Landlords have a vital interest in ensuring that tenants maintain an adequate cash flow to pay rent and meet their other financial obligations under the lease. You may be able to help a tenant improve cash flow—without hurting yourself—by calculating percentage rent cumulatively rather than on the traditional month-by-month basis. The cumulative percentage rent alternative is especially attractive when dealing with seasonal businesses and other tenants whose sales revenues fluctuate throughout the year. Here’s a briefing on the cumulative rent method and how to implement it, including a Model Lease Clause that you can adapt for your own use. 

Cumulative vs. Month-by-Month

To illustrate the benefits of cumulative rent, consider the example of a retail tenant with sales revenues that are consistent on a year-to-year basis but vary widely from one month to the next. The tenant perennially earns 75 percent of its revenues in the first six months of the year, peaking in June. After that, things slow down and cash becomes tight.

Under a traditional month-by-month formula, the tenant will end up paying artificially high percentage rent during the first part of the year, especially in June. The landlord will then have to give the tenant a percentage rent refund for those months when it tallies up the tenant’s annual percentage at the end of the lease year. In the meantime, the tenant’s cash flow will suffer as it awaits its year-end refund.   

By contrast, a cumulative method calculates the tenant’s monthly percentage rent payment in a way that accounts for the tenant’s fluctuation in monthly sales. Consequently, the tenant would pay comparatively less percentage rent in a strong sales month than it would under the traditional method, which enhances its cash flow. In addition to bolstering the tenant’s business, this enables the landlord to avoid having to scramble to come up with a big year-end refund when the lease year ends. 

Percentage Rent Basics

Under both the traditional and cumulative methods, a tenant generally pays percentage rent in addition to minimum rent. The break point is a crucial element in the percentage rent calculation. The break point may be equal to minimum rent or some other fixed-dollar amount. In the former situation, you calculate annual percentage rent by multiplying annual sales by a fixed percentage and subtracting minimum rent.

Example: A jewelry store tenant’s lease runs from July to June. The fixed percentage is set at 10 percent and the store’s annual rent is $36,000. This same dollar amount also serves as the break point. The store has annual sales of $480,000 for the lease year. To calculate annual percentage rent, the landlord would multiply annual sales of $480,000 by the 10 percent fixed percentage, which equals $48,000. The landlord would then subtract the $36,000 minimum rent from that total. Result: The tenant’s annual percentage rent obligation is $12,000. 

Percentage rent leases typically require tenants to pay their annual percentage rent in monthly installments. The key question then becomes: How are those monthly installments calculated? 

Traditional Method 

Under the traditional, month-by-month method where the minimum rent is the break point, you calculate monthly percentage rent due for the current by multiplying the tenant’s previous month’s sales by the fixed percentage and then subtracting monthly minimum rent.

Example: In May, a jewelry store tenant had $40,000 in sales. To determine the monthly percentage rent due in June, the tenant would multiply $40,000 by the fixed percentage of 10 percent. From that resulting $4,000 product it would then subtract the minimum monthly rent of $3,000, i.e., the $36,000 annual minimum rent divided by 12. Result: The tenant’s monthly percentage rent for June is $1,000.

As long as the tenant rakes in that same $40,000 each month, its monthly percentage rent payments at year-end will add up to $12,000, the same as the percentage rent due for the entire year. But that kind of consistency in sales may not happen. And these fluctuations in monthly sales can create cash flow problems for both sides. 

Example: The jewelry store tenant with annual sales of $480,000 posted $220,000 of those sales revenues during the December Christmas rush. Under the traditional method, its monthly percentage rent for January would be a whopping $19,000 (10% of monthly sales of $220,000 equals $22,000 minus the monthly minimum rent of $3,000). 

When it’s all and said and done, the $19,000 in percentage rent in January is $7,000 more than the $12,000 in percentage rent it owes for the entire year. And it won’t get a refund or credit on that $7,000 until the lease year ends in June. That could result in six months’ worth of cash flow problems.

Cumulative Method 

The tenant can avoid these problems by paying monthly percentage rent on a cumulative basis. The difference is that under a cumulative method, monthly percentage rent is based on total sales in all previous months of the lease year, rather just the sales of the prior month. 

To calculate the monthly percentage rent payment for the current month when the break point is the minimum rent:

• Step 1: Multiply total sales for all previous months of the lease year by the fixed percentage;
• Step 2: Subtract from that product all minimum rent paid during those previous months;
• Step 3: Subtract all percentage rent, if any, paid during those previous months.

Example: The jewelry store tenant’s annual sales during the July to June lease year break down as follows: 

• July to November: $16,000 per month;
• December: $220,000;
• January to June: $30,000 per month.

Under the cumulative method, the tenant would pay only $12,000 in percentage rent for January, as opposed to $19,000 under the traditional method. Explanation: During the period from July through December, the tenant had $300,000 in total sales. Multiplied by the fixed percentage of 10 percent, that comes to $30,000. From that total you’d subtract the $18,000 in total minimum rent that the tenant paid, i.e., $3,000 per month through the weeks of July through December. Then, you need to subtract the percentage rent that the tenant paid during those months. Since the tenant in our example didn’t make any such payments, the tenant would owe $12,000 in monthly percentage rent in January ($30,000 - $18,000 - $0 = $12,000).

That’s still a big payment. However, because the tenant in our example owes $12,000 in annual percentage rent for the entire year, it doesn’t have to pay any more monthly percentage rent for the rest of the lease year. 

No Cost to Landlord

It’s not hard to understand why a tenant would like this arrangement. But what does the landlord get out of the deal? Answer: The landlord gets to provide meaningful financial support to tenants without sacrificing a nickel of percentage rent revenues. The cumulative method doesn’t reduce the total amount of percentage rent that a tenant must pay for the lease year. Thus, under our scenario, the annual percentage rent that a tenant with $480,000 in yearly sales would have to pay is $12,000 regardless of method of calculation. The cumulative method merely impacts the size of the monthly installments the tenant must pay to meet that $12,000 obligation. 

Of course, in helping tenants with their cash flow, landlords may be compromising their own. After all, the additional percentage rent that tenants pay during the year is money that landlord can put to use. But this cash injection is only temporary because landlords also have to refund that money at the end of the lease year. And this can create cash flow problems for the landlord. In fact, attorneys tell us that lenders look favorably on cumulative percentage rent arrangements because it alleviates their concerns about that a landlord won’t have sufficient cash reserves to make the necessary refunds.