Leasing Commercial Real Estate

How does the commercial real estate (“CRE”) industry work?

Most owners of real estate hire real estate agents to lease their property on their behalf. The agent obtains a listing agreement, which calls for that agent to act on the owner’s behalf as a fiduciary in leasing the property. The agreements are performance based, meaning the agent earns a commission upon the signing of a lease. The commission is typically paid one-half upon lease execution and one-half upon tenant occupancy. Owners of real estate can lease their own properties without having to have a real estate license.

Real estate agents are required by law to have a salesperson’s license issued by the state that the agent does business in. All agents must pass an exam in order to obtain a license. The agent then “hangs” their license at an office with a designated Broker. The Broker has additional licensing and educational requirements that they must meet in order to have agents that work for them. The Broker is ultimately responsible for any acts committed by an agent whose license is “hung” in their office. Most all states have continuing education requirements, meaning that each licensed agent and broker must obtain a certain number of educational credits (also called clock hours) in order to renew their license.

Commissions are paid to the Broker who then pays the agent responsible for the lease. Agents typically work on “splits” with the house. Splits can vary anywhere from 50/50 to 90/10 in favor of the agent. Agents are typically independent contractors who are then responsible for paying their own taxes.

In some cases, a tenant will retain an agent to find a space on the tenant’s behalf. Most listing agreements require that the listing agent split the commission earned with the tenant’s representative. In most cases, commissions are split 50/50. There are exceptions to this rule. In soft markets where vacancy rates are high and tenants are at a premium, the owner may pay the tenant’s representative a full commission. In this case, the listing agent usually continues to receive a half commission, which results in a commission and a half being paid out by the owner.

How do commercial real estate professionals (“brokers”) get paid?

Commercial Real estate agents are typically paid a commission upon the signing of a lease. The commission is paid by the owner of the building and is typically paid one-half upon lease execution and one-half upon tenant occupancy. The commission is most often calculated as a percentage of the lease value and usually ranges between four and six percent. For example, if a tenant signs a 3-year lease for 2,000 square feet at $20 per SF per year, a 5% commission equals $6,000 (3 yrs x 2,000 SF x $20 x 5%).

To further complicate matters, the agent’s Broker is the one that gets paid the commission. The Broker then pays a portion of the commission to the agent, depending on the agent’s split. Commission splits range anywhere from 50/50 (most common) to 90/10 in favor of the agent. Using the above example, the agent would receive anywhere from $3,000 to $5,400.

How do commercial real estate commissions work?

There are several reasons why it is important to understand how commissions work:

One of the most common pitfalls a tenant makes is to tour properties without having decided on a brokerage relationship. If you plan on hiring a tenant rep, do so in advance of going on a property tour. If you plan on trying to find space on your own, make sure that any properties you have an interest in are shown to you by the listing agent (or owner, if the property is not listed). The reason this is so important is that in most cases, all an agent has to do is to bring the tenant to a property and he/she is legally entitled to a portion of the leasing commission as the “procuring” broker. A tenant may never see the agent again, but since that agent showed them the property, that agent will be paid a commission. These situations can also get real messy. For example, if later on that tenant hires a tenant rep, a commission dispute will likely occur if the tenant enters into a lease on a property that was shown to them by another agent.

Knowing how much your tenant rep will earn is important when it comes to how much service to expect. The larger the commission, the more work you should expect and the more diligent you should be in hiring your tenant rep. Commercial real estate commissions are, in most cases, calculated as a percentage of the rent due under the lease.

The higher the rent and longer the term, the more commission is paid. This may be great for the landlord, but is usually contrary to what the tenant is trying to achieve. Commissions are paid only if a lease is successfully executed. The quicker a lease is signed, the faster the agent gets paid. While this may be great for the agent, be careful to ensure that you are making compromises that make sense and not just to hurry up and get the deal done.

What’s the difference between a leasing agent and a tenant rep?

The leasing agent has the listing on the property and represents the interests of the building owner. A tenant representative or “rep” represents the interest of the tenant in a lease transaction. Some agents work exclusively on listings, others will take on tenant representation engagements only, while others will work on both.

Are all properties listed?

No. In some cases, an owner will lease the property directly. Sometimes, the owner will employ an in-house leasing agent. Typically, these are called open listings, where the owner will pay a full commission to any broker who brings a tenant to the property. An in-house leasing agent is usually paid on a salary basis, so their incentive to enter into a lease is different than from a listing agent who is paid a commission.

It is also essential to understand that when you are negotiating with an owner, the terms of your lease take on a much greater importance. The owner is going to receive your entire rent payment, while the listing agent receives only a small percentage as his commission. Also understand that if you hire a tenant rep, there is a possible conflict of interest. He may get paid a full commission on an open listing versus receiving a half commission on a listed property.

When would I want to find space on my own?

The best circumstance to find a space without retaining the services of a tenant rep broker is when you are looking for a small space and/or short-term lease. Generally speaking, since the total lease consideration is small, the commission that will be paid is even smaller. It is hard to find a good broker that is willing to work for a small commission. Remember, it takes the broker just as much time to help you lease 5,000 square feet for five years as it does to lease 1,000 square feet for three years. In addition, the listing agent will usually work harder to lease a small space if the commission does not have to be split.

Is finding a space without hiring a broker a good idea?

Generally speaking, the answer is no. You as the tenant enter into a lease once every so often. A broker negotiates for space on a daily basis. Would you go into an IRS audit without having your CPA by your side? Same reasoning applies here.

Now let us examine a couple of cases where you might lease space on your own. The biggest driver is the dollar value of the lease commitment. The less space you lease and the shorter the term, the less rent that is due under the lease. Less rent means a smaller commission. A listing agent is much more motivated to lease space directly to a tenant versus having to share their commission. This is especially true for small spaces that generate small commissions. Also, if you are leasing a small space, you sometimes can’t get a tenant rep to work for you because it is simply not worth their time.

Now that I’ve hired a broker, what should I expect from him/her?

A broker is like any other service professional. You should expect them to represent your interests, to give you good advice and to help you through the first phase of the leasing process; that is helping you determine how much space you need, what are your most important selection criteria, and then finding and negotiating for the space that best meets your needs. Don’t be afraid to ask your broker all kinds of questions. Know how much money your broker is going to make on your lease. That will help you determine just how demanding you can be and how much work you should expect. Remember that your broker doesn’t get paid unless a lease is signed, therefore their primary aim will be to make the transaction happen. No matter which broker you hire to represent you, the person who cares most about your interests is you. Ask questions, know your options. Make sure your broker understands what is important to you in the lease negotiation.

My broker doesn’t have much experience; should I be worried?

The answer to this question depends on the size of your lease. If your plans call for a large space with a long lease term, then your broker’s experience is a very important consideration. On the other hand, if you are leasing a small space, then you may be better off using a broker that is fairly new to the business. The reasoning here is that a younger broker is looking to establish himself and will work harder for a small commission. As the tenant, you need to know how much commission your lease is going to generate and then determine how to best get your money’s worth from your broker. If you are working with someone that is new to the business, then you need to understand what kind of training the broker has had. It is also important to know if the broker is working together with an experienced broker or is totally on his own. You need to know what resources the broker has available to him, particularly if he has never leased a space from the landlord and/or listing agent you are negotiating with.

What is the best way to select a broker?

There is no one best way to select a broker, but there are several things to avoid:

  1. Don’t choose a broker without first checking client references
  2. Understand what properties, if any, a broker has listed that could create a potential conflict of interest
  3. If a conflict does come up, how is your broker prepared to handle it?
  4. If you haven’t hired a broker, only let a broker show you spaces that they have listed

Don’t hire a broker if you are unsure about moving

What is a representation letter and should I sign one?

A representation letter is something a tenant rep broker will ask you to sign. It has several purposes. First and foremost, it demonstrates your commitment. Once the tenant rep broker has that letter from you, they know that are much more likely to get paid a commission on your lease. This means that they will work hard for you. In fact, a good tenant rep broker will not do much more than a simple market survey without a signed letter. If you want to get the most out of the brokerage community, we recommend that you sign an exclusive agreement rather that working with several different agents on a non-exclusive basis.

How can I put myself in a priority position with leasing agents?

There are two primary reasons leasing agents do not return calls. One is that they are too busy and the space you are interested in is simply too small and the other is that they perceive you to be a flake. There is not much that you can do about the agent being too busy, but there is everything you can do to be convincing. Put yourself in the leasing agent’s shoes and then compare the following messages:

“Hi Bob. I drove by your leasing sign that was on a building that I can’t quite remember. I’m thinking about starting a new business and am trying to get a feel as to what’s out there. Can you give me a call back at 555-1212 and let me know what spaces you have for lease?”

“Hi Bob. I found your listing on AdvantageRealtyInc.Com.com. I’ve been looking at my options for a while now and am very interested in viewing the 915 square foot space that you have listed on the 2nd floor of the Atrium Building. Can you please call me at 555-1212 to set up a time when I can tour the space?”

How do I hire a broker?

The best way to get a broker to work for you is to hire them as your exclusive tenant representative. Most brokers have representation letters for you to sign and once they know that you are committed to them, they will work hard for you.

I’m leasing a space for a new business; where do I start?

The first thing you need to do is to determine your needs:

  1. How much space do we need?
  2. How much rent can we afford to pay?
  3. How important is location?
  4. When does my new space need to be ready?
  5. Have I taken into account everything that is needed in my new space (furniture, phones, computers, copy/fax/postage machines, Internet access, etc.)?

Do I want to find the space on my own or hire a tenant rep to assist me?

How much does it cost to use a broker?

Most brokers will tell you that their service is free; their fee is paid by the landlord and it doesn’t cost you, the tenant, anything. Generally, we agree with this statement. To understand why a broker may not always be free, we must look at each of the four most common type of leasing scenarios:

  1. You hire a tenant rep broker and lease space in a listed property.
  2. You don’t hire a tenant rep broker and lease space at a listed property.
  3. You hire a tenant rep broker and lease space directly from an owner.
  4. You don’t hire a tenant rep broker and lease space directly from an owner.

Scenarios 1 and 2 are by far the most common, as most commercial space is listed by the owner with a real estate agent. In Scenario 1, your tenant rep broker is indeed free. This is because when you sign a lease at a listed property, the listing agent is required to split the commission due on the lease with your tenant rep broker. If you did not have a tenant rep broker (Scenario 2), the listing agent would have kept the entire commission for himself; hence the split results in your broker being free. There is a bit of gray area here, which happens when you are leasing space in a soft market. Since tenants are at a premium, the market dictates that a full commission is paid to your tenant rep broker. This adds 2-2.5% percent to the cost of the transaction to the owner, which the owner will try and recover in other areas of the lease. It is unlikely that you will pay a higher rent, as your alternatives in the marketplace prevent that. You may end up with a lesser tenant improvements, but your tenant rep is there to make sure you don’t.

Scenarios 3 and 4 offer the most debate. Under Scenario 3, while you don’t pay the tenant rep broker directly, the owner does. This adds cost to the lease and the owner will try hard to recover that cost, either with a slightly higher rent or lower lease incentives (i.e., one less month of free rent provided). However, we would offer that a good tenant rep broker will negotiate for a better lease than a typical tenant can achieve without representation. Clearly there are savings under Scenario 4, but it takes a lot of work by the tenant to be able to receive the full benefit of those savings.

Whom does a broker work for?

Brokers generally work in two capacities, as listing agents or as tenant reps.  Some of the brokers if not most, do both, meaning that they have property listings and they also work as a tenant rep. If you are working directly with the property listing agent, make no mistake, that broker is working for the property owner. If you hire a tenant rep that also has listings, then you need to have a very good understanding of what listings they have and what conflicts, if any, which creates. For example, in addition to the fiduciary issues that come with representing both parties in a transaction, the agent will most likely make more money if you lease a space at his listing. Instead of having to split the commission, he collects both sides.

What is the difference between a large and small space?

Opinions vary on the answer to this question. We like to think of a small space user as any company with an office space need that is 3,000 square feet or less. A medium space user has a space need between 3,000 square feet and 10,000 square feet, while a large space user needs more than 10,000 square feet.

The definition also changes based on space type and metropolitan area. The numbers tend to be bigger for industrial users, where 5,000 square feet or less is considered to be small. In New York City, 10,000 square feet is considered small. On the other hand, 5,000 square feet is huge in a city like Danbury.

It is also important to answer this question from the building owner’s perspective. For example, a 3,000 square foot space user is much more important to the owner of a 20,000 square foot, 2-story building than the owner of a 500,000 square foot, 25-story building. Some owners prefer to have large space users so as to limit the number of tenants they have to deal with in any one building. Other owners prefer smaller space users, as this reduces their vacancy risk when it comes to any one tenant moving out of the building. Generally speaking, small tenants tend to be the most profitable type of tenant for the owner. They tend to be less sophisticated and therefore less demanding. A full floor tenant is much more likely to require a specific and therefore costly build-out, while a small user can often take possession of a space with a simple painting and re-carpeting.

When you are negotiating for a small space, it is important to understand the nature of the space that is available. Often times, significant discounts can be achieved on niche spaces. Depending on your flexibility, you can usually get a deal on an “option” space; that is a space where another, usually larger, tenant carries a right to lease that space in the future (in which case you will be forced to move). Another example might be in leasing a slightly larger space than you really need. If you are looking to lease 1,000 square feet but the landlord can only offer you a 1,200 square foot space, he may be willing to come down in price to meet your budget.

I’m thinking about moving my office; where do I start?

The first thing you need to do is to decide if moving is right for you:

  1. Exactly why are we moving?
  2. How will this move benefit the company and its future?
  3. What are the drawbacks of moving?
  4. Can we afford to move?
  5. Can we afford not to move?
  6. Can we afford to lose some business during the transition?
  7. Is now a good time to move? Are we gearing up for the holiday season or other period of increased production or sales?
  8. If we are thinking about moving to a faraway location, can we afford to lose some personnel who choose not to relocate?

Is the company in a healthy state to move? Is there a history of indecisiveness, lack of leadership, high turnover, or other morale-related problems?

Do I need to broker to help me find space?

Perhaps….. What you need a broker for is their expertise surrounding the leasing process. A good broker is much more than just a space finder; you should view them as you would your attorney or accountant. You want their advice as to what space is best suited for your business and what are the best terms that the space can be leased for. A good broker will help you in all aspects of the commercial space transaction. That starts with understanding your business and ends with a signed lease. Finding the space is simply one small step in the overall process.

Commercial Real Estate Terms

Now that I’ve found a space, how long of a lease should I sign?

This can be one of the most difficult decisions you will need to make. There are a number of factors that come into play here (yes answers are more indicative of a longer lease term, while no answers indicate that short term lease flexibility is more important):

  1. Is my business stable such that I don’t expect my future space needs to change?
  2. Does the space that I am leasing require a substantial investment in tenant improvements?
  3. Do I expect rents to increase significantly in the future?
  4. Is the location of my new space very important to the success of my business?
  5. Is relocating my business hard to do?
  6. Is my rent lower if I sign for a longer term?

The first two items are the most important points to consider. If you have a start-up business, then a shorter lease term is most likely better. However, if your start-up business requires significant improvements, then you may be forced into a longer term lease by the simple economics of amortizing the improvements over a long term so that your base rent is affordable. One potential pitfall to avoid is bad advice from your broker or the property’s listing agent. Remember, the longer the lease term, the more money is paid out in commission. While that may be good for the broker, it might not be what is best for you. Ask the question, “What is the difference in rate between a three year and a five year lease?” Once you have that answer, then decide.

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