How standard commission agreements work for the broker but not always for the client – Part I

Monty Hall - Lets Make A Deal

Monty Hall – Lets Make A Deal

As a consumer of real estate services, it’s in your best interest to understand what motivates your broker. If commercial real estate is a game played by brokers and developers, then it is important to know how they decide who is winning and who is losing.

While many brokers might tell you they have a fiduciary responsibility to you, incentives in the industry often work against your best interests. And it can be hard for brokers to resist the lure of larger fees, even if it hurts their client.

Brokers, for example, earn bigger commissions when you pay more in rent. This can translate into you signing on for more space than you need or paying a higher rate because your broker didn’t “go to the mat” against the landlord on your behalf. Why would she if it was not in her financial best interest?

People often choose their broker using the classic mix of commerce and camaraderie: They pick the guy they know from the country club because they see the broker service as a commodity and figure they’ll chose someone they know. But by doing so, they could be hurting their bottom line because brokers, by their very nature, respond strongly to incentives. And there are a lot of incentives at play when a commercial real estate deal is being transacted.

Consider this example, where a broker snagged a $21-million commission when Macy’s renewed their lease earlier this year:

The department store renewed 647,000 square-feet at 11 Penn Plaza in New York city in the first half of 2013. Their arrangement called for an effective rent in the high $40s and a lease term of 20 years. To figure out what commission might have been (and potential conflicts of interest), let’s calculate an example fee structure that is representative of one commonly in tenant representation assignments:

  • Assume fees paid by the landlord are as follows:

    • 4% for Years 1-10

    • 2% for years thereafter

  • Part I: 647,000 (square feet) x $49 (rent/sq. ft) x 10 years (term @ 4% commission) x 4% (commission)

  • Part II: 647,000 (square feet) x $49 (rent/sq. ft) x  10 years (term @ 2% commission) x (2%)

  • Sum up the two numbers from Part I and Part II

    • $12,681,200 + $6,340,600 = $19,021,800

It is important to note that commission structures range wildly from market to market. Regardless, that’s an incredibly large commission, almost enough to buy an entire office building!

If in the 12th hour Macy’s decided it wanted to secure a 10-year deal with options to renew instead of a 20-year deal, it would have cut the commission by nearly 30 percent–or $6.3 million.

Consider the following:

  • Negotiation Fatigue Syndrome: There have been many studies that show how fatigue, or simply wearing someone down, can weaken a broker’s resolve to fight for his client’s best interests. In the example above, how tenacious would the broker be, especially if the “victory” resulted in $6.3 million in his pocket?

  • Negotiations with strangers: You may feel that hiring a broker that performs only tenant representation is a good idea, but does he have a better relationship with the landlord that he has knows from deals in the past, or with you? There have been studies that demonstrate that common negotiation adversaries lead to faster deals – but they are far less creative.

How hard do you think the broker would have fought for those terms over the more lucrative ones?

As you can see, understanding how the broker is compensated can help you spot potential conflicts.

The good news is you don’t have to blindly accept what is offered as a “standard” commission arrangement–often 4 percent to 5 percent of the lease. With some understanding of the real estate process, you can structure your broker’s compensation based on your goals.

In our next blog, we’ll explain how you can move away from traditional agreements, and we’ll share examples of alternative fee structures that can better serve your needs and help boost your bottom line.

8 Tips for Hiring the Right Broker

These are the hard questions that any and all individuals and companies with real estate needs should be asking of their real estate professionals.

1. The R-Factor
Credit here to Dan Sullivan and his “Strategic Coach” method of training entrepreneurs; our first question is adapted from one of Dan’s core methods for teaching people to set goals and be effective in their lives.To test whether a firm’s foals are aligned with yours and how seriously it is listening to your goals and objectives, ask this question:

Assume that is it a year from now, and you and I are meeting and looking back at the progress made on this transaction, what will have to have happen for you to feel good?

If the broker’s answer doesn’t encompass the goals and objectives you have outlined for your transaction, you’re talking to the wrong person. At Cardinal, we have asked the question hundreds of times. We take the responses our clients give and make them a part of our Key Performance Indicators by which we are graded at the end of the deal.

2. Driven by Process, or Instinct?
Ask for samples of deliverables from past transactions that you would hope to see during your transaction — things like market reports, financial projections and spreadsheets, analyses of terms.  Ask to see due diligence checklists for leases, purchases and sale negotiations.  If a broker can’t provide basic process documents, you’re likely dealing with a hipshooter who believes real estate is still a “gut” business. Ask to see their “playbook”; and if they do not have one, ask for examples of best practices.

3. Teamwork
If you’re being offered a team to work on your transaction, ask exactly what each member’s area of expertise and responsibilities are. The team should be a well-rounded mix of aptitudes that makes sense to you. If the transaction involves real estate outside the local market, ask how the firm will handle out-of-market resources. Does the broker ever refer deals outside of their company or network?  If not, why?  You want the top team working on your transaction, regardless of whose business cards they carry.

4. Real Results
How does your potential broker measure results? Ask this as an open-ended question and note carefully whether “client satisfaction” is mentioned. If you ask the potential broker how he or she will measure results in your transaction, is there any reference to your goals and objectives?

Next, drill down: What is the broker’s plan for achieving your goals? How are they going to help you determine how much space you need? How will they find the buyer for your challenging asset? Will they just shop you around to the usual suspects, or do they have some creative ideas about how to achieve your goals that come from outside the normal playbook?

5. Doing the Details

Ask detailed questions that demand specific answers. Something like, “How can you help us reduce facility expenses?” should yield a set of specific answers and (even better) examples of how the broker has helped past clients achieve this goal. Their answer will give you a good idea of whether the potential broker regards details as things that get in the way of the deal or critical steps that must be worked through regardless of the time it takes.

6. Negotiation 101
Drill in on negotiating tactics, skills and experience. Ask for an example of a situation where the broker’s negotiating skills reversed a deal that was going down the tubes and turned it into a win. What are their goals in a negotiation?

7. Listen & Learn
As we saw during the real estate executive focus group, not being listened to is a top complaint of clients. Ask your potential broker if they survey their clients. How often? What are the results?

After you’re done with the interview, think back on the time the potential broker took with you and how respectful they were of your objectives and agenda for the meeting. If they weren’t paying close attention, there’s less than zero reason to think that will change once you’re signed as a client.

8. Pay for Performance?
Finally, we come to the bottom line: Is the firm willing to put its fee on the line for your satisfaction? Ask about the “pig in the poke” and get “the elephant out of the room” – the reality that the brokerage’s interests aren’t necessarily aligned with yours. Will they acknowledge that fact and discuss it without becoming defensive? Tell the potential broker that you expect some portion of their fee to be put at risk until you’ve met your objectives at the end of the transaction.

Anticipate pushback on this demand; national brokerage firms generally reserve this mechanism for their largest clients. But stick to your guns. To see a list of suggested mechanisms for linking fees to objectives both quantifiable and soft, visit the Cardinal Partners resources page on our website: And watch closely how your potential broker acts when you open this avenue of negotiation; see what their behavior says about Point 6 above.