A kick-out clause is an option the tenant holds on its own sales. Priced with a probability, it is neither free nor a certain break.
A sales kick-out clause costs the landlord the probability that the tenant's sales fall below the threshold, times the rent lost if it then leaves. On an illustrative shop paying 150,000 a year, with a year-three threshold of 2,200,000 against expected sales of 2,600,000, the chance of exercise is 17.7 per cent and the loss if exercised is 256,116 in present value, an expected cost of 45,252, or 4.40 per cent of the rent every year of the lease.
Worked in full in Retail Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A kick-out clause, common in retail leases for new formats and in centres where the tenant takes a leap of faith on footfall, lets the tenant terminate at a set date if its sales in a test period fall below an agreed figure. Unlike a plain break option, it can only be exercised when trading is poor, which is exactly when the landlord will find the unit hardest to re-let. Its cost therefore sits between zero, the way it is often treated in a valuation, and the full cost of a break, the way a cautious lender may treat it.
| Input | Value |
|---|---|
| Rent, fixed for the term | 150,000 |
| Lease term / kick-out date | 10 years / end of year 3 |
| Sales threshold in year 3 | 2,200,000 |
| Expected year-3 sales (median of the forecast) | 2,600,000 |
| Sales uncertainty, standard deviation of log sales | 18.0% |
| Void if exercised / landlord's irrecoverable costs while empty | 1 year / 40,000 |
| New letting: rent below current / rent-free / letting fees | 10.0% / 6 months / 15.0% |
| Discount rate | 7.5% |
The threshold is 84.6 per cent of expected sales. At the threshold the rent would be 6.82 per cent of the tenant's sales, against 5.77 per cent at expected sales: the clause has been set close to the point where the occupancy cost ratio starts to bite.
z = ln(threshold ÷ median sales) ÷ σ = ln(2,200,000 ÷ 2,600,000) ÷ 0.18 = −0.928
P(sales < threshold) = N(−0.928) = 17.7%
Excel: =NORM.S.DIST(LN(2200000/2600000)/0.18,TRUE)
The working assumption is that a tenant below the threshold always leaves and a tenant above it never does. Both can be wrong, and the sensitivity below shows how much the answer depends on the probability.
| Year | What happens | Loss | Present value |
|---|---|---|---|
| 4 | Void: rent lost plus irrecoverable costs | 190,000 | 142,272 |
| 5 | New tenant at 135,000, six months free, fees of 20,250 | 102,750 | 71,571 |
| 6 | Rent shortfall | 15,000 | 9,719 |
| 7 | Rent shortfall | 15,000 | 9,041 |
| 8 | Rent shortfall | 15,000 | 8,411 |
| 9 | Rent shortfall | 15,000 | 7,824 |
| 10 | Rent shortfall | 15,000 | 7,278 |
| Loss if exercised | 256,116 |
In year 5 the new tenant pays 67,500 after the rent-free, so the shortfall is 150,000 less 67,500, plus the 20,250 of fees. The loss if exercised is 24.9 per cent of the 1,029,612 present value of the full lease.
Expected cost = 17.7% × 256,116 = 45,252
Annual rent premium = 45,252 ÷ annuity factor (7.5%, 10 years) = 45,252 ÷ 6.8641 = 6,593 a year, 4.40% of the rent
Put another way, a lease with this kick-out is worth about the same to the landlord as a lease without it at a rent 6,593 a year lower. That is the figure to have in mind when a tenant offers a slightly higher headline rent in exchange for the clause.
| Threshold | % of expected sales | Probability | Expected cost | Rent equivalent a year | % of rent |
|---|---|---|---|---|---|
| 2,000,000 | 76.9% | 7.2% | 18,563 | 2,704 | 1.80% |
| 2,200,000 | 84.6% | 17.7% | 45,252 | 6,593 | 4.40% |
| 2,400,000 | 92.3% | 32.8% | 84,077 | 12,249 | 8.17% |
| 2,600,000 | 100.0% | 50.0% | 128,058 | 18,656 | 12.44% |
The threshold is the term that matters. Moving it from 2,200,000 to 2,400,000 nearly doubles the cost, because it moves the trigger from the tail of the sales distribution towards its middle. Uncertainty matters too: at the base threshold, a 10.0 per cent standard deviation gives a 4.7 per cent probability and an expected cost of 12,142; at 25.0 per cent it gives 25.2 per cent and 64,541. A new concept in an untested pitch deserves the wider figure.
The tenant only leaves when trading is weak, and weak trading in the unit usually means weak demand for it. If the re-letting rent is 20 per cent below the current one rather than 10, the loss if exercised rises to 302,046 and the expected cost to 53,367, or 5.18 per cent of the rent.
Valuing the lease to expiry and ignoring the clause because the tenant "is expected to trade well". Expected trading is exactly what the threshold is set against, and a 17.7 per cent chance of losing 256,116 is not zero. The opposite error is treating the kick-out as a certain break at year 3, which values the clause at 37,313 a year, 24.88 per cent of the rent, and overstates its cost more than fivefold. The clause is an option the tenant holds on its own sales: price it with a probability, and set the threshold with the occupancy cost ratio in view.
Illustrative. The new letting is assumed to be on terms that leave value at year 10 unchanged in both cases, and sales are assumed lognormal, with "expected sales" meaning the median forecast, slightly below the mean. Test the threshold definition in the lease: gross or net of VAT, which period, and whether online sales attributed to the store count.
A kick-out clause at 84.6 per cent of expected sales costs this landlord about 4.40 per cent of the rent each year, rising quickly as the threshold approaches expected sales. Ask for the threshold the tenant's own business plan supports, not the one it opened with. The book treats retail rent as something revealed by the tenant's sales, and the free workbooks for the book run occupancy cost and rent at risk unit by unit. For the unconditional version of the option, see what a tenant break option costs the landlord.
A right for the tenant to terminate at a set date if its sales in a test period fall below an agreed threshold. In the worked example the tenant can leave at the end of year 3 if sales are under 2,200,000, which is 84.6 per cent of expected sales and a 17.7 per cent probability on the assumed sales uncertainty.
No. A break can be exercised at will; a kick-out only when sales are poor. Treating the worked example's clause as a certain break would value it at 37,313 a year, 24.88 per cent of the rent, against an expected cost of 6,593 a year when the probability of the sales test failing is priced in.
Below the sales level at which the rent becomes unaffordable for the trade, and well below expected sales. In the worked example a threshold of 2,000,000 costs 1.80 per cent of the rent a year, 2,200,000 costs 4.40 per cent and 2,400,000 costs 8.17 per cent, so each step towards expected sales costs more than the last.
This article is one calculation from Retail Real Estate. 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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