Calculating the commission for a lease to be paid to a broker can be very simple or very complicated, based on the complexity of the terms agreed upon by the landlord and tenant in the lease transaction. You'll not only have to define the calculation of the commission but also when it is due.
Commissions for residential real estate leases
In residential lease transactions, the calculation of a commission to be paid to the brokers is often simple. In many markets, it is typical for the landlord to pay the broker representing the tenant a commission equal to one month’s rent as defined in the lease. This commission is usually paid in lump sum at the time the lease commences. If the landlord and tenant are each represented by a different broker, the landlord may pay each broker an amount equal to one month’s rent, or may ask the brokers to each accept a specified amount -- like $1,000, for example -- as their commission.
Commissions for commercial real estate leases
In commercial lease transactions, a much broader range of commission calculations exist. The most common method of calculating a commission in a commercial lease is to multiply the aggregate value of the lease (all of the rent to be paid over the entire term of the lease by the tenant) by an agreed percentage amount. As an example, if the tenant agreed to pay $1,000 per month in rent for five years, the aggregate value of the lease would be $60,000. This aggregate value would be multiplied by a previously agreed commission percentage, which might range from 2 percent to 8 percent, with a 4 percent being common in most markets. In this case, the lease commission would equal $2,400, or 4 percent of $60,000. The commission is usually paid in lump sum when the lease commences, although the parties may agree to split the payments into two equal parts pursuant to a prior agreement.
Alternative commercial real estate commission calculations
In the retail real estate arena, landlords often try to simplify and reduce commissions paid to brokers by simply offering a “per square foot” commission. In this calculation, the landlord simply multiplies the number of square feet to be leased by the tenant by a preset dollar amount. As an example, if a hair salon leased 2,500 square feet in a shopping center, and the landlord offered a commission to the broker representing the tenant of $2.00 per square foot, the commission would be $5,000. In this case, the amount of the base rent and the length of the lease term have no bearing on the commission.
Complexities in calculating a commercial real estate commission
The commission calculations are perhaps most complicated when working with office space. Multiplying the aggregate value of the lease by a percentage usually works, but the definition of aggregate value can shift. For instance, some landlords will deduct any concessions or cash allowances offered to the tenant from the aggregate value. It is common for a landlord to offer to build out an office space for a tenant -- the cost for these tenant improvements to the space often surpasses one year’s rent -- but then deduct that expenditure from the aggregate value of the lease for calculation purposes. Many landlords will also restrict the aggregate value of the lease to the first five or ten years of the lease, so a broker may negotiate a long-term lease on behalf of the tenant, but then receive a commission calculated on only a portion of the total lease term.
Timing of commission payments can affect the calculation
The timing of a commission payment is a significant component of the agreement for the broker. Many landlords will pay the commission in full at the time the tenant takes possession of the space. In some markets, commissions are still paid “over time,” meaning that the landlord pays a commission to the broker each month as the tenant pays rent. In a sale transaction, the commission is paid up front because the buyer pays the seller in full at time of closing. In a lease transaction, the payments flow out over time, and landlords occasionally struggle with the philosophy of paying a full commission for a potentially unfulfilled lease term. Ultimately, these timing considerations may come into play in the calculation of a commission, with a broker often agreeing to take a lower commission up front in place of a greater commission over time.