The bustling corridors of an airport or a shopping mall present a lucrativeopportunity for franchises and retail companies to capitalize on foot traffic. This increase in sales opportunities can also factor into the company’s lease agreement with the commercial management company. A percentage lease may be required in these circumstances, which may present a new set of challenges regarding compliance and financial reporting for franchisees and retail owners.
A percentage lease uses a base rent, which is usually lower than market value, and supplements that with a percentage of revenue earned. Companies may also see this as ‘percentage rent’ in their lease agreements. This lease structure benefits tenants because they pay lower rent, while lessors could benefit from a successful business. These agreements are especially favorable in high-volume tourist and hospitality areas. Percentage leases may be used by one company with multiple locations, like in the case of a franchise opening in an airport setting. For example, a Sunglass Hut location or a new Chick-fil-A franchise may encounter a percentage lease when operating in an airport. A company with a single location in a mall or strip mall can also use a percentage lease.
A percentage lease relies on accurate sales reporting to calculate the total rent owed each month. Because of this, it’s imperative that the restaurant or retail location’s management company investigates the lease requirements to determine whether an independent audit is required.
It’s crucial to first understand the terms of the lease agreement. The lease will lay out the percentage of sales that must be paid in addition to an agreed-upon base rent. The sales percentage will be calculated either as a fixed breakpoint, a pre-determined amount of sales that must be reached before percentage rent kicks in, or a natural breakpoint, which is calculated by dividing the base rent by the percentage rent rate. These terms will affect the calculations needed to audit the lease, and in some cases, the total revenue earned will determine whether businesses can self-report or whether they need an independent audit to support reported revenue.
A commercial lease audit provides an in-depth review of the terms and conditions of a lease and can target specific aspects of a lease. Once rent calculations are complete, an audit is necessary to ensure all numbers are accurate. Regular auditing will double-check sales data and breakpoints and cross-check previous records for any inconsistencies. An audit will also review sales reports for any possible anomalies or errors that could affect the rent calculation.
An audit can also ensure that a company operating at an airport is complying with federal, state or local regulators. If an airport receives federal funding, the lease agreement must comply with Federal Aviation Administration grant assurances. Airports are required to maintain accurate financial records and reports. An increase in compliance requirements has more companies seeking independent audits, even those that used to self-report their revenues.
It’s common for airports, especially larger ones, to outsource the management of their retail and restaurant operations to third-party companies. It often falls to these third-party management companies to implement best practices and ensure compliance with the terms of a percentage lease. The management company is responsible for conducting regular monitoring of financial records as well as conducting internal audits to identify discrepancies or underreporting of revenue.
It’s imperative that businesses are aware of the requirements of their lease. While smaller companies may have been able to self-report in the past, many leases have requirements that change over certain revenue thresholds. A growing number of landlords are also cracking down on the requirement of an outside audit for these franchisees. If these requirements are not met, businesses could face late fees. That could mean daily or monthly payments on top of the cost of rent, making it all the more important to stay on top of auditing requirements well ahead of the deadline. Most deadlines are typically within 30 to 90 days after year-end, so businesses will want to engage a firm for an audit sooner rather than later to avoid those penalties.
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If your franchise operates under a percentage lease agreement and is subject to a commercial lease audit, Withum’s Franchise Services Team can help ensure your reporting is accurate and on time.
