What Is a Percentage Lease?
A percentage lease is a type of lease where the tenant pays a base rent plus a percentage of any revenue earned while doing business on the rental premises. It is a term used in commercial real estate. A percentage lease agreement generally decreases the base rate for lessees and offers the lessor additional upside potential.
Percentage Lease Explained
A percentage lease has two components — base rent (or minimum rent) and a percentage of the monthly or annual gross sales made on the premises. The lessee could find this arrangement attractive, as it lowers this fixed cost, which normally accounts for a large proportion of operating costs, and the lessor obtains some upside potential beyond what a standard lease (i.e., no percentage of sales component) could yield. Additionally, the percentage lease aligns the interests of lessee and lessor. By providing a desired location and upkeep services to the tenant, the lessor enhances the presence of the retailer to capture more foot traffic and hence, the possibility of greater sales, part of which would go to the lessor under the percentage lease agreement.
Negotiating a Percentage Lease Contract
The landlord and tenant negotiate a "breakpoint," the level of sales where percentage lease payments kick in, in conjunction with the base rent. If a landlord agrees to a lower base rent, it would want a lower breakpoint as well. The lessee is interested in a low base rent and high breakpoint. After back and forth and settling on those two figures, the two parties must determine exclusions to the sales figure (sales to employees of the store, for example), operating hours of the store, rights to amend the breakpoint, and procedures for auditing store sales, among other details.
Accounting for Percentage Leases
Tapestry, Inc., owner of Coach and Kate Spade brands, calls this portion of its lease payments "contingent rentals." The company recognizes contingent rentals on its income statement when "the achievement of target (i.e., sale levels) ... is considered probable and estimable." In its fiscal year 2017, Tapestry paid approximately 30% of total rent in the form of contingent rent. Contrast that with Signet Jewelers Limited, whose percentage lease payments were less than 2% of the total rent.