A health ratio, also known as an occupancy cost ratio, is the relationship between a retailer’s sales and total occupancy costs. A retailer’s health ratio for a given location is calculated using the formula of total annual rent (inclusive of reimbursements) of the location divided by its gross annual sales for that location.
For example, if a tenant has an occupancy cost of $150,000 and generates gross annual sales of $1,200,000 from the location, then the tenant’s health ratio would be 12.5% ($150,000 occupancy costs divided by $1,200,000 gross sales). Note that “healthy” health ratios can differ by type of tenant and sales per square foot.
An acceptable health ratio for a grocery store, which is typically a low margin business, is often 2.0% or less, whereas a jewelry store, which often generates high sales dollars per square foot, may have an acceptable health ratio of 14.0% or greater.
The health ratio is just one of many performance metrics that both tenants and landlords can utilize and plot over time to determine trends. Plotting the health ratio can reveal if a tenant’s sales are slipping compared to its fixed rent cost. If that is the case, the tenant will need to increase sales or look for a lower-cost location.
The landlord can also make adjustments based on health ratio trends. If the ratio is increasing, but rent is staying constant, it means the tenant’s sales are decreasing. The landlord can closely monitor this increase in the ratio or decide to take action and lower the tenant’s rent. If the ratio is decreasing, the tenant’s sales are increasing. The landlord may increase the tenant’s rent at that point.
If a tenant applies with a high health ratio, it doesn’t necessarily mean the landlord will reject the tenant’s application. There may be other factors to consider, such as the tenant's growth potential. The landlord will want to see that the ratio doesn’t deteriorate over time. If the ratio can remain steady or potentially decline, it likely means the tenant’s growth is strong enough to cover the higher rent cost.