As we discussed previously in these abstracts (“A Different Kind of Buyer’s Market: Retail Tenants Still in Business Demand New Lease Agreements from Landlords,” October 2020), the coronavirus necessarily prompted some innovations in retail leasing operations. Without sufficient sales to maintain their brick-and-mortar stores, retail tenants demanded relief from landlords.

One of the options that the partners came up with altered the way rent would be calculated. Rather than a fixed monthly fee, the landlords allowed their retail tenants to pay a percentage of their sales as rent. If a retailer suffered drastically diminished sales, at least it could avoid a situation in which its revenues were simply insufficient to cover rent. The thinking was that once sales rebounded, tenants would go back to paying rates in line with their pre-pandemic, fixed rents. It represented a gamble for landlords, whose income dropped, but it also was a necessary risk. The alternative was the loss of tenants completely, and a small rent payment is better than none. If they could help keep the businesses afloat, they ultimately could return to traditional leases and look forward to steady income in the future.

But that isn’t exactly how the experiment has developed. For both sides, the appeal of percentage rate leases have proved lasting. Many retailers continue to struggle with sales, and as some legacy brands have exited the market, new operators are looking for ways to decrease their start-up costs and risks. Thus they continue to request such concessions.

For the landlords, the benefits are less clear, but here again, their acceptance of such leases might reflect a lack of choice. Occupancy rates have not rebounded to their pre-pandemic level, meaning that property managers have a lot of space to rent and not enough renters to fill it all. This supply-and-demand imbalance leaves them with little option other than to agree, within reason, to the conditions that tenants request. Some operators continue to insist that the percentage payment option must remain a temporary one, such that they agree to one-year percentage-term leases and warn tenants that they will revert to fixed rates soon.

Some retailers also are perfectly happy to go back. A percentage-rate lease requires them to monitor, track, and share sales data constantly, an effort that can be cumbersome, especially for smaller firms. Other companies never wanted the variable rates in the first place; for Apple for example, a fixed rate is nearly always going to be less expensive than a rate that is based on store sales.

Discussion Questions:

1. Will percentage-rate leases become a permanent fixture of the retail rental market, in your opinion? Why or why not?
2. What other ways might retailers exert their increased power over property management firms? What additional demands might they make?

Source: Esther Fung, “Covid-19 Rent Breaks for Retailers Are Becoming the New Norm,” The Wall Street Journal, June 15, 2021.