Ultimate Guide About Percentage Lease and How Percentage Lease Work 2023

Most people think of leasing as either a way to get into a more excellent car or minimize their monthly payments. But there's more to leasing than that. Leasing can also be a powerful tool for businesses, allowing them to manage their expenses and save money in the long run. 

This post will explain a percentage lease and how it can work for your company. So whether you're shopping for a new car or looking for an innovative way to finance your business, read on!

Define Percentage Lease

If we talk about the percentage lease definition, then a percentage lease is a legal agreement between a tenant and a landlord in which the tenant pays rent based on their sales or revenue. This type of lease is often used in retail or commercial settings, as it allows the tenant to share in the business's financial success (or failure).

A percentage lease, also known as a PIP or percentage participation lease, is a type of commercial real estate lease. In a percentage lease, the tenant pays the landlord for the use of the property and, in return, receives a portion of the profits generated by the property.

Suppose you're considering entering a percentage lease agreement for your business' next office space or retail location. In that case, it's important to be familiar with the implications of such contracts on your financials. To help you get started, we'll look closely at what exactly goes into calculating profit share percentages and how to negotiate them effectively with your landlord.

How Does a Percentage Lease work?

A percentage lease is a kind of rental agreement between a tenant and landlord in which the tenant pays rent based on a percentage of the tenant's sales. The advantage of this type of lease is that it gives tenants the flexibility to pay only when they are doing well.

However, the downside is that tenants may pay more than they would a traditional fixed-rate lease. Percentage leases are most commonly used for retail space, where sales can be volatile. A typical percentage lease entails the tenant agreeing to pay a base rent, plus a portion of their sales.

This percentage is known as the "percentage rent." The tenant may also be required to pay other charges, such as property taxes and insurance. Some landlords will allow tenants to deduct certain expenses when calculating the percentage rent, such as the cost of goods sold.

Ultimately, a percentage lease can be a good option for tenants who want the flexibility to pay only when they are doing well. However, it is important to consider the lease terms carefully before signing anything.

How is a Percentage Lease Calculated?

The percentage is typically calculated on a per-square-foot basis. There is usually a breakpoint, or minimum sales threshold, below which the tenant does not have to pay additional minimum rent.

For example, if a tenant's percentage lease rate is 3% and their breakpoint is $100,000, they would only owe additional rent if their sales exceed $100,000. If their sales are $120,000, they would owe 3% of that amount, or $3,600. While percentage leases are commonly used for retail businesses, they can be applied to any business.

The percentage of sales can be based on gross revenue, net income, or any other metric that makes sense for the specific business. And while most percentage leases are calculated on a per-square-foot basis, this is only sometimes the case. Some landlords may base the percentage on the property's total square footage, regardless of how much space the tenant occupies.

There are times when a percentage lease can benefit both parties. For landlords, it is a source of income that is not directly dependent on the success of the tenant's company. And for tenants, they offer the flexibility to scale their rental payments up or down based on their own performance.

However, percentage leases can also be risky for tenants since they may end up owing more rent than anticipated if their business is successful. As such, tenants need to understand how percentage leases are calculated before signing a lease agreement.

What Are the Advantages of a Percentage Lease?

A percentage tenancy is a sort of rental contract whereby the tenant is obligated to make a payment on the basis of a percentage of their gross sales. This type of rental agreement is often used for retail business customers. 

The advantages of a percentage lease include the following: 

1. Lower base rent: The percentage lease scheme is used for retail space, where the tenant is obligated to pay a base rent percentage in relation to their revenues. This can be advantageous for tenants because it lowers the base rent.

To negotiate a percentage lease, you'll need to understand your business' sales volume and projected growth. You'll also need to be prepared to negotiate with the landlord on things like the percentage rate and length of the lease.

2. Mutually beneficial: The tenant and property owner can benefit from each other because a percentage lease is beneficial to each. Under this type of lease, the tenant pays a fixed base rent plus a percentage of their profits. 

The landlord benefits from having a lower-risk lease and being able to share in the tenant's success. The tenant benefits from having a lower base rent and being able to keep more of their profits. Mutually beneficial arrangements like this can help both parties succeed.

3. Percentage yield for landlords: The third advantage of a percentage lease for landlords is that they can achieve a higher yield on their investment. The break-even point is the sales level at which the landlord will receive the same rent regardless of whether the tenant pays a fixed or variable rental rate based on sales.

What Are the Disadvantages of a Percentage Lease?

A percentage lease is a type of commercial lease in which the tenant agrees to pay a base rent plus a percentage of their monthly sales. While this can be advantageous for the landlord if the tenant's business is doing well, there are some potential downsides to consider as well.

1. Less money on new leases: This type of lease can be advantageous for tenants in high-traffic areas with high sales but disadvantageous for tenants in lower-traffic areas with lower sales.

Because the total rent is based on a percentage of sales, tenants in lower-traffic regions may end up paying less rent than they would under a traditional fixed-rate lease. This can be disadvantageous for landlords, who may rely on rental income to cover their mortgage payments and other expenses.

2. Difficulty negotiating: One of the biggest problems with a percentage lease is that dealing can be challenging. Most landlords are looking for a tenant who will commit to a long-term lease and is often unwilling to budge on terms. This can make it challenging for tenants to get the space they need at a price they can afford.

3. Tenant fees: A percentage lease is a commercial lease where the tenant pays base rent and a percentage of their monthly sales. This can be advantageous for the landlord if the tenant's business does well, but it can also be disadvantageous for the tenant if their business could be doing better.

In addition, some landlords may charge additional fees on top of the base rent and percentage of sales, which can further increase the amount that the tenant has to pay each month. While a percentage lease can be a good option for some businesses, it's important to weigh the pros and cons carefully before signing on the dotted line.

Frequently Asked Questions

What is an example of a percentage lease?

Here is a simple example to understand a percentage lease easily. For example, if a retail store has a percentage lease with a base rent of $1,000 per month and a 5% sales clause, the store would owe an additional $500 in rent for that month if its sales totaled $10,000. 

Percentage leases are standard in retail and restaurant leases, as they allow landlords to share in the success of their tenants' businesses. They can also be used in office and industrial leases, though this is less common. 

 Percentage leases can be advantageous to tenants because they often have lower base rents than other types of leases (such as net or gross leases). However, they can also be riskier because the tenant's rental payments can fluctuate greatly depending on their sales.

What is a typical percentage lease?

A typical percentage lease is a type of commercial lease in which the tenant pays rent based on a percentage of their sales. The advantage of this type of lease is that it allows the tenant to only pay for the space they use, and doesn't require them to pay a fixed amount each month. The downside is that if sales are slow, the tenant may have to make up the difference in rent.

What type of tenant uses a percentage lease most often?

When it comes to leasing commercial space, there are various options available to tenants. One type of lease often used by businesses is a percentage lease, which is typically used by retailers or other companies that generate income from sales.

Under a percentage lease, the tenant pays rent based on a percentage of their sales. This can benefit tenants, as they only have to pay rent when generating income. This type of lease can be somewhat riskier for landlords, as it depends on the tenant's business success.

Overall, businesses that are looking for flexibility and lower upfront costs may be best suited for a percentage lease agreement.

Who benefits most from a percentage lease?

In a percentage lease, the lessee agrees to pay a base rent plus a percentage of their sales. This type of lease is common in retail and office spaces. The amount of percentage can vary but is typically between 2-5%.

So, who benefits most from a percentage lease? The answer may surprise you.

While the landlord does benefit from the increased payments when sales are high, they also take on more risk. If sales are low, the landlord may receive less rent than they would under a traditional fixed-rate lease.

On the other hand, the tenant benefits from lower payments when sales are down, and this can provide some much-needed financial relief during tough times. And, if sales are booming, the tenant gets to keep more of their profits!

At its core, a percentage lease is an agreement between the tenant and the landlord in which the tenant pays a fixed percentage of their sales to the landlord. This type of lease can be advantageous for both parties involved, and the tenant knows precisely how much they will need to pay each month, making budgeting easier.

While the landlord has a reliable source of income even if the property is not rented out 100% of the time, if you're interested in learning more about percentage leases or are considering entering into one yourself, don't hesitate to contact our expert team for advice. Thanks for reading!