Percentage Lease

Article byPrakhar Gajendrakar
Edited byAlfina
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Percentage Lease?

A percentage lease is an arrangement between the lessee and the lessor where, along with the base rent, the lessee also pays a predetermined percentage of the revenue they generate from a business that is conducted in the premise. This revenue can be from anything, such as the land, office, or shop, giving lessors an opportunity to earn beyond just the base rent.

Percentage Lease

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The revenue percentage the landlord will receive is added on top of the base rent, and it allows the estate owner a good income. In such percentage lease agreements, the base rate is set lower than standard base rates. This way, it becomes a reasonable deal and attracts lessees to commit to such a lease agreement.

Key Takeaways

  • A percentage lease is a lease arrangement in which the lessor receives a base rent and the percentage of profit from the business established on the rental property.
  • The lease agreement has two components: the base rent and the preset percentage from revenue.
  • These are typically associated with commercial tenants, and the revenue percentage is only offered after the business reaches a sales break-even point.
  • Not every business requires a percentage lease; a tenant must always strive to negotiate the rent and percentage and ensure no hidden clause demands them to cover other expenses like taxes, utilities, and interests.

Percentage Lease Explained

A percentage lease is a real estate contract between the property owner and the tenant which states that on top of the agreed monthly rent, the tenant will also pay a percentage of the annual sales revenue of the business they established on the rented property. A percentage lease is a common scenario in commercial renting and property management.

The agreement is created on a lower base rent because the landlord now receives a profit percentage. These leases are generally made when the commercial tenant is planning for a long-term business plan. The lease terms often vary from owner to owner and are also based on the estate’s location. However, it can always be negotiated on good terms between both parties.

At first glance, it may look like the deal is inclined to the land owner but setting up a lower base rent than standard attracts many potential tenants looking to open a store, shop, or business. The percentage lease agreement also comes with a crucial term of sales break-even point which clearly defines that the tenant will only pay the landlord a share of the profit percentage if the sales reach or cross a certain point, below which the property owner has no right to ask for a percentage of the revenue earned.

This break-even point is expressed in capital amount and calculated using a formula. A natural break-even point is preferred over an artificial one in small businesses. Tenants should always do personal research and take good advice from people before signing such lease agreements because not every business can operate on a percentage lease basis.

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Examples

Check out these examples for a better idea:

Example #1

Suppose Ariana started a new footwear-selling business and is looking for a shop to rent to set up her retail footwear store. She meets Gwen, who owns a small shop in the local market. Ariana finds the shop perfect for her business and agrees to become a commercial tenant to Gwen by signing a lease agreement.

But Gwen, on the other hand, wants to sign a percentage lease in which Ariana would pay her monthly rent. Still, additionally, she will share 9% of Ariana’s total revenue from her footwear business annually. Gwen states that if Ariana agrees to this, she will lower the base rent from $450 to $225 monthly, and Ariana only needs to share her revenue when her business makes $9000 or more annually. Upon thinking, Ariana agrees and starts her shoe business. She makes all the rent payments of $225 on time every month, and at the end of the year, when Ariana calculates, she has earned a revenue of $9900.

It means she must give Gwen 9% of $9900 as the additional part of the lease agreement.

Therefore, 9% of $9900 = $891, which Ariana gives to her landlord Gwen. It is a simple percentage lease example, but the lease terms can differ from lessor to lessor, and other additional factors can be included.

Example #2

In 2020, the Hart stores, a Quebec-based retail chain, was offered a lease agreement by the Elliot Lake City Council. The business area spread to 7271 square feet in the Pearson Plaza, 40 Hillside Drive South. Harry Hart founded the Hart stores, which Paul Nassar later took over.

It is a good percentage lease example in which, according to the lease agreement, Hart stores were liable to pay 10% of its net revenue every year. The retail chain has approximately 80 Hart stores and 20 grocery stores, and on its official website, it announced more stores to be opened. Moreover, many tenants and state offices have previously used the business premise for election purposes.

Percentage Lease vs Gross Lease

  • Percentage leases come with monthly payments made by tenants. In contrast, gross lease refers to a single rent amount the owner uses once made to cover all the utilities, surcharges, and additional costs.
  • Percentage leases, in most cases, favor the landlord. But the gross lease is more tenant-friendly as they do not have to worry about any other payments after that.
  • It consists of base rent and sales percentage. In comparison, most of the time, the tenant is aware of where the lump sum payment is going and what is the exact rent amount.

Percentage Lease vs Net Lease

  • Percentage lease involves base rent plus a percentage of gross sales to be paid to the property owner. In comparison, a net lease does not include sales, but the tenant is responsible for base rent and taxes, interest, and insurance.
  • The former excludes tenants from other liabilities. In contrast, single, double, triple, and absolute net leases incur more tenants’ liabilities.
  • There is a break-even point pre-decided by the tenant and owner. On the other hand, net leases do not have the concept of break-even point calculation.

Frequently Asked Questions (FAQs)

How is the break-even point calculated for a percentage lease?

The formula to calculate the natural break-even point on percentage lease = minimum yearly base rent/ percentage rent. For example, if the minimum yearly base rent is $180000 and the percentage rent is 9%, then 180000/9% = $2000000
However, if the property owner wants to operate on an artificial break-even point, they can as part of the lease agreement.

What are the disadvantages of a percentage lease?

The percentage lease’s disadvantages mostly lie with the tenant as they have to share their profits if the pre-decided break-even point is reached or exceeded. Also, a tenant should report their financial and sales figures to the landlord. At the same time, if the tenant is in dire need, they must accept the lease agreement favoring the property owner.

Who benefits most from a percentage lease?

Landlords and property managers reap the maximum benefits of a percentage lease agreement apart from the base rent. They also get to decide a percentage of revenue they will receive as part of the rent. The base rent may get lower, but earnings from sales are much higher, nullifying the difference.

This has been a guide to what is Percentage Lease. Here, we explain it with its examples and differences with gross & net lease. You can learn more about it from the following articles –

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