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Sluggish retail opens door to percentage leases

Landlords and brokers looking to fill vacant retail spaces in downtown Portland think they might find relief in a type of lease that puts a new spin on who stands to gain when a tenant turns a profit.

Percentage leases, usually reserved for malls, are more frequently being used by local real estate professionals to fill spaces in downtown Portland, where the retail vacancy rate is 8 percent. But the leases nevertheless carry risks for the brokers, landlords and tenants involved.

In a percentage lease, a landlord charges less per square foot in exchange for a percentage of the overall profits a tenant earns while in the space. The landlord’s share usually will range between 3 and 12 percent, once the tenant’s profits reach a level that the retailer and the landlord agree to when the lease is signed.

“These types of leases have been common for years at malls and shopping centers, where the landlords play a big part in promoting the center as a whole,” said J.J. Unger, a broker with the retail team representing the Portland offices of NAI Norris, Beggs & Simpson. “But now that tenants are getting such low lease rates, landlords are using percentage clauses to make sure the terms of the lease are somewhat fair.”

Percentage leases are most common for start-ups. Knowing that most businesses fail within their first four years, a landlord often will give a start-up retailer a lower rent in the first few years to help keep the business’ costs low, but will also take a higher percentage in case the retailer does well. In some of these instances, the lease rate will rise and the percentage will fall in the final years of the agreement.

Percentage leases most commonly are used for pop-up stores and temporary retail spaces, according to Unger. These types of tenants have become more common in Portland during the past few years as landlords have become more open to shorter leases simply to fill empty spaces, he said.

Central Cal Properties, which handles leasing for Bridgeport Village in Tigard, uses straight percentage leases for pop-up retailers when leases are for fewer than 12 months, said Dimitri Lalagos, senior leasing agent with the company.

“We will use them for new businesses, and even some national retailers, who want to see if a space works for them,” Lalagos said.

But leases lasting longer than a year have a base rent with a percentage clause in it, he said.

But even established companies and landlords are looking at percentage leases. Art DeMuro, president of Venerable Properties, thinks the recession has uncovered the benefits of percentage leases.

“I’ve learned that I should have a stake in every business that leases one of our spaces, and percentage leases help accommodate that,” DeMuro said. “They let both the landlord and the retailer put some skin in the game.

“Plus, when things bounce back in a few years these percentage lease clauses will keep landlords above water despite having a tenant locked in at such a low lease rate.”

Six percent is the usual amount of profits that the landlord gets in a percentage lease situation, said Doug Magnusen, principal broker with HSM Pacific Realty. The 12-year real estate veteran recently brokered his first percentage deal and has heard they are common now more than ever.

“In this economy both landlords and tenants have to get creative,” Magnusen said, “and adding a percentage clause into a lease is one of the ways to do that.”

Tenants receive lower lease rates via percentage leases, but Unger noted that they also will pay more if they do well.

Landlords, meanwhile, may fill their spaces, but they cannot use the leases to their advantage when refinancing or selling their properties. Percentage leases are not factored into loan underwriting because the future lease profits aren’t guaranteed, Unger said.

“If a (property owner) wants to restructure his loan or do something else with the property, (he) can’t take the percentage profits into account,” Unger said. “So it can really affect a landlord in that sense.”

While both parties can benefit, or be hurt, by these leases, Unger said they are helping agents reach their ultimate goal: filling spaces that would otherwise sit vacant.

“Tenants can only pay so much in this economy,” he said. “So, in order to fill a space it’s definitely an option to look into.”

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