Commercial real estate brokers are paid via a commission agreement: a written and executed agreement between the landlord and the broker whereby the landlord agrees to pay the broker a commission if the broker is the “procuring cause” of the lease. In other words, the broker is responsible for bringing the tenant to the landlord.
HOW MUCH ARE BROKERS PAID ON MY LEASE?
It varies by market, but the total commission paid to brokers is almost always calculated as a percentage of your total rent payment. A good rule of thumb is 6.0% per year up to ten years of lease term, with a declining percentage in the years following the 10th year.
The basic formula is:
(annual rent per square foot) x (total square feet) x (years of term) x 6.0%
If Company A signs a 10-year lease for 20,000 square feet at $30.00 per square foot, the total commissions paid by the landlord would be: 10 x 20,000 x $30 * 6.0% = $360,000.
Note: The above formula does not incorporate adjustments for base rent increases, or “step ups”, during the term of the lease, in which case the commissions would be even higher. Also, in some markets, the broker is paid on the “net rent” defined as the rent exclusive of operating expenses.
SPLITTING UP THE PIE: WHO GETS WHAT AND WHEN?
The tenant representative broker usually gets twice the commission of the listing broker. So, in a typical 6.0% commission, 4.0% goes to the tenant representative broker and 2.0% to the building listing broker.
Further, standard market convention is that tenant brokers should be paid 50% when the lease is signed and 50% when you move in. If problems arise and you don’t or can’t move in, this reduces liability for the landlord.
IF THIS IS ALL STANDARD ANYWAY, WHY DO I NEED TO READ MY BROKER’S COMMISSION AGREEMENT?
The commission agreement is the contract between the landlord and your broker which details the economic terms of the broker’s commission to be paid on your lease, including base commissions, bonus commissions (if any) and the timing of payment (at signing, upon occupancy, etc). In our experience, the vast majority of tenants do not read their broker’s commission agreement believing it is between the landlord and the broker, and therefore not relevant to them.
While the landlord is technically responsible for paying your broker’s commission, the landlord pro-rates it back into your rent. Thus, in actuality, YOU are paying the commission – borrowing the commission up front from your landlord to pay your broker, and then paying the landlord back (often plus an imputed interest rate) over the term of your lease via your rent!
Lastly, and maybe most importantly, this agreement often binds the landlord to pay the broker on the renewal and/or expansion of your space, even if the broker does nothing and is not involved in your next deal. You read that right. What if your broker did a bad job the first time around? Renew your lease and he gets paid… again.
It is our strong recommendation that all tenants read and understand their broker’s commission agreement to ensure that their interests are properly represented. We designed our standard Spaced Brokerage Commission Agreement© to protect client interests, ensure advisors are paid fairly for their services and save time and legal fees on lengthy negotiations.
In the event you are not using the Spaced Brokerage Commission Agreement©, we recommend tenants take the following steps:
- Require that your broker share with you his/her commission agreement and require that YOU sign and approve the agreement alongside the landlord.
- Work with your lawyer to identify and correct the following standard, broker-friendly provisions in your broker’s agreement:
Provision: The broker gets paid on any and all of your lease renewals and expansions, even if they no longer represent you, and even if they do not work on said renewal and/or expansion.Solution: In other words, your broker should only be paid for the original term of the lease. If in fact you require additional representation at the time of a renewal or expansion, your broker at that time should enter into a new commission agreement. You do not want the landlord to be contractually obligated to pay two commissions (to your old broker and new broker) on your renewal, creating more costs that you will have to pay back as part of your renewal rent.
Note: Renewal and expansion commissions are often 25 – 50% lower than for new leases
Provision: The broker gets paid an above an above-market, or bonus, commission on the deal, usually $1 per square foot. Landlords typically do this in order to incentivize brokers to come to their building or close a deal.
Solution: Strike any bonus commissions paid by landlords to your broker. One, you ultimately pay for this in the form of higher rent and should keep that money for yourself. Two, this creates the wrong incentive for the broker, who should be representing your best interests, not steering your lease toward the landlord offering the highest commissions.
Provision: The broker offers to provide you an additional service – such as construction management – and then charges the landlord for it (who will in turn charge it back to you in rent).
Solution: Any additional services offered by the broker should be paid for out of their commission. Most commonly, they should offer to supervise your construction and moving process (with a specialist from their firm) as part of the fee without billing such services back to the landlord.
- Ask your broker how much if any of their commission they are willing to share before co-signing your brokerage commission agreement. Increasingly, brokers will often offer to share a portion of their commission in the form of cash back to you, especially on larger transactions. Check out this Wall Street Journal article from our blog!
Note: It is a common misconception, or more accurately misinterpretation, that brokerage commission rebates are illegal. While it is true that unlicensed individuals may not receive compensation for real estate transactions, if that individual is a party to the transaction (e.g. the lessee… you) then most states allow that company or individual to receive a rebate. In fact, brokerage commission rebates are legal in 40 out of 50 states (including Pennsylvania). As for those remaining 10 states, the US. Department of Justice is in litigation with most of them to change the laws in order to encourage competition in the industry, but in the meantime you can just ask your broker to take less of a commission from the landlord while you take the difference in the form of free rent.