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Understanding and Utilizing Percentage Rent Provisions
As retailers like to say, 'The three most important factors in retailing are location, location, location.' The real value of a retail lease, however, resides in the volume of sales produced at the location; therefore, the provider of the location ' namely, the landlord ' is a key player in the retailer's success. That is why percentage rent has developed in retail leases as a way by which the landlord that provides a successful location might share to some degree in that success.
A developer setting out to construct a shopping center or strip mall typically prepares a pro forma plan for the project, thereby determining the fixed rent that must be realized from the project in order to cover its debt service and meet its desired rate of return. This is similar to what the developer of an office building would do. In the case of most retail centers, that fixed rent is a triple net rent, with the tenants paying all common area costs, property taxes, and the landlord's insurance premiums. Most pro forma plans are prepared without regard to any percentage rent; thus, percentage rent is truly the icing on the cake. However, it has also been suggested that percentage rent permits a lower fixed rent than would otherwise be the case and, therefore, lends stability to the project by enabling retailers to ride out downturns in retail activity.
This article discusses the basics of percentage rent; the various ways in which percentage rent may be determined, including the concept of 'breakpoints'; and how percentage rent works in practice.
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