One division sets the breakpoint. What it implies for rent steps, sales risk and artificial breakpoints takes a few more lines.
The natural breakpoint is annual base rent divided by the percentage rate. A 4,200 sf unit paying 45.00 a foot, 189,000 a year, with 6 per cent percentage rent has a natural breakpoint of 3,150,000 of sales. At 4,500,000 of sales the tenant pays 6 per cent of the 1,350,000 above it, 81,000, for 270,000 of total rent.
Worked in full in How to Read a Commercial Lease by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The unit is the ground-floor retail unit that How to Read a Commercial Lease uses to explain percentage rent, with its breakpoint and its sales. The book's companion files reuse it in a case on co-tenancy. The variants further down, an artificial breakpoint, a rent step and a range of sales, are illustrative extensions.
| Input | Value |
|---|---|
| Area | 4,200 sf |
| Base rent per sf | 45.00 |
| Annual base rent | 189,000 |
| Percentage rate | 6% |
| Gross sales, as defined in the lease | 4,500,000 |
Natural breakpoint = annual base rent / percentage rate = 189,000 / 6% = 3,150,000
Percentage rent = MAX(0, sales − breakpoint) × rate = (4,500,000 − 3,150,000) × 6% = 81,000
Total rent = 189,000 + 81,000 = 270,000, or 64.29 a foot
Excel: =Base+MAX(0,Sales-Base/Rate)*Rate
The breakpoint is called natural because it is the level of sales at which 6 per cent of sales exactly equals the base rent. Below it the tenant pays base rent; above it the tenant pays 6 per cent of every dollar of sales. On this unit that is 750.00 of sales a foot against 1,071.43 actually achieved.
Above the natural breakpoint, total rent is simply the percentage rate times sales: 6 per cent of 4,500,000 is 270,000. The base rent no longer affects what the tenant pays, only where the switch happens.
| Sales | Change | Percentage rent | Total rent | Rent / sales | Change in % rent |
|---|---|---|---|---|---|
| 3,000,000 | -33% | 0 | 189,000 | 6.3% | -100% |
| 3,150,000 | -30% | 0 | 189,000 | 6.0% | -100% |
| 3,600,000 | -20% | 27,000 | 216,000 | 6.0% | -67% |
| 4,050,000 | -10% | 54,000 | 243,000 | 6.0% | -33% |
| 4,500,000 | 0% | 81,000 | 270,000 | 6.0% | 0% |
| 5,000,000 | +11% | 111,000 | 300,000 | 6.0% | +37% |
Percentage rent is a geared claim on sales. Its sensitivity is sales / (sales − breakpoint): 4,500,000 / 1,350,000, or 3.33x. A 10 per cent fall in sales removes 33.3 per cent of the percentage rent; a 30 per cent fall removes all of it. This is why an underwriter treats percentage rent as the least secure line in the rent roll, and why a valuer who capitalises 81,000 at the same yield as the base rent is valuing a different kind of income at the same price.
A lease can instead state a fixed breakpoint. If it is set below the natural level, the landlord earns percentage rent on sales the base rent already covers.
The second point is the one that catches readers out. For a tenant trading above its natural breakpoint, a scheduled rent increase does not increase what the landlord receives at all, unless the breakpoint is drafted as a fixed figure that does not move with the base rent. Which of the two the lease says is a sentence worth finding before relying on rent steps in a model.
The usual errors are three. First, using monthly base rent against annual sales, or prorating neither in a part year, which puts the breakpoint in the wrong place by a factor of twelve. Second, ignoring the lease definition of gross sales: exclusions for returns, sales taxes, staff discounts or online orders all lower the figure the 6 per cent applies to. Third, modelling rent steps and percentage rent independently, which counts the same dollars twice whenever the breakpoint is natural. Here that would show 275,670 of rent where the lease delivers 270,000.
The unit, its breakpoint and what a dark anchor does to its sales are worked in the case workbook on the free workbook page for this book. For the anchor scenario across a whole centre, see what losing the anchor actually costs; for operating cost caps on the same kind of lease, cumulative against non-cumulative caps.
A natural breakpoint is base rent divided by the percentage rate, the sales level at which percentage rent equals base rent. An artificial breakpoint is a fixed figure in the lease. Set at 2,800,000 instead of the natural 3,150,000, it raises the worked tenant's percentage rent from 81,000 to 102,000.
Not if the breakpoint is natural and the tenant trades above it. A 3 per cent step to 194,670 moves the breakpoint to 3,244,500 and cuts percentage rent to 75,330, so total rent stays 270,000. Only a breakpoint frozen as a fixed number lets the step add rent, here 5,670.
Its sensitivity is sales divided by sales above the breakpoint. On 4,500,000 of sales and a 3,150,000 breakpoint that is 3.33 times: a 10 per cent fall in sales cuts percentage rent by 33.3 per cent, and a 30 per cent fall eliminates it.
The ground-floor unit and its breakpoint come from chapter 3 of How to Read a Commercial Lease. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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