Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Updated October 02, 2022A percentage lease is a type of lease where the tenant pays a base rent plus a percentage of any revenue earned while doing business on the rental premises. It is a term used in commercial real estate. A percentage lease agreement generally decreases the base rate for lessees and offers the lessor additional upside potential.
A percentage lease has two components — base rent (or minimum rent) and a percentage of the monthly or annual gross sales made on the premises. The lessee could find this arrangement attractive, as it lowers this fixed cost, which normally accounts for a large proportion of operating costs, and the lessor obtains some upside potential beyond what a standard lease (i.e., no percentage of sales component) could yield. Additionally, the percentage lease aligns the interests of lessee and lessor.
By providing a desired location and upkeep services to the tenant, the lessor enhances the presence of the retailer to capture more foot traffic and hence, the possibility of greater sales, part of which would go to the lessor under the percentage lease agreement.
The landlord and tenant negotiate a "breakpoint," the level of sales where percentage lease payments kick in, in conjunction with the base rent. If a landlord agrees to a lower base rent, it would want a lower breakpoint as well. The lessee is interested in a low base rent and high breakpoint. After back and forth and settling on those two figures, the two parties must determine exclusions to the sales figure (sales to employees of the store, for example), operating hours of the store, rights to amend the breakpoint, and procedures for auditing store sales, among other details.
Let's take a look at the financial statements of Tapestry, Inc., owner of Coach and Kate Spade brands, which calls their percentage portion of its overall lease payments "contingent rentals." The company recognizes contingent rentals on its income statement when "the achievement of target (i.e., sale levels) . is considered probable and estimable." In its fiscal year 2019, Tapestry paid approximately 30% of its total rent in the form of contingent rent (i.e. through a percentage lease). Contrast that with Signet Jewelers Limited, whose percentage lease payments were less than 2% of the total rent for the same year.