What Should a Leasing Brokerage Agreement Say?

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Let’s see if Ruminations can work near the third rail without touching it. No flaming please.

There are two kinds of lease brokerage agreements: the ones that appoint a broker to represent a property or a particular leasable space; and, the ones for a specific deal on the table. In our experience, retail leasing brokerage agreements are frequently written for a particular lease. That doesn’t mean that there aren’t a lot of leasing assignment brokerage agreements, but it sure seems that the one-up ones are pretty common. So, today’s discussion today will be biased toward this variety. If we don’t get electrocuted, we might try juggling razor blades again with a later set of thoughts about the “appointment” variety.

One of the “nice” things about the single lease commission agreement is that it avoids all of the questions about: “how much effort will be exerted,” “what would demonstrate that effort,” who pays for marketing,” “how long will the assignment last,” “how will any commission be split between cooperating brokers,” and other “what if” questions.

The key concern of a lease brokerage agreement is the amount of commission, and rightly so. A service was rendered, and it wasn’t a gift. Often, it may seem like it didn’t take much effort to get a tenant and therefore the size of the commission seems “awfully big” when compared to the perceived effort expended. Ruminations doesn’t see it that way. For one, if you have a five year lease and a 5% commission, you’re talking about turning over three months’ rent (5% of 60 months is three months). From that perspective, the commission is the equal of avoiding three extra months of vacancy. More importantly, brokers experience a lot of “failures,” and the successes need to pay for the failures. Otherwise, there wouldn’t be many brokers out there. This is an entirely subjective matter, and it seems that if an owner or a subletting tenant wants to find a tenant or subtenant without engaging a broker, it certainly can choose to do so.

That having been said (about the reason for paying a commission), let’s look at “how much” and “on what basis?” At the end of the day, the answers are related to bargaining power and the local marketplace. Landlords who are “always” in the marketplace can establish relationships based on the continuing flow of leases. Those landlords generally pay less. It may even be generally known in the brokerage community that they pay X% or that they pay $Y per square foot of floor area. Those who are in the leasing marketplace on an intermittent basis are more likely to start their brokerage fee negotiations with the broker’s demand, and that is usually “list price” in the community. Those landlords would be wise to make a lot of inquiries, preferably to other landlords, so as to get some semblance of marketplace information. It won’t ever reach the level of what brokers themselves know, but some information is better than none, and “knowledge is power” [Francis Bacon, 1597].

If the commission is to be paid on a percentage of rent basis, what should “rent” mean? Should it be “net rent” or “gross rent,” and what do those mean? Ruminations thinks percentage commissions should be based on “the aggre­gate net rental based solely upon the net rental pay­ments provided in the Lease (excluding any free rental granted to Tenant and payments of Additional Rent, which embodies, but is not limited to, taxes, common area mainte­nance and utili­ties).” To make a commission a “tax on a tax” just doesn’t feel right. Items of additional rent are pass-throughs. Landlords, in effect, are collection agents. If these items are commissionable, collect them from the real recipients. Where a gross rent or modified gross rent is charged (meaning that base year taxes,CAM, etc. are embedded in the base rent), an appropriate adjustment can be made in setting the commission rate or setting the rent.

If all of the terms of a lease were fully known up front and if there could never be a renewal, extension, expansion or similar event that would result in a change in the landlord’s expected rent revenue, the brokerage agreement could simply state a “number,” obviating the need to use a formula. That’s a possible, but unlikely, scenario. One can expect renewal rights. It is not rare for a tenant to take more space. In today’s world, space contractions are also expectable. Brokers brought the tenant to the table, and deserve to be compensated based on the value of the deal to a landlord. Just because it isn’t known how “big” the deal is at the time of lease signing (or when a term sheet is put on the table), doesn’t mean the broker shouldn’t get paid. What needs to be done is to establish a formula to figure out that compensation.

Ruminations suggests that brokers are entitled to be paid for lease renewals, etc., but only to a point. Why, you ask? That’s because it seems that the tenant may have “come” to the property because of the broker’s efforts (and signed up because of the space itself), but eventually remains there because of the space itself and the character of the landlord, and far less because of the broker’s initial efforts. We can’t quantify that feeling, but it translates into a sense that commissions ought to be payable for only up to 10, 15 or 20 years, and not beyond that agreed-upon point.

There is, however, a common problem about paying “renewal” commissions. While it is known who the broker or brokers were at the time of initial lease signing, it isn’t known if the tenant will engage a different broker to assist it with renewal negotiations. If that happens, the “new” broker expects to get paid by the landlord. There are a number of reasons a “renewal” broker appears. Let’s assume that one shows up for “good reason” and that the renewal broker adds value to the deal. Should the landlord have to “pay” an extra commission? Should or can the landlord insist that the renewing tenant pick up the tab? Possibly, but even if it does, does it make economic sense for so much commission to be paid for the same deal? We think not. The premise behind paying a renewal commission to the original broker(s) is that it (or they) brought the tenant to the property and that the tenant is renewing its lease mainly because of the deal it (or they) got for the tenant. When a different renewal broker shows up, that initial premise doesn’t seem so certain. Given that it’s only fair that a landlord pay no increase in commission, the original brokers ought to be agreeing to give up or share the renewal commission with the renewal broker. We’ve never figured out how that works, i.e., what happens behind the curtain. So, we invite our readers to offer up their suggestions.

Logically, a commission should be paid out as and when the corresponding rent is received, month by month. We’ve seen that, but so rarely, that we know that ain’t goin’ fly. On the other hand, how about letting the landlord get some cash in hand before paying it all out? A good compromise is to allow for four or six payments, the first being made either when the first rent is received or when the first rent is due. You can say that there will be four installments, with the first one due on the Rent Commencement Date (as defined in the Lease) and with the others due at six month intervals. That equates to full payment in 18 months. Commissions payable when a lease is renewed could logically follow the same installment basis, though the logic isn’t as strong given that the landlord has already pocketed a lot of rent.

Obviously, the stated commissions should be full payment for all of the services rendered and should only be payable upon execution and delivery of the lease and possibly only if the first installment of rent (not the advance rent called for in the Lease, if any) is paid. There should be no obligation imposed on the landlord to actually sign a Lease for whatever reason (or no reason at all) and, if no lease is ever signed, there should be no commission. The tail shouldn’t wag the dog. Essentially, the agreement could say, “We may withdraw from negotiations and refuse to continue there­with at any time for any reason or for no reason or for any cause what­soever without notice to you, and if no lease is signed, we shall have no responsi­bility or obligation to pay you any compensation, commissions or damages.”

The brokerage commission contemplates that the tenant will honor its obligations under the lease such that the landlord will get the entire expected rent. If the commission were payable month by month, it would stop if the tenant stopped paying rent. When the commission is paid up front (and even installment payments constitute paying up front), it isn’t likely that a broker will want to sell that Lexus and pay back any “unearned” commission. So, we’re looking at compromise. The greatest credit risk is at the outset, and it makes perfectly good sense to pay the commission over 18 months (as shown above) or over 30 months (six installments). If the tenant “bails out,” let the commission installments that were payable before that date be paid to, or retained by, the broker and abate the remaining ones. Brokers aren’t going to want to refund any commissions especially because cooperating brokers may be involved and the individual brokers may have “retired” in the interim.

Where a lease has a “kick-out” provision, commissions should not be paid on account of rent payable after the “option” date has passed without the tenant electing to take an early lease termination. In effect, this is no different than a lease renewal option.

The broker should represent that it is licensed in the jurisdiction and represent that there were no other brokers who could claim a commission or fee other than any with whom the landlord, but not the broker or its cooperating broker, dealt. The broker should name all cooperating brokers and agree to pay all claims made or makeable by those cooperating brokers. The brokerage agreement should have corresponding indemnifications.

We’re heading to the finish line, needing some boilerplate. Since this style of brokerage agreement is aimed at a particular, singular deal, the agreement should say so. To do that, it might say, “You hereby acknowledge that this letter agreement gov­erns only the proposed Lease transaction and that this letter agreement does not and is not intended to authorize you to act as a leasing broker for, nor obligate us to recognize you as a leasing broker with respect to any other transaction.”

Finish it up with an integration and merger clause and a couple of other concepts (“This letter agreement contains the entire agreement of the parties with respect to the subject matter hereof and may not be changed, modified, terminated or amended except by written instrument signed by the party against whom enforce­ment is sought. This letter agreement shall be binding upon and shall inure to the benefit of the parties hereto, their respective heirs, successors and assigns”) and you’re done. Except, of course, for special terms of your agreement.

This is a discussion. We’re sure there are a lot of different approaches out there. Let’s share them with each other. There is no “truth” in today’s blog. All we have to offer is some observations, some opinions, and a wide-open receptiveness to the thoughts of others. Let us know what you think by posting your comments to www.realestatelaw.com.

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Comments

  1. As always, good stuff, Ira. I would take exception to the bit about installments, though. As brokers, we are paid to bring a tenant to the table, not for accepting the credit risk of the tenant. The landlord is the one that has accepted the risk of ownership and tenant risk is part of the equation.

    Attorneys, engineers, and architects, etc. are all paid for their time. They are not asked to accept payment on the 6th month of tenant possession, provided the tenant is still in good standing. Why should the broker? If the landlord accepts the deal presented by the broker, then the broker should be paid at the time of lease execution, with perhaps a condition of a second and final portion of the complete commission at the time the tenant takes possession of the space. If the landlord wants to consider other forms of payment, then perhaps equity in the property should be considered for compensation for risk trade off….Suggesting that a broker take payment based on tenant performance is akin to asking the broker to take an equity level of risk without the upside of equity ownership.

  2. Steve Noll says:

    I like your thinking on all this except the installments. I think Eric in Tampa summed it up exactly right. There is always risk to the Broker by the way of upfront work invested in getting the deal done with no guarantees that the deal will get done. And then to have to wait for payment with still no guarantees by way of escrow or retainer, and the chance that the Landlord will default prior to making broker commision payments (or just stop paying.) In some cases, these deals can take months or even years of work before a tenant takes possesion and opens for business. It’s imperative that brokers get paid at lease signing, or possesion, or at first rent payment. Beyond that just plain takes the fun out of things.
    Most agreements I have been a part of decline to take renewal commisions if the Tenant is represented by another fim at the time of the renewal. Also, we sometimes share commisions as finders fees or referral fees behind the curtain. It’s usually small but the commisions are often split 4, 5 or 6 ways.

  3. Michael Lieberman says:

    Over the years I have offered to be paid on an installment basis as a landlord receives rent… up to monthly over the entire term of the lease. The trade-off is that my rate schedule is higher because being paid 100% on lease execution or occupancy is discounted to the present value of the payment schedule. In 37 years of practice I have never had a landlord choos to pay over the term. I believe the reason is based on Eric’s comments… property owners build tenant credit risk into their overall ownership calculation. They also have the opportunity to evaluate a specific tenant’s financial circumstances, and where necessary negotiate enhanced credit (letters of credit, personal guarantees, etc.).

  4. I enjoy reading your blogs, Ira. Question—how to manage some really big comissions (say, $5 per square foot for a five year lease at $10, NNN for the tenant’s broker) with an early term at 36 months? Or what if the Tenant can’t get their sh** together and defaults 6 months in?

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