Percentage Rent Explained

By Gary E. Wilson, President & Designated Broker, Wilson Management, Inc.

Percentage rent gives a landlord a share of a tenant's sales above an agreed threshold. In principle it aligns the two parties: a location that performs well pays the landlord more, and a tenant struggling to trade is not carrying rent calibrated to a better year.

In practice it is the most under-administered provision in retail leasing. Landlords negotiate it carefully and then never verify it, which turns a participation right into a clause nobody enforces.

This covers how the mechanics actually work and where they go wrong.

The breakpoint

Percentage rent is only payable above a sales threshold, called the breakpoint.

The natural breakpoint is the sales level at which the percentage rent would exactly equal the base rent. The arithmetic is simple: base rent divided by the percentage rate. A tenant paying $60,000 base rent under a 6% percentage clause has a natural breakpoint of $1,000,000 — above that, the landlord participates.

An artificial breakpoint is any negotiated figure used instead. Higher than natural favors the tenant, since more sales are required before the landlord participates. Lower than natural favors the landlord.

Which is used, and why, is a negotiating outcome — but the administration differs. A natural breakpoint moves whenever base rent moves, including with every escalation. An artificial breakpoint stays where it was negotiated unless the lease provides otherwise.

That distinction is a recurring source of error. A lease with a natural breakpoint and annual escalations has a breakpoint that changes every year, and a landlord calculating against last year's figure will under-collect for the life of the lease.

What counts as gross sales

The definition of gross sales is where percentage rent is genuinely won or lost, because it determines the number the whole calculation rests on.

Typically included: all sales made at, from or through the premises, whether for cash or credit, including sales by any concessionaire or subtenant operating within the space.

Typically excluded:

• Returns and refunds
• Sales, use and excise taxes collected from customers
• Employee discounts
• Gift card and gift certificate sales until they are redeemed
• Transfers of merchandise between the tenant's own locations
• Proceeds from the sale of fixtures or equipment
• Bad debts, in some leases
• Insurance proceeds

Each exclusion is negotiated, and the list varies considerably between leases. A landlord administering several leases with different definitions cannot apply one calculation across them.

Online sales are the live question

This is the provision that most needs attention in modern retail leasing, and the one older leases handle worst — usually by not addressing it at all.

The scenarios that matter:

Ordered online, collected in store. The customer transacts online and the store fulfills. Does that count toward the breakpoint?

Ordered online, shipped from store inventory. The physical location provided the stock and the labor.

Ordered in store, shipped from a warehouse. Staff at the premises made the sale.

Returned to store, purchased online. A return processed at the location, reducing sales that may never have counted.

A lease drafted before these patterns became normal will simply say "sales made at or from the premises", and both parties can read that in good faith to opposite conclusions. For a retailer whose model is genuinely omnichannel, the difference can be substantial.

For new leases, this should be addressed explicitly. For existing ones, it is worth knowing which of your leases are silent before the question arises with a tenant.

This article is general information, not legal advice.

Reporting is where it fails

Percentage rent depends entirely on sales reporting, and this is the provision retail landlords most consistently under-enforce.

The pattern is familiar. The lease requires monthly or annual sales statements. The tenant provides them late, incompletely, or not at all. Nobody chases, because chasing is unrewarding and the absence is not immediately painful. Two years later the landlord has no idea whether any breakpoint was crossed.

Percentage rent that is never verified is percentage rent that is under-collected. Not occasionally — structurally, because a tenant with no reporting obligation being enforced has no reason to volunteer that they exceeded a threshold.

Enforcement is unglamorous and effective:

• Reports requested on the schedule the lease sets, without waiting to see whether they arrive
• Followed up promptly when they do not
• Reconciled against the breakpoint as they come in, rather than at year end
• Certified annual statements obtained where the lease requires them
• Audit rights exercised where the numbers invite it

Audit rights

Most leases with percentage rent give the landlord a right to examine the tenant's books, usually on notice and within a defined window.

Landlords rarely use it, which is understandable — an audit is an intrusive step in a relationship the landlord wants to continue. But the right's existence is part of what makes reporting accurate, and a tenant who knows the landlord has never audited anyone draws a conclusion.

Where an audit is warranted, the practical points are giving proper notice, defining the period and scope, and agreeing who bears the cost — many leases shift the cost to the tenant where an underpayment above a stated threshold is found.

Sales data is worth more than the rent

Here is the argument for enforcing reporting even where percentage rent is unlikely to be triggered.

Sales per square foot by tenant is the best early-warning system a retail landlord has. A tenant whose sales have declined across several consecutive periods is a renewal risk and a covenant risk — usually months before it becomes a payment problem.

That changes what a landlord can do. Six months of warning allows a quiet approach to replacement operators, planning for any capital the unit will need, and negotiating an orderly surrender rather than pursuing arrears a failing tenant cannot pay. A landlord who learns about it when the keys arrive has none of those options.

It also informs everything else about the center: which categories are working, which part of the site trades best, and whether a proposed new tenant's projections are plausible against what comparable tenants actually achieve. See Tenant Mix and Leasing.

Administering it properly

Percentage rent requires the same discipline as any other lease provision that carries a date and a calculation:

• Breakpoint recorded per lease, natural or artificial, and updated when base rent changes if natural
• The gross sales definition abstracted, including exclusions, since they differ between leases
• Reporting obligations calendared with the frequency each lease requires
• Statements reconciled as received
• Annual true-up calculated and invoiced
• Audit rights tracked, including any window in which they must be exercised

None of this is difficult. It simply has to be done by someone, on a schedule, rather than remembered.

What percentage rent tells a landlord about a deal

Beyond the income, the presence and shape of a percentage rent clause carries information worth reading during a negotiation.

A tenant who resists sales reporting is telling you something. The reporting obligation is administrative and inexpensive; resistance to it usually reflects either an expectation of underperformance or an intention not to comply. Either is worth knowing before signing.

A tenant pushing hard for a high artificial breakpoint is signalling their own sales expectation, which is useful to compare against what you know comparable tenants in the center actually achieve.

A tenant comfortable with a low base rent and a percentage clause is confident about the location — and is also transferring some of their downside to you, which is the trade.

No percentage clause at all in a center where others have one means that tenant's performance is invisible to you, and you lose the early warning that sales data provides.

None of these are decisive on their own. Together they are part of reading a tenant's own assessment of the location, which is frequently more informative than their financial statements.

Where to go next

Our Retail CAM and Percentage Rent page covers how we administer both, and Tenant Mix and Leasing covers using sales data to read a center.

For the full service, see Retail Property Management, or contact us to discuss your center.