn more from successful tenants. For tenants, it offers a way to reduce fixed costs during slow months while still securing a good location.
All that said, this type of lease can be more complicated as well, especially when negotiating the breakpoint, revenue exclusions, and reporting obligations. Getting these details right can be the difference between a fair agreement and one that slowly drains a tenant’s profitability.
How Percentage Leases Work in Practice
Meet Sarah, the owner of a boutique coffee shop in a busy shopping plaza, and Mike, her landlord. Sarah has agreed to a percentage lease, which means she pays a fixed base rent each month, plus an additional amount if her sales exceed a certain threshold, called the breakpoint.
The Role of the Breakpoint
The breakpoint is the sales level where Sarah starts paying percentage rent. If she earns less than this amount, she only owes base rent. If she earns more, she pays a percentage of the excess to Mike.
There are two ways this can be structured. A natural breakpoint is calculated by dividing the base rent by the percentage rate. For example, if Sarah’s base rent is $5,000 per month and her percentage rent rate is 5%, her natural breakpoint is $100,000 in monthly sales ($5,000 ÷ 0.05). Any revenue over that is subject to percentage rent.
Mike, however, prefers an artificial breakpoint, which is a fixed threshold they negotiate instead of using the formula. He proposes setting it at $80,000 instead of the natural $100,000, meaning Sarah would start paying percentage rent sooner. For her, this could mean higher overall costs, so she pushes back in negotiations.
What Happens in Slow Months?
If Sarah has a month where sales are only $75,000, she won’t owe percentage rent—just her base rent. But what if she has a zero-revenue month? The lease still requires her to pay base rent, no matter how her business performs.
Some landlords, like Mike, include minimum sales requirements, meaning if Sarah’s sales repeatedly underperform, he has the right to terminate the lease. This is common in shopping centers where landlords want to keep high-performing tenants.
Seasonal Fluctuations
Retail and restaurant businesses often see big seasonal swings. Sarah’s shop might make a killing in December but struggle in February. Some percentage leases allow for annual percentage rent calculations instead of monthly ones, ensuring one bad month doesn’t disproportionately impact her rent.
| Scenario | Base Rent | Breakpoint | Sales Revenue | Percentage Rent Owed? |
|---|---|---|---|---|
| Natural Breakpoint | $5,000 | $100,000 | $90,000 | No |
| Natural Breakpoint | $5,000 | $100,000 | $120,000 | Yes, 5% on $20,000 ($1,000) |
| Artificial Breakpoint | $5,000 | $80,000 | $90,000 | Yes, 5% on $10,000 ($500) |
The Math Behind a Percentage Lease
Once Sarah and Mike finalize the terms, the next step is understanding how the percentage rent is actually calculated. The formula is straightforward:
For example, if Sarah’s lease terms are:
- Base Rent: $5,000 per month
- Percentage Rate: 5%
- Breakpoint: $100,000 per month
If her sales in a given month are $120,000, then she pays:
- Base rent: $5,000
- Percentage rent: 5% of ($120,000 – $100,000) = 5% of $20,000 = $1,000
- Total rent due: $6,000
If Sarah has a slow month with sales of only $85,000, she only pays the base rent of $5,000, since she hasn’t exceeded the breakpoint.
How Artificial Breakpoints Change the Math
If Mike negotiated an artificial breakpoint at $80,000 instead of the natural $100,000, the numbers change:
- If Sarah’s sales are $90,000, she owes 5% of ($90,000 – $80,000) = $500 in percentage rent, bringing her total to $5,500.
- If she makes $120,000, she now owes 5% of ($120,000 – $80,000) = $2,000 in percentage rent, for a total of $7,000.
Due diligence is important, to say the least, as not all percentage leases are structured fairly. Small differences in thresholds can have a big impact on monthly expenses.
Final Thoughts: Getting a Fair Percentage Lease
A percentage lease can be an effective way to balance costs and revenue, but only when the terms are clearly defined and fairly structured. Sarah benefits from lower fixed costs, while Mike gets a share of her success. However how certain details are defined significantly impact long-term costs.
Before signing, tenants should double check that:
- Breakpoints are reasonable and not artificially low to trigger percentage rent too soon.
- Gross sales definitions exclude non-revenue items like refunds, employee discounts, and taxes.
- Audit rights are fair and prevent excessive financial scrutiny.
- The lease allows flexibility for slow months, rather than imposing strict sales targets.
If you’re a soon-to-be-tenant negotiating a percentage lease, make sure that you understand these factors upfront so you can prevent unexpected costs later. Before committing, it’s always worth reviewing the agreement with a commercial lease expert to ensure the deal is structured for success.
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