A Rent To Sales Ratio is found by dividing the total annual rent by a tenants gross annual sales. The metric helps investors and tenants determine if staying ope at a given location makes economic sense, and is commonly used when determining the value of a QSR deal.
An an example is outlined below.
A Burger King operator has 22 units throughout Alabama. They are restructuring their financials and need to determine which sites they may have to give up. Are they more likely to close (or ask for a rent reduction on Example A or Example B)?
Location A) $100,000 Annual Rental Income/ $1,200,000 Gross Annual Sales = 8.33% Rent To Sales Ratio
Location B) $150,000 Annual Rental Income/ $1,300,000 Gross Annual Sales = 11.54% Rent To Sales Ratio
Although the tenant (operator) is grossing $100,000 extra in annual sales at Location B, the rent they are paying is not sustainable. A healthy rent to sales ratio is typically 6-8%. It is imperative that the tenant is generating enough business in conjunction with the rent they are paying to keep a location open.
The lower the rent to sales ratio the more secure the investment. If a tenant is absolutely crushing it at a given site, you as a landlord should feel extremely comfortable that they will continue operating business. Not only that, but when it comes time for them to incur a rental increase in an option period, you have leverage knowing they want to stay at your property. If they try to negotiate with you, you can easily push back knowing they would be crazy to leave the site since it is generating such a healthy income stream for that tenant (operator).
The higher the rent to sales ratio the less profit a business is making, and the more likely they are to leave that location. You will often see deals being marketed at high cap rates that seem to go to be true, the reason is almost always because the rent to sales ratio is out of line and the tenant is going to require a huge rent reduction to continue operating or even worse, vacate at the end of the lease.