Real Deal REInvestor Network

Percentage Lease - Lionel Trains Hobby Store
The business plan for this store indicated that the expected sales for Year 1 were $50,000 and between $75,000 and $100,000 for Year 2. This is a thousand foot store and you are trying to get $1,725 a month from the store. To calculate the Lionel Train guy’s minimum breakpoint, give him the benefit of doubt by asking for 8% percentage rent.

That would mean that he needs to sell $21,500 in a month to be able to pay the rent under a percentage lease scenario. That equates to $258,000 for the first year. The train guy says that he can make $50,000 this year and, maybe a $100,000 next year, so he’s more than a little short in that kind of deal!

Let’s examine a straight lease deal, then. If we choose to estimate on the conservative side, if he sells $50,000 without paying the rent, he has $25,000 in his hand, because he must have his cost of sales for buying the trains (we’re assuming that was half his revenue to buy his goods).

So, now he has $25,000 left, but if he pays rent to you of what you wanted, or $1,700 a month, that’s $20,400 a year in rent costs. This Lionel Train guy has a hobby store, and a hobby is not a viable business. His hobby is a very costly business. This is not a win-win solution!

Key Point: The higher the percentage, the lower the value. Most of you will not start in the commercial real estate business by investing in a huge mall or spending $5,000,000 for a high-end retail property.

These are the kind of situations where you would work with percentage rents. If you go into retail, you’ll probably start by spending $200,000 or $300,000 to get a retail business going. You won’t get percentage rent for such a small retail operation.

Nevertheless, this information is critical to your success in the commercial real estate arena. It doesn’t matter whether you are ever going to charge percentage rent-- that’s not the point. However, this Course wants to give you a quick idea of how percentage rent works such that if a tenants ASKS for it in a smaller property you can see for yourself whether that would be a good risk for you to take (often not).