When to Conduct Percentage Rent Audits

Q: The leases I’ve signed with the tenants in my shopping center give my property manager the right to audit the gross sales on which the tenants base their percentage rent. How often should the manager exercise that audit right?

A: There are certain events that should automatically trigger an audit of a percentage rent tenant. They include:

• When the tenant requests rent relief.
• When the tenant tries to exercise its kick-out right.
• When the manager or owner wants to exercise the kick-out right.
• When the tenant tries to exercise other performance-based rights.
• When the tenant makes an assignment request.
• When the tenant reports its gross sales are just below its breakpoint.
• When the tenant requests a refund of an overpaid percentage rent.
• Before the tenant’s ownership changes (for example, because of a corporate takeover of a chain store or a mom-and-pop tenant’s decision to sell the business).
• When a tenant files for bankruptcy.
• Before the expiration or the termination of a lease.

Also, tell your property manager to be on the lookout for certain warning signs that a tenant may be misrepresenting its gross sales or could be in financial trouble:

• The tenant’s gross sales don’t mirror the center’s overall gross sales trend. For example, the center’s gross sales are up 10 percent overall, but one tenant’s sales are down 1 percent.
• The tenant’s gross sales don’t mirror the gross sales trend of other tenants in that category (fast food, jewelry, clothing, etc.).
• The tenant is part of a national chain and its gross sales don’t mirror the chain’s trend.
• The tenant’s gross sales are flat throughout the year. For example, a toy store’s sales will pick up during the year-end holiday season, but may be down in the spring. But if the store’s sales were flat through the year, it may be an indication there’s a problem.
• The tenant is providing estimated or rounded numbers in its sales reports, and may be misrepresenting its gross numbers.
• A tenant has several percentage rent breakpoints or percentage rent rates (for example, a newsstand has a breakpoint for newspaper sales, another for lottery tickets, and a third for candy), but submits sales reports with lump-sum figures.
• The tenant consistently submits its sales reports late—or fails to hand them in at all.
• The tenant is paying its percentage rent late or not at all.
• The tenant’s sales are flat despite an increase in foot traffic.
• The tenant’s sales are flat despite a significant increase in its inventory (such as a new shoe department).
• A long-term tenant that was always paying percentage rent because its gross sales were above its breakpoint suddenly stops paying percentage rent because its gross sales have dropped off.
• The tenant’s gross sales have dropped dramatically—for example, from $25,000 a month to $8,000 a month.
• There has been a change in the ratio of the tenant’s base rent to its sales—that is, the percentage of the tenant’s sales that go toward paying rent.
• The tenant is trying to exclude certain sales from its gross sales.