RealTown Words

A lease whose rental is based on a percentage of the monthly or annual gross sales made on the premises. Percentage leases are common with large retail stores, especially in shopping centers. An underlying concept of the percentage lease is that both the landlord and the tenant should share in the locational advantages of the leased premises. There are many types of percentage leases: the straight percentage of gross income, without minimum (uncommon); the fixed minimum rent plus a percentage of the gross; the fixed minimum rent against a percentage of the gross, whichever is greater; and the fixed minimum rent plus a percentage of the gross, with a ceiling to the percentage rental (among others).
The Institute of Real Estate Management, the International Council of Shopping Centers, the Urban Land Institute, and other real estate management organizations publish percentage lease tables which can be used as general guides when negotiating lease terms. For example, the percentage ranges of bowling lanes might be 8 to 10 percent; for cocktail lounges, 7 to 10 percent; and for movie theaters, 10 to 12 percent.

Most percentage leases are based on a percentage of gross sales, not gross profits, because of the difficulty in determining what a “profit” is. Utmost care must be taken to adequately and fully define gross sales. It is particularly necessary to differentiate the applicability of the percentage to credit sales, sales made at other store locations, credit card discounts, mail orders, trade-ins, gift certificates, and interstore transactions. The definition of gross income usually excludes sales and excise taxes. A generally acceptable definition of gross sales is “the gross amount of all sales made in, from, or at the leased premises, whether for cash or on credit, after deducting the sales price of any returned merchandise where a cash refund is given.”

The landlord should consider protective provisions to cover the following: tenant’s obligation to act in good faith; tenant’s obligation not to compete by opening a nearby store; periodic reports of sales volume; landlord’s right to inspect books and records; tax participation clause; landlord’s prohibition of assignment or subletting without consent; and recapture of the premises.
The percentage rent requires detailed auditing procedures, which are difficult to apply to small business operations, difficult to enforce, and do not apply to personal service businesses such as real estate brokers or attorneys.