Owning properties can be a great financial investment; however, there are different types of properties investors and owners can purchase. Commercial properties can be very lucrative, especially if you determine a natural breakpoint that factors in their sales or gross sales.

Typically, with percentage rent or percentage lease, this is a concept that is heavily associated with commercial properties, such as those found within a shopping center.

Defining Percentage Rent

To understand what one should charge or how much should be paid to the owner, it is important to understand percentage rent. Percentage rent, also known as percentage lease, is a common guiding principle of calculating the minimum rent paid by the tenants to the owner.

This concept of percentage rent is just one of many ways retail tenants are charged by the landlord to use the space.

How is Percentage Rent Calculated

The percentage rent is typically calculated when the clients have paid a base rent, and factors in the tenant's gross sales as a point of measurement in determining the percentage rent payable.

Ways to Determine Percentage Rent

There are two formulas that come to determining the percentage rent rate or percentage rent number. That formula takes into consideration the percentage of gross sales, as well as the natural breakpoint. This notion of a natural breakpoint is where the owner determines the base percentage rent needed to cover the most basic of costs.

The other alternative to determining a percentage rent is looking at the percentage of sales or the tenant's gross sales versus the artificial breakpoint. An artificial breakpoint is essentially a number, whether it is a set percentage or dollar value that both parties agree upon. This number can take into consideration the sales, the price per square foot, or look at the industry standard for retail rentals.

What to Factor in When Calculating Minimum Rent

When determining the pay percentage rent between a landlord and tenant, there may be factors that could be overlooked in the calculation. Here are a few things that one should consider when calculating not just the base rent but any possible additional rent that the landlord and tenant may consider combining together.

The annual gross sales or even gross sales of the business may be considered when determining even a base rent or natural breakpoint. When a client, for example, rents space out for their business, they don't know how successful it is going to be. They may estimate their sales, and the landlord may just ask for them to pay a base rent as opposed to a percentage rent. If the company or business starts to see massive growth and their gross sales exceed, the landlord may see this as an opportunity to renegotiate the terms of the lease.

They may look at an annual base rent, then determine the natural breakpoint before considering their sales as part of some form of payment in addition to the rent. There may be negotiations that the landlord is to have a lower base rent and the gross sales of the shop be used to determine a higher breakpoint.

Why Does Percentage Rent or Minimum Rent Matter?

Sometimes, when determining the percentage rent, one has to determine what the minimum rent or base rent is that they are willing to accept for their real estate property.

In real estate, a company profits through collecting payment; how that payment is determined is what matters. Furthermore, this is why determining and understanding the pay percentage rent is important. Collecting percentage rent can be lucrative if done correctly.

The base rent that a company or landlord receives sometimes is not enough to truly cover the expenses; therefore, one may look at a higher minimum rent or base rent. This is why percentage rent is a common practice in calculating the lease or rent of a tenant.

A landlord may ask the tenant to pay based on per square foot used, in addition to sales, or they may look at the cost of operating the space and find a happy medium for a rent percentage.

Understanding Gross Sales - Commercial Properties

Whether you own a company that owns or manages retail shops, it is important to understand the various approaches and advantages of generating income for yourself and the businesses. Some may calculate things based on a percent, while others may look at the sale records, also known as the tenant's gross sales as determining the lease payments.

Regardless of the circumstances, consider these key terms when owning and managing a retail business or property.

Key Terms to Know in Commercial Real Estate

Incidental Expense

Despite businesses wishing it were only rent that they are responsible for, on top of the total rent, businesses may find that they may have to contribute to other expenses that come with their location.

The incidental expense may be a certain amount set out for the tenant to pay. Examples of incidentals that the tenant may find themselves paying include property tax, insurance, utilities, or maintenance.

When it comes to the amount, the landlord and tenant may negotiate the terms of who is to pay for what, etc.

Common Area Maintenance

The common area maintenance is something that may require negotiating either on the landlords' or tenants' part. Sometimes the payment may be more than one expects, or how one may calculate the expense to be split is not fair. The common area maintenance is a fee that covers any possible services that may touch on the rental property being used as well as other businesses as well.

Examples of common area maintenance services include janitorial, snow removal, security, or property management.

Net Lease

The net least is a type of commercial real estate lease in which the clients' expenses include insurance and or utilities. Whatever is not covered by the tenant, is covered by the landlord, or they negotiate who and where the money is coming to pay for such expenses.

Tenant Improvement Allowance

Typically, a tenant pays the landlord; however, in some circumstances, the landlord may offer a tenant improvement allowance to their commercial leases. This is to help with any repairs or upgrades. The amount is normally calculated based on the square foot of the space.

Leasehold Improvements

Parties may be fortunate to have found a space for is subject to minimal to no renovations or improvements; however, there are times where either the landlords or the tenants may require changes to be made.

In this circumstance, this is known as leasehold improvements or tenant improvements. This is where updates or renovations may be made either by the landlord or tenant to improve if not make the space suitable for business operations.

Manage and Own Property Successfully

As a landlord, you have endless opportunities to profit greatly from a lease with your tenant. The advantage of managing leases can be quite rewarding when done correctly. If you are able to establish a great working relationship with your tenant, this can bode well as it means that the chances of them staying long term with you as a landlord is quite high.

The most important thing when it comes to managing and owning a successful property that can generate income through rent is to consider the type of working relationship that one wants. Keep in mind that a tenant and landlord relationship can be quite delicate, especially when it comes to commercial real estate.

David is the co-founder & CMO of DoorLoop, a best-selling author, legal CLE speaker, and real estate investor. When he's not hanging with his three children, he's writing articles here!