Your shopping center is hot.  All the luxury brands are there or want in, the high-end celebrity restaurants are opening soon and a few of the hot, quick serve restaurants are open.  This buzz is great for your retailers and if you have a retail sales clause in your lease language it’s great for you as well.  The retail sales clause in the lease allows the shopping center owner to capture a percentage of the retail sales as rent.  The primary philosophy is to align both the tenant and owners interests.  When the retailers do well, so will the owner.

The image above shows the window in Argus Valuation DCF to enter the retail sales information for a tenant.  This window is available through the Tenant Rent Roll page, by right clicking or getting the details on the retail sales column.  The first option, volume, can be broken down further into different levels (i.e. higher percentages as revenues increase).

What you will notice in both of these windows is the reference to a breakpoint.  The option of adding categories, allows you to specify multiple breakpoints for a lease.  What is a breakpoint?  It is simply the point at which percentage rent kicks in.  The breakpoint will be specified in the tenants lease and will usually be something specified on a per square foot basis or as gross revenue volume ($50/SqFt or $500,000 in revenue per year).  If your tenant has two breakpoints, say 2% of revenues after $500,000 and 1% of revenues after $1MM, you capture this by setting up separate categories for each breakpoint.

Natural Breakpoint Calculation

When the breakpoint column is left blank, Argus Valuation DCF will calculate the natural breakpoint for the tenant.  Say for example, the percentage rent is 3% of gross sales.  If the base rent is $100,000 per year, simply divide the rent by the percentage rent to get your natural breakpoint:

Natural Breakpoint = Annual Rent / Percentage Rent
$100,000 Annual Rent / 3% Percentage Rent = $3,333,333

Any sales over $3,333,333 the tenant will pay 3% in rent.

Other Breakpoints

The natural breakpoint is not always used as the default for percentage rent.  The lease could specify the breakpoint is $3,000,000.  Or, as mentioned earlier, a breakpoint could be defined for different levels:

3% over $3,000,000

2% over $4,000,000

1% over $5,000,000

When reviewing this, it’s easy to see how retail sales align both the retailers and the owners goals to making the shopping complex succeed.  The more revenue the retailers generate, the more cash the shopping center will generate in percentage rent and in turn Net Operating Income.

This post is a part of a collection of posts about Argus Valuation DCF and the Argus Certification Exam. You can view all posts in the series by following the Argus Certification Exam tag.

A key component of Argus Valuation DCF: Tenant Rent Roll. A lot of the fields in the Tenant Rent Roll screen are self-explanatory.  Some fields require further explanation.  Upon Expiration is one field that requires a bit of elaboration.  Immediately following the Market Leasing Assumptions field, the Upon Expiration field allows for defining the likelihood of the tenant to renew, vacate or go in a different direction.

The Options

So, what are the options?  Market, Renew, Vacate, Option, ReAbsorb and Non-Contiguous. What do each of these options do?

• Market - selecting Market in the Upon Expiration field denotes that the space will be released based on the weighting of the market leasing assumptions defined.  In the image above, there are two different Market Leasing Assumptions (MLA) setup:  Greater than 20,000 Square Feet (> 20K SqFt) and Less than 20,000 Square Feet (< 20K SqFt).  The second row shows the tenant term following the tenants expiration should be based on the Market Leasing Assumptions defined in < 20K SqFt.  If Market is selected, you can override the Renewal Probability of the MLA with the next column, Rnwl Prob.
• Renew - Selecting renewal means the tenants probability of renewal is 100%.  Using the MLA defined, the New Tenant column will be ignored and data from the Renew Tenant column will be used.
• Vacate - Vacate is basically the opposite of selecting Renew.  In this instance, the tenant will vacate and the renew probability is 0%.  All items in the MLA associated with Renew Tenant are ignored and figures from the New Tenant column are used.
• Option - Option leases are a continuation of an original lease. Selection option puts Option in the Lease Type field of the Rent Roll.  Use option when the tenant has a renewal option for the space.  Under this setting, the start date of the option lease will begin at the expiration of the original lease.
• ReAbsorb - When this option is selected, it means the space will be reabsorbed into the property – essentially taken off the market.  One approach to using this option is when a number of small spaces are expiring soon and the goal is to combine them into a larger space.
• Non-Contiguous - This allows you to link multiple leases into one lease.  For example, if you have an office tenant that occupies floors 20 and 22, you can use this selection to have both spaces occupied under one lease.

The Upon Expiration field and different options are important to know when taking the Argus Certification Exam.  Be sure to understand the impact of each of the options as described above.