Brokerage Commissions

Perhaps the most straightforward commission structure, often applicable in office leasing, is based upon the area of the premises. For example, the long-standing market rate commission in the Chicago office market is $1.25 per square foot. In the event a cooperating broker is present, the fee is commonly split equally between the brokers. In certain instances, the brokerage agreement may provide for a discounted commission for leases of large space; maximum commissions in premium-rent transactions; and floors for low-yield transactions.

Advances in technology have enhanced networks and allowed owners and tenants greater access to information, which in turn has created greater competition among brokers. That competition, particularly among tenant representatives, has resulted in fee compression, which in turn has given rise to a variety of other discount programs. For instance, larger firms may promote discounts in either cash savings or through in-kind services, such as project management services, incentives or workplace strategy consulting.

Another common structure, often found in the retail context, is based upon the aggregate base rent over the initial term of the lease or some other defined period. For example, the standard commission for retail leases in the Chicago market is 4% of the total base rent payable during the term, and 5% if a cooperating broker is involved (and the fee is payable in equal parts to both brokers). Particularly in major markets, retail rental rates fluctuate greatly relative to other sectors, so there may be increased opportunity for owners to negotiate a discount of the rate initially proposed.

For purposes of this commission structure, the agreement will expressly state that the base rent used in the calculation includes increases over the term, and specifically excludes free rent, any pass-through amounts for common area maintenance and taxes and other components of additional rent. Tenant improvement allowances are not deducted from the rent used in the calculation.

Alternative formulas are available as well. For instance, an owner might negotiate a hybrid arrangement that calls for a commission equal to the greater of an amount based upon the premises area or a stated percentage of base rent. Commissions may decrease for the largest tenant spaces or as the lease term ages. For example, the commission could be stated as the greater of: 1) $5.00 per square foot for the first 10,000 square feet leased, plus $4.00 per square foot for the next 10,000 square feet, plus $3.00 per square foot for the balance of the premises; or 2) 4% of the base rent for the term. Further protection for the broker could be provided by a commission floor or minimum term, and, likewise, protection for the owner could be afforded by a maximum term of years. The presence of a cooperating broker may increase the commission to 150% of the scheduled amount, with the resulting commission to be split equally among the brokers.

Brokers may negotiate for incentives that affect the commission payable. For example, a brokerage agreement may provide for an additional one-time fee based upon a fraction of base rent payable during the term if the broker procures a tenant that commences rent payments by a date certain. If the lease calls for rent abatement, then the incentive fee is usually based upon base rent that would have been payable but for the abatement.

Lease renewals may also trigger commissions. In some instances, a broker will be entitled to a commission based upon a fraction of the commission due for the initial term; however, a common exception applies if the tenant option is based upon predetermined economics. Issues can arise when a tenant wishes to renegotiate a renewal notwithstanding the terms stated in the lease. Extensions of shorter initial lease terms (e.g., those under five years) may entitle the broker to a commission based upon 100% of the commission that would have been due on the term, with a fractional commission for the balance of the renewal term.

Similarly, some brokerage agreements call for a commission payable on the expansion of the leased space. Upon an expansion, the broker would be entitled to a commission on the same terms as the initial space, either on a per-square-foot basis of the expansion space or on the base rent for the expansion space over the applicable term. Again, contingent commissions like these are commonly waived as part of the competitive process.

In addition to commissions, brokerage agreements commonly include provisions requiring the owner to reimburse the broker for marketing expenses. These can include costs for the design of materials such as signs, flyers and brochures, as well as the expenses of incentive programs, marketing receptions and open houses organized by the broker. If an owner is willing to agree to these reimbursements, he should require the broker to present a budget for these items to be approved in advance. Reimbursement terms are negotiable, and brokers are known to waive these requirements if they are problematic for the owner.

Subleases

Commissions for subleases are commonly lower than those for direct leases. If a broker earned 4% of gross rent for a direct lease, she may earn 2% or less of the rent due from subtenant for the term of the sublease. Sublease brokerage agreements also commonly provide that the broker will earn a commission if and when the tenant/sublandlord is relieved of liability for rent under the prime lease, or if the subtenant assumes liability under the prime lease. In either such event, the commission is based on the percentage of rent for the remaining term under the prime lease. If in either case the subtenant or prime landlord makes a cash payment, then that amount is deemed rent for purposes of the commission. Conversely, if the tenant/sublandlord makes a cash payment, then that amount is deducted from the rent used to calculate the commission.

Time and Manner of Payment

Applicable law will govern the time at which a commission is legally earned and the brokerage agreement will provide when the commission is payable. Generally, for the broker to be entitled to a commission, a lease document must be executed by the landlord and tenant or subtenant, and the broker must be the “procuring cause” of the transaction. Brokerage agreements often provide that in a new lease, a fraction of the commission is due upon execution of the lease document and the remaining fraction is due either upon the date the tenant occupies the space or opens for business, or the date rent commences. Other trigger dates may include waiver of tenant contingencies, waiver of early termination options in favor of the tenant and stated outside dates. A commission can be payable in installments over a stated number of months or years, with a discount if the owner elects to pay up front.

Some agreements allow the broker to deduct commissions earned and payable from any rent or security deposits made by the tenant, and include an assignment by the landlord of those amounts. Others contain language authorizing and directing the tenant to make payments directly to the broker in the event the commission is not paid when due (or following a notice period). This may be accompanied by a covenant to credit the tenant in the amount of the funds paid to the broker and a waiver of claims against the tenant arising out of such payment to the broker.

Conclusion

Although dramatic variances exist between sectors, markets and properties, an understanding of these most common components of commissions will save an owner time and resources in negotiation.

David P. Resnick, a member of this newsletter's Board of Editors, is a shareholder at Robbins, Salomon & Patt, Ltd. in Chicago.