Commercial Classroom: Commercial commissions - by Edward Smith

March 05, 2019 - Long Island
Edward Smith, Smith
Commercial Real Estate

This column is offered to help educate agents new to commercial and investment brokerage and serve as a review of basics for existing practitioners. 

All commission rates are negotiable.  What is fair compensation for our services? When we sell a building, we are generally paid a percentage of the selling price, in other words our fee is based on a percentage of the seller’s financial gain. Due and payable on title passage.

The fee for successfully negotiating a lease agreement should also be based upon consideration of the landlord’s financial gain. If a ten-year lease is signed and the rent is $25,000 per year, our fee should be based upon all the money the landlord will receive in rent during the entire term of the lease. In this case $300,153 (compounded to include a 4% rent escalation each year). 

There are several different methods of calculating a lease commission:

Split Rate Commission – The fee is based upon one rate X% for the first three years and a different (lower) rate Y% for each year thereafter. The rent to be collected each year by the landlord, including escalations is first calculated, and then these percentages are applied. The commissions for each year of the lease are then totaled; that is the fee due. This method is generally used when the landlord is paying the fee.

Aggregate Rent Method – This is very similar to a sales commission calculation, a percentage for commission is negotiated. The rent to be collected each year of the lease by the landlord, including escalations is calculated and added together. The total rent to be collected is then multiplied by the agreed percentage; this is the commission due. This method is generally used when the broker/agent is exclusively representing the tenant and they are responsible to pay the commission. Most tenant representative agreements have language making the tenant responsible for the commission if it cannot be collected from the landlord.

Declining Scale In this case a starting percentage for commission is established, which is reduced down to zero over time. This may be a reduction of a “point”, per year or every two years, for as long as agreed upon. This could be a 15-year lease, but the commission calculation is based on eight years. Also in this method, the rent to be collected each year by the landlord, including escalations is first calculated. Then the declining percentages are applied each year for as long as has been agreed upon.

Fixed Fee – A specific dollar amount is negotiated for completing a lease. This is most common in newer buildings where there may be multiple units to be rented out.

Multiple of Monthly Rent – This is not common in longer leases, however in very short leases (one or two years) a multiple of the monthly rent (one, two, or three month’s rent) may be set as the commission.

The entire commission is usually due and payable upon lease signing. It is reasonable to not receive the entire fee upfront if the landlord is not yet collecting rent due to construction or a concession to the tenant; after which the balance would be paid. Even large fees are due upfront, but sometimes are paid out over a short period of time; six months or even a year. It is generally not acceptable to be paid our commission annually.

Many leases have an option to renew or extend the lease. As stated earlier our fee is based upon all the financial gain of the landlord. If the lease is for five years and there is a five-year option to renew, and the tenant exercises their option to renew; the landlord will receive another five years of rent payments. We are then entitled to another five years of commission for the extension period. 

There may also be an option to expand or a first opportunity clause (for the tenant to take more space in the building); or a purchase option or option to buy. We are entitled to a commission on that money; provided your listing or commission agreement says so.

Generally, the seller or the landlord pays our fee, but you may have a buyer or tenant representation agreement whereby your client is responsible for the commission. The commission fees to be paid are stated in our listing agreements as percentages. It is a good idea to present a commission agreement with any offers stating our fee duo in real dollars, so there is no misunderstanding as to what the client owes us if the offer is accepted.

We work very hard to complete a transaction; you deserve to collect a full commission.

By the way, I have been in this business for over 45 years and our commission rates are the same as when I started. I think we deserve a raise!

The next time a client asks us to reduce our commission rate perhaps we should say, “Oh my mistake! What I just quoted you was our old commission rate; the company just increased our fee to X%.” You could be nice and then say: “But, since I made the mistake, I will honor the rate I quoted you.” 

Edward Smith, Jr., CREI, ITI, CIC, GREEN, MICP, CNE, is a commercial real estate consultant, instructor and broker at Smith Commercial Real Estate, Sandy Hook, CT.

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