Retail Traffic

LEASE LANGUAGE: Percentage rent & e-tail

Get your leases in line with the new online world, or you may end up paying the price later in lost revenue.

Now that even the most stubborn of us has accepted the fact that the Internet is here to stay, how should our shopping center leases reflect this radical change in the way America shops?

Traditional shopping center leases not only provide for the payment of a fixed minimum rent, but also a percentage rent based upon the volume of sales over a breakpoint. But if today's marketing-savvy tenants join the growing list of retailers that sell online, landlords will have to find new ways to capture those sales in order to protect their percentage rent receipts.

A percentage rent clause typically has a tenant pay a percentage of its gross sales, either over and above an agreed-upon breakpoint, or after deduction of minimum rent and other expenses such as real estate taxes. In the new world of online sales, the parties must come to an agreement up front as to what constitutes gross sales for the purposes of the percentage rent calculation.

Obviously if you are a tenant, you will want to exclude all Internet sales from the definition of gross sales. As many of us have already found out, several of the larger national retail tenants refuse to even discuss inclusion of Internet sales during the lease negotiation process. Others agree online sales generated from a shopping center location are fairly included within the definition. But what do you do about a sale made over the Internet when the customer returns the item?

The fine-tuning of the definition of gross sales to include or exclude Internet sales is just one more economic issue of the transaction. The outcome of which will be based upon the bargaining power of the parties and how much they each want the deal.

If Internet sales are to be excluded from the definition, that should be explicitly stated in the lease. Otherwise a court might be forced to divine the intent of the parties at the time they entered into the lease. The inclusion of a percentage rent provision might lead a court to imply all sales, whether at the store or over the Internet, should be added into the calculation.

Once the parties agree to include Internet sales, they will be faced with a further issue of definition: Internet sales from where? Do you look at all sales made within the zip code in which the store is located? Or all sales within a certain radius of the store? Or just sales that are fulfilled from the particular shopping center location? Or, in the case of a national tenant, should we allocate a portion of the national sales to each region or store? The answers to these questions will evolve as the use of the Internet for retail shopping evolves.

And if you think that the calculation of percentage rent is the only lease provision which may be impacted by e-commerce, you are wrong. Consider these other questions:

- Should we reconsider the value of the use clause when everyone can shop on the Internet?

- Why battle for exclusives and co-tenancies today when vertical and horizontal integration between tenants seems to be generating more income?

- Should tenants consider reducing store size for their longer term leases as fulfillment space is much cheaper?

Whether you are a landlord or a tenant, the increasing and expanding use of the web is changing the way you do business. It is critical that you consider this impact on the leases you are signing today.

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