OT: General Question. Landlord wants to charge tenant Gross Percent of Revenue in lieu of rent. If the profit margin is around 26%...
- Thread starter Mr. Potter
- Start date
I think you need to know what a "fair" normal rent would be and then back into it. For example if a "fair" normal rent or said another way if the rent you built into your business model was say $10k per month simply take 10K divided by .26 and you get around $38,000.
If your revenues are $38,000 you pay $10k, if worse you pay less if more you pay more.
Obviously you need to make sure this model will make money for you.
Another caveat is it might get the landlord questioning your pricing. Use the example above. Hypothetically if you r sales would be $38,000 with a 26% margin you could raise your price's and get a larger margin and power gross sales. Your rent would go down, your margins would go up, and arguably your other variable expenses may go down as well. All sounds good until the landlord says WTF?, lower your prices and sell more.
If your revenues are $38,000 you pay $10k, if worse you pay less if more you pay more.
Obviously you need to make sure this model will make money for you.
Another caveat is it might get the landlord questioning your pricing. Use the example above. Hypothetically if you r sales would be $38,000 with a 26% margin you could raise your price's and get a larger margin and power gross sales. Your rent would go down, your margins would go up, and arguably your other variable expenses may go down as well. All sounds good until the landlord says WTF?, lower your prices and sell more.
Due to the COVID-19 pandemic, a number of landlords provided "rent relief" to retail tenants by charging them percentage rent (i.e. a % of gross sales) in lieu of the retail tenants paying full, a portion, or none of their base rent. This allowed both the retail tenant to pay and the landlord to receive cash towards rent during the pandemic. The amount of percentage rent was always "capped" by the monthly base rent, so the retail tenant never paid more than they normally would under a base rent scenario. Some Landlords like percentage rent because it could be lucrative to them if the retail tenant's business does really well, but it could also be bad if the retail tenant is lazy and/or unethical when it comes to reporting sales figures.
By profit margin, do you mean operating margin or net margin? Is 26% before rent expense?
depends on the center your business is in, term of your lease, are there extra charges on your lease, etc
depends on the center your business is in, term of your lease, are there extra charges on your lease, etc
This is fairly common especially today during Covid in retail leases. I’m assuming when you say food use it’s a retail food use? If so then you’re probably on a NNN lease and you will need to factor in operating expenses as part of your analysis
Mr. Potter: What you are talking about is called a "percentage rent" form of lease. They are not uncommon, particularly in the context of leases involving retail tenants. The rent is stated as a percentage of the tenant's gross revenue, which essentially puts the landlord in the position of taking an entrepreneurial risk along with his or her tenant. (The higher the tenant's revenue, the higher the landlord's rent.) The opposite is true as well, unless the lease reserves a fixed minimum rent (often called a "Base Rent") which is payable in all events, without regard to the amount of revenue the tenant earns. That is also quite common.
You are right in noting that a tenant's profit margin is relevant for purposes of a percentage rent lease. Not for purposes of computing the rent (gross revenues are used for that), but in terms of setting the "percentage rent rate" by which gross revenues are multiplied in computing the rent. The reason for this is simple: different kinds of retail businesses operate with different kinds of profit margins. A grocery store typically operates with small margins but high dollar volumes. A lower percentage rent rate is appropriate for that kind of retain tenant. By contrast, a jewelry store (which operates at a much higher profit margin but on lower gross sales volume), should be expected to have a higher percentage rent rate. If you do some internet research, you should be able to get some general information and guidelines on percentage rates, broken down by the kind of retail use in question.
There are some traps for the unwary here. For example, you should pay special attention to the definition of "gross revenues" used in the percentage rent clause of the lease. It should only include revenues derived specifically from sales made on or from the leased premises. If the business in question derives revenues from other locations, the tenant should be trying to exclude such revenues. Also, business revenues from sources other than normal sales (e.g., sales of capital assets of the business, loan revenues, etc.) should be excluded from the definition of "Gross Revenues" for percentage rent purposes.
Unless you are thoroughly familiar with these concepts, I suggest that you consult with an attorney who specializes in leasing or transactional real estate law. (No litigators.) Hope this helps.
You are right in noting that a tenant's profit margin is relevant for purposes of a percentage rent lease. Not for purposes of computing the rent (gross revenues are used for that), but in terms of setting the "percentage rent rate" by which gross revenues are multiplied in computing the rent. The reason for this is simple: different kinds of retail businesses operate with different kinds of profit margins. A grocery store typically operates with small margins but high dollar volumes. A lower percentage rent rate is appropriate for that kind of retain tenant. By contrast, a jewelry store (which operates at a much higher profit margin but on lower gross sales volume), should be expected to have a higher percentage rent rate. If you do some internet research, you should be able to get some general information and guidelines on percentage rates, broken down by the kind of retail use in question.
There are some traps for the unwary here. For example, you should pay special attention to the definition of "gross revenues" used in the percentage rent clause of the lease. It should only include revenues derived specifically from sales made on or from the leased premises. If the business in question derives revenues from other locations, the tenant should be trying to exclude such revenues. Also, business revenues from sources other than normal sales (e.g., sales of capital assets of the business, loan revenues, etc.) should be excluded from the definition of "Gross Revenues" for percentage rent purposes.
Unless you are thoroughly familiar with these concepts, I suggest that you consult with an attorney who specializes in leasing or transactional real estate law. (No litigators.) Hope this helps.
I’m not sure what your profit margin is actually referring to in this case but I would want to know what percent the landlord wants to charge and multiply it by my expected sales to come up with a projected rent. Compare it to similar priorities for some guidance.
Percentage rent is very common for restaurants even pre-Covid. Charging 26% of gross revenues is likely high. A rent of 26% of gross profit is still likely high, but not exorbitant depending on location
Even better are sales percentage overrides. Lessor and Lessee haggle over fair rent or slightly below market rent in lieu of Lessor asking for a small percentage of Lessee's gross sales.....fully auditable of course to ensure Lessee doesn't cheat.
It didn’t say 26% of gross profit. That’s why I think you need to figure out what that percent is...not enough info here.
I lease office space in the subs of Philly (non-retail) and personally know (outside our landlord) 2 commercial RE agents and 2 attorneys that specifically deal with commercial. I have been in contact them throughout this crap show to see when/if I should go back to the table with our landlord. In summary here is what I heard from these third parties:
April-July 2020 - “this will all pass and be back to normal. You have little negotiation room”
July-November 2020 - “we are seeing serious interest from the metro areas into the ‘burbs, but sqft is softening due to companies planning to allow wfh policies into the future.” “Go to the table and renegotiate in if you want.” “Rents rates are stable, but landlords are getting a ‘little’ more flexible and creative.”
November 2020 - January 2021 - “landlords see a strong rebound for office space in late 2021 and into 2022 and are being less flexible in lease terms and less willing to regotiate existing lease terms.”
January 2021 - March 2021 - “landlords still believe in the rebound” “more prospects want ‘Pandemic’ clauses that are outside the “act of god” clauses.” From the attorneys: “Rents are dropping fast from advertised prices.” “Anything under 10k sqft is a true struggle for the commercial landlords.”
Again, I am only talking office space here. I never asked about retail with the exception of their clients that are locked into REITs locations
April-July 2020 - “this will all pass and be back to normal. You have little negotiation room”
July-November 2020 - “we are seeing serious interest from the metro areas into the ‘burbs, but sqft is softening due to companies planning to allow wfh policies into the future.” “Go to the table and renegotiate in if you want.” “Rents rates are stable, but landlords are getting a ‘little’ more flexible and creative.”
November 2020 - January 2021 - “landlords see a strong rebound for office space in late 2021 and into 2022 and are being less flexible in lease terms and less willing to regotiate existing lease terms.”
January 2021 - March 2021 - “landlords still believe in the rebound” “more prospects want ‘Pandemic’ clauses that are outside the “act of god” clauses.” From the attorneys: “Rents are dropping fast from advertised prices.” “Anything under 10k sqft is a true struggle for the commercial landlords.”
Again, I am only talking office space here. I never asked about retail with the exception of their clients that are locked into REITs locations
psualt: If you were a retail tenant (say a shopping center tenant) and the shopping center landlord presented you with a percentage rent lease that had provisions for both a fixed Base Rent and percentage rent, you would divide the Base Rent by the percentage rent rate (which is typically somewhere between 2% and 5%), and the figure you derive would be the amount of gross revenue necessary to produce the Base Rent. That figure is typically called the "Breakpoint" or "Percentage Rent Breakpoint." Any rent paid over and above that amount would be Percentage Rent in the purest sense. For example, if your monthly Base Rent was $3,000 and your percentage rent rate was 3%, your Breakpoint would be $100,000 in gross revenues (i.e., $3,000 divided by 3%).
High?!! That would be astronomical! I have never seen a percentage rent lease that had a percentage rent rate that was not in single digits (i.e., below 10%), and I have drafted or reviewed a LOT of them.
Also, I have never seen a percentage rent lease that used "gross profits" (as opposed to "gross revenues") as a percentage rent metric. The computation of profits, whether gross or net, is subject to too many variables. It is a whole lot simpler to come up with a mutually agreeable definition of "Gross Revenues." As some one here has already noted, a percentage rent provision in a lease usually contains provisions allowing the landlord to audit the tenant's books and records in order to confirm that the gross revenues reported by the tenant for percentage rent purposes are in fact legit. The frequency and extent of the audit, and the contractual consequences for the tenant and landlord if the audit does or does not disclose a material discrepancy, are usually the subject of serious negotiation.
That seems high to me, but you should ask a lawyer or (better yet) a commercial leasing agent who works in the vicinity of the leased premises. A couple of items to mention when you ask for his or her opinion:
1. Is there a fixed Base Rent, and what is it? (The higher the Base Rent, the harder it should be for the landlord to collect a meaningful percentage rent, meaning the percentage rent rate should be lower.) If the lease dd not call for any fixed Base Rent at all (meaning that the landlord was taking a very legitimate business risk by depending entirely upon percentage rent), a higher percentage rent rate would be far more reasonable. For purposes of addressing this issue, you are going to have to operate on some kind of basic assumption concerning the amount of gross revenue you are likely to generate at that location.
2. Is the lease a pure/triple net lease (i.e., does it call for the tenant to pay all maintenance expenses, insurance premiums, and real property taxes attributable to the premises, so that the rent the landlord collects is net of those three primary landlord expenses)? If the rent is a gross rent (in which the tenant is not asked to directly pay or reimburse the landlord for such expenses), the Base Rent should be appreciably higher. It is rare for commercial leases to be gross leases. You see that much more frequently in the residential lease context.
You need to be extremely careful as to how the numbers are calculated. Everything obviously should be in writing with a clear understanding of the terms and maybe a cap on the rent.
Although irritating and subject to abuse, I don't consider the right to audit to be a huge problem. A confidentiality clause could be inserted, and is probably customary for these types of leases. Also, Microsoft requires business customers with large numbers of licenses to agree to be audited, so the audit business numbers in situations like this is not that unusual. Personally, I would be much more concerned about Microsoft than a landlord. However, ultimately whether a renter would agree to a business audit is a value decision for the renter (and the landlord) to make.
Although irritating and subject to abuse, I don't consider the right to audit to be a huge problem. A confidentiality clause could be inserted, and is probably customary for these types of leases. Also, Microsoft requires business customers with large numbers of licenses to agree to be audited, so the audit business numbers in situations like this is not that unusual. Personally, I would be much more concerned about Microsoft than a landlord. However, ultimately whether a renter would agree to a business audit is a value decision for the renter (and the landlord) to make.
