Sometimes Landlords ask for percentage rent. I often get asked what is percentage rent, immediately followed by the question how to calculate a natural breakpoint.
Basically, percentage rent is a way for the Landlord to share in the success of your business. The idea is that they receive a negotiated amount of additional rent if you hit a negotiated milestone in sales. Lots of use of the word ‘negotiated’ here because there are several variables.
There are two ways that Landlords establish the threshold above which they receive ‘percentage rent’. One way is a natural break calculation. Here, the amount that you’ll pay in additional rent is a function of your base rent. I’ll work through an example below. The second way to establish the threshold is an unnatural break. Here, the Landlord an you just agree on a sales volume.
Lets work through an example of a natural break and an unnatural break.
Natural Breakpoint Example: Lets say your paying a base rent of $25 psf on a 4,000-sf space. You annual rent in this scenario is $100,000. The Landlord has proposed percentage rent at 5% above natural break. So $100,000/0.05 = $2M. This means your natural breakpoint is $2M in sales. The Landlord will reap 5% of anything you make above that $2M mark. If you make $2,200,000 in annual sales, the Landlord will be owned $10,000 from you in additional rent. Heres how I calculated that: $2,200,000(your sales) – $2,000,000 (natural break) = $200,000 (0.05) = $10,000.
Unnatural Breakpoint Example: Using the same example $25 psf on a 4,000-sf space. In this example the Landlord want 5% over an unnatural breakpoint of $1.8M. Here, the Landlord has set a breakpoint that is not tied to the base rent – he can set it as high or as low as he needs to make his ROI work for him. Lets say you made the same $2,200,000 in annual sales. The Landlord would get $20,000 in additional rent. Here’s how I calculated that: $2,200,000(your sales) – $1,800,000 (unnatural break) = $400,000 (0.05) = $20,000.
The concept of percentage rent is usually in the favor of the Landlord. I’ve seen it used by an experienced broker to reduce the base rent. The key to percentage rent is to put that ‘carrot’ of a breakpoint as high as you can so that when you do hit it, your sales are so strong the additional payout doesn’t have an impact on your operation.