Monday, February 15, 2016

How to Calculate Leasing Commissions

What are Leasing Commissions?

While owning a property, particularly one with many tenants, there will invariably be turnover. From the landlord's perspective, it doesn't make a whole lot of sense to spend time trying to find new tenants because it's very time consuming, requires a different skill set, and is often relationship based and the landlord might not have the right relationships. Instead, property owners will rely on brokers to lease vacant spaces at their properties.

Brokers need to get paid for the service they provide landlords. However, landlords want their leasing brokers to be incentivized to get deals done at a healthy rate. Subsequently, the market has adopted a compensation for leasing brokers where they typically receive a percentage of the rent on executed deals. Brokers might negotiate a dollar per square foot leased fee instead of a percentage, but it's the same idea.

Click the button below to download a a comprehensive rent schedule generator that can incorporate several rent increase structures and free rent schedules, and a leasing commission calculator where you can input a custom leasing commission structure. With this tool, you'll be able to create a professional looking rent schedule and perform a detailed leasing commission calculation in a matter of minutes.

Commission Structures

For retail, medical office and industrial, a percentage of rent is typically paid for a commission. A common structure is to pay 6% of the total rent for the first 5 years of the lease, 3% of the total rent for the next 5 years, and 1.5% for the remaining term. Note that the actual percentages vary between markets and property type. Some brokers might only charge 5% for the first 5 years and 2.5% for the next 5. The point is that there isn't a standard structure and it will vary broker to broker, market to market.

A dollar per square foot leased commission is more common to general office. In my opinion, it's the most unfavorable structure for landlords because brokers are motivated to get deals done and care less about the rate.

Another important aspect of leasing commissions is when brokers actually get paid. Brokers obviously want to get paid as soon as possible after getting a signed lease agreement. In fact, they'll often try to slip that language into the listing agreement. However, a property owner should try and push for commissions to not be paid until the tenant occupies their space and is paying rent. This does two very important things. First, it motivates brokers to push tenants to start paying rent sooner rather than later and to limit the amount of free rent. Second, it motivates brokers to do deals with stable tenants that will stay solvent and be able to cut that first rent check. It seems crazy, but it's not unheard of to sign a lease with a tenant and in the subsequent few months watch them go belly up and default on the agreement. Having to pay a sketchy broker a fat leasing commission would be salt on the wound.

Are Leasing Commissions an Operating Expense?

An important point of discussion is whether or not leasing commissions are considered an operating expense or not. You might think they are because leasing commissions are, more or less, a part of normal property operations. However, leasing commissions are not considered above the NOI operational expenses. The reason is leasing commissions change from ownership group to ownership group. For example, some property owners have internal leasing departments and handle everything in-house. These groups wouldn't have a leasing commission expense at all. Other groups might do everything through third party brokers. Some might have a mixture of both--some properties have brokers, others are done in-house. Because the expense will vary between ownership styles, leasing commissions are below the NOI. Remember, NOI is meant to be apples to apples across different ownership groups.

Calculation Example

In our example spreadsheet, we'll calculate the commission owed to a broker who leases a space for 1,000 per month, for ten years, with 3% annual increases. We'll assume the broker negotiated a fee of 6% for the first 5 years and 3% for the final 5 years. The commission for the first year of rent would be 1,000 × 12 × .06 = 720. Year 2 would be 1,000 × 1.03 × 12 × .06 = 742. Years 3-5 would be calculated similarly, but with the rent increasing 3% each year. Year 6 would be calculated as 1,000 × (1.03)^5 × 12 × .03 = 417.

As you can see in the linked spreadsheet, the total leasing commission over 10 years is 6,038.

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