The heart of the percentage-rent formula is the definition of “gross sales.” A well-drafted shopping center lease includes receipts of all types. The focus is on revenues arising from use of the leased premises. The definition of gross sales often specifically excludes customer refunds, employee discounts, accommodation sales (stamps, money orders, etc.), coin-operated devices, commissions paid to third-party credit card companies, merchandise exchanged between stores, returns to manufacturers and sales taxes collected.

The traditional method to calculate percentage rent is to take a percentage of gross sales and deduct annual, fixed-minimum rent. Tenants sometimes want other expenses that increase (for example, ad valorem real estate taxes) deducted from percentage rent. The breakpoint method of calculating percentage rent takes a percentage of gross sales in excess of a stated dollar amount or breakpoint.

A “natural” breakpoint is the volume of gross sales a tenant must generate to pay the fixed minimum rent, at a rate equal to percentage to be used for percentage-rent calculations. It is calculated by dividing the fixed minimum rent by the percentage used for percentage-rent calculations.

For example, if the fixed rent is $140,000 per year, and the percentage for percentage rent purposes is seven percent, then the natural breakpoint would be $2,000,000. The underlying rationale of a natural breakpoint is that if it is agreed that the landlord gets seven percent of gross sales, it should not receive a percentage of gross sales necessary to generate sufficient revenues (for example, $2,000,000) for the tenant to pay the minimum rent ($140,000). If the percentage is lower, the natural breakpoint will be higher.

Use of a natural breakpoint would result in the same percentage rent as the traditional method.

Use of an “artificial” breakpoint can change the result. With the artificial breakpoint method, fixed-minimum rent and percentage rent can be set independently.

For example, a landlord might agree to reduce fixed-minimum rent if a tenant agrees to increase percentage-rent with a higher artificial breakpoint. A high-volume tenant with economic strength may argue for more minimum rent in exchange for less percentage rent. If the lease term is long, the landlord may wish to reduce the risks of inflation by greater reliance on percentage-rent. This will be a function of the respective financial obligations and expectations of the parties.

The final step in calculating percentage rent is to calculate a percentage of gross sales in excess of the breakpoint. Different percentage rates are used for different types of stores. The higher the profit margin on the merchandise, the higher the percentage figures.

For example, the percentage used to calculate percentage rent typically is lower for a supermarket (higher volume and lower profit margin) than it would be for a jewelry store (lower volume and higher profit margin).

Percentage-rent provisions are accompanied customarily by a requirement that the tenant maintain contemporaneous records of sales, submit periodic sales reports, allow the landlord to audit books of the tenant, sell a specific type of merchandise, establish minimum hours of operation, and not compete. Continuous-operations clauses, which prohibit a tenant from “going dark,” may also be included.

Typically, a non-competition provision prohibits the tenant from opening additional stores within a stated radius of the shopping center. The non-competition clause is intended to prevent the dilution of sales that would result from an additional store within the same market area. A common remedy for violation of such non-competition clauses is to include the sales from any additional stores in the market area in the gross sales of the store for percentage-rent purposes.

 

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