What are the various commission structures being offered in Chicago commercial real estate leasing transactions? What circumstances dictate which calculations, how are they calculated and who really benefits? A broker’s perspective…
My name is Steven Goldstein and I’ve been active in Chicago’s commercial real estate market since 1988 as a property manager, building leasing agent, tenant representative, developer, and real estate investor. My company ChicagoBroker.com Inc. specializes in Chicago area office and retail leasing, tenant representation, and development in the Chicago market. Over the years we have had the privilege of working with many different types of clients, closing transactions, and being paid so-called “market” commissions. Regardless of the location, type of property, or terms of the deal, the question always comes up as to what is the “market” commission?
The term “market” commission is a loaded question. First, there is no such thing as a true “market” commission” because it would illegal and unethical for brokers to combine their efforts and set a commission rate that is “market” for any type of transaction. Second, each firm sets its own policy and has its own way of calculating broker fees in its commission and listing agreements. These two points are very important because it would be illegal for brokers to set commission rates or claim that any rate is the “market”.
Here are the various types of calculations that I have encountered in our market and typically how my firm has evaluated, applied and calculated each:
The Seven and Two: This commission is frequently used for office, industrial and retail transactions. It’s probably the most popular commission that we see for smaller buildings and smaller landlords. In this scenario the brokers get paid more if the client signs a longer lease and pays more in gross rent. The commission is calculated by (a) multiplying the average annual gross rent payable over the lease term by 7% , (b) multiplying the remaining annual gross rent (i.e. total gross rent less the average annual gross rent) payable over the lease term by 2%, and (c) adding those two products together. So, for example, on a 5 year lease that has an average annual rent of $50,000, the broker would charge $7500, calculated as follows: 7% X $50,000 = $3500, PLUS 2% X $200,000 = $4,000. The total commission in this scenario would be $7,500 or 3% of the gross rent payable under the lease. If there is a listing broker handling the transaction for the owner, typically that broker would receive one full commission ($7,500) if there are no outside brokers representing the tenant. If there is an outside broker, this same amount is usually paid to the outside (tenant representative) broker, and the inside broker typically gets an additional half commission ($3,750).
The Eight and Three: This commission structure is generally seen in retail properties or in properties where the rents are quoted on a NNN (or “triple net”) or another net basis. The calculation method is the same as the 7/2% above except that it is only paid on the net rent (as opposed to gross rent) and the respective multipliers are 8% and 3%. In the scenario above if the gross rent were $50,000, the net rent may be $35,000. In that scenario the broker would have been paid – 8% x 35,000 plus 3% x $140,000 = $7,000 or 4% of the net rent over the entire term.
Dollars per square foot per year: This calculation is usually reserved for downtown office buildings and bigger owners. The commission rate generally ranges from $1.00 – $2.00 per square foot per year in the lease term. The benefit of this calculation is that the brokers are paid a flat fee based on the square footage of the tenant and the term of the lease. Unlike the percentage-based calculations, the flat fee spells out what everyone is getting paid so the clients (typically the tenant) doesn’t have a perception that the broker might not negotiate as hard for them on rent because the commission isn’t tied to what the tenant eventually pays. The commission is calculated by multiplying the square footage of the premises times the number of years in the lease times the commission rate. So, in the above example, if the premises were 2000 ft and the rent was $25.00 per foot gross ($50,000 per year rent) on a five year lease, the rent is not used in calculating the commission and a full brokerage commission would be calculated by multiplying 2000 ft x 5 yrs x $1.25/ft = $12,500 (which is approximately 5% of the rent).
Here are some other methods of calculating commissions:
Percentage of the gross lease value: this is typically calculated by taking the total rent, taxes, CAM (common area maintenance charges) and insurance payments that are due from the tenant over the entire term of the lease and multiplying it by some multiplier amount. Typically 3-5%.
Percentage of the net lease value: same as above except taxes, CAM and insurance are not part of the equation
Percentage of the savings: Another way that we have worked in the past is on a percentage of savings basis. If a client is out looking for new space or discussing a renewal with their landlord and the rent being proposed over the term is $100,000. We have worked with clients so that if we save them money by creating leverage in the negotiations, we get paid a percentage of that savings. If the percentage of savings rate were 50% as we have worked in the past, and the negotiation leverage can be created whereby the landlord lowers the rent to $85,000 because they fear losing the tenant to another building, the broker would be paid 50% of the $15,000 savings or $7500. Since the broker is working for the tenant in this scenario, the tenant would typically pay. We have negotiated free rent and moving allowances in the past to help our clients offset this payment obligation
Flat Fee: this is simply a consulting fee that a tenant or landlord would pay for leasing services. Fees would be negotiated directly between the broker and the client. Usually they are based on whatever the market commissions are and then modified based upon the particular circumstances surrounding the deal
Payment Terms: Typically leasing commissions are paid upfront upon signing of the lease, payment of the rent and security deposit, waiver of any contingencies, occupancy in the space, and the payment of rent or burn off of the free rent period. Many times the tenants are asked to come up with additional lease security, cash deposits or guarantees to cover the commissions as they are part of the landlord’s outlay for the transaction.
I hope this was helpful. Please keep in mind that ChicagoBroker.com set its own independent rates for commissions and negotiates each scenario differently. In addition, everybody has their own unique way of calculating these rates and there really is no normal when it comes to commercial real estate leasing commission rates in Chicago or any other part of the world. It’s a negotiable figure that the parties need to hash out, hopefully at the beginning of the transaction.