I recently read a post by Jo Tango of Kepha Partners about how VCs are paid, and thought it was a good way to understand how one of the more mythical industries actually pays its players. Similar to most incentive-based compensation models, the real money is in the big deal, but how a firm operates behind the scenes with regard to fees and partnership can have a significant impact on the end-user. In the case of CRE, the end-user is typically an occupier or owner of real estate, and as we know, deals are facilitated by intermediaries (brokers) almost 100% of the time. Given the preponderance of brokers in the commercial leasing and owning process, I thought it would be valuable to provide an explanation of how brokers are paid for their services. Two key areas of focus for tenants or landlords that are hiring brokers are firm structure and transaction type.
It is first important to understand the structure of the firm that is representing you. Is it a global, publicly traded player, a boutique local firm or an affiliate of a loose network of mid-sized firms across the country? Do brokers at this firm get paid on a 100% commission basis, salary and bonus, or some other model? Is the firm owned by public stockholders, a small group of partners, or a sole proprietor? It is important to ask these questions because you need to understand what factors influence your broker’s advice, and how those that advice impacts the huge real estate decision you are making.
In a pure commission based firm, there can be both positive and negative influences on the outcome of a transaction. Commissioned brokers are incentivized to bring in as much money as early in the calendar year because they typically have to pay back a draw or salary before they begin to collect commissions. The sooner this happens, the sooner the money begins to pile up, and a commission first mentality may develop. A nuanced part of broker compensation that is typically invisible to the client is the internal fee split. Often times the fee split between brokers can dictate the team on the field for the deal, and even jeopardize the project’s objective. For example, a senior broker may need transaction support on a rather complicated deal, so he might enlist a young associate knowing that he will not command as large a split on the commission. Thus, the client gets a greenhorn broker who cannot manage their expectations or the transaction. On the flip side, a commission-based firm has distinct advantages for a clients. When working properly, a commission firm is a well oiled machine of interconnected parts. Because the money is not going into a central pot, there tends to be more focus on a particular assignment given the individual broker’s direct line of sight to the revenue created by the deal. Clients benefit from this in that they typically get an expert on their account, rather than the best salesperson.
The boutique firm that pays brokers on a salary and bonus basis works a little differently. In a worst case scenario, you may be wooed in your pitch by the silver-haired partner representing the top-level of responsibility at the firm, only to find that once the deal gets going, he is nowhere to be found. He is most likely out pitching other business, managing the day-to-day operations of his firm, or on his boat. For him, this is ok. The business has been secured, the grunts are doing the dirty work, and the partner pile grows. For the client, this might suck. It may be difficult to determine the single point of contact on the deal resulting in delays in negotiations, missing information, and poor decisions. In the best case scenario, the senior partner and junior associate work hand in hand, with the senior partner always stepping in when he is needed and overseeing or sometimes spearheading the deal. After all, the fee is going in one big pot, so collaboration should be at a maximum at this type of firm.
Brokerage commission come in all shapes and sizes. It is important to consider the type of deal you are executing in order to understand how your broker is being paid.
Leasing fees – in a basic lease transaction, both the tenant rep broker and landlord rep broker are paid a fee by the landlord. The fee amount is usually tied to a market based commission structure that is tied to a percentage of the overall rent considered, or a per square foot per year fixed amount. For example in Boston, tenant rep commissions can range from $1.00 – $1.50 per SF per year for office deals depending on location and building quality. The landlord rep typically receives half of the tenant rep fee or, $.50 – $.75 per SF per year. An example tenant rep fee calculation for a 10,000 SF 5 year deal in downtown Boston is as follows:
$1.50 x 10,000 SF x 5 years = $75,000
This may seem like a big pay-day for a broker, but when you consider the splits with the house (50%), splits with partner broker on the deal (50%), and maybe a draw pay down, the money shrinks awfully fast. Needless to say, the larger the space, the longer the term, the bigger the fee.
Sale fees – brokers also make money by selling buildings. Sale fees are almost always a percentage of the sale price. Typically, the higher the sale price, the lower the fee. This is because, regardless of the building size, there is a ton of work involved with selling a building. Brokers don’t just list the property, throw up a sign, have an open house and collect offers. Sales fees can range from 1% – 5% depending on the size of the sale. A 1M SF downtown skyscraper that sells for $600/SF will yield a fee closer to 1%. Unlike leasing deals, in a sale process there is typically only one broker, the selling broker. Investors are approached directly, and a buyer’s broker is only involved when the buyer happens to be a user or company that hires a representative.
I would advise any tenant or landlord who is considering hiring a broker to ask how they are paid. Don’t even be afraid to ask how brokers are splitting up a commission with the house or with their partners. In the name of transparency, shouldn’t brokers be willing to tell you this? It is not a sin to make money, after all, it’s just good to know that money is not made at the expense of trust.