A common question people ask in the commercial real estate industry is “How do brokers get paid?” Although the payment to a broker is involved with every commercial real estate transaction, it seems many people lack clarity on the subject. Truth be told, the process of getting paid as a broker can get a bit complicated. The fact that commission rates can vary also contributes to the confusion around how brokers get paid. Whether you’re interested in becoming a broker one day or you’re thinking you might want to work with one, this blog post will explain how brokers get paid for their work.
What many people do understand is that commercial real estate brokers get paid based off commission. The commission is typically paid by the seller of the property, but the buyers of the property may also owe the broker a payment as well. Who pays the commission depends on who the broker is representing in the transaction. When representing both parties, both the seller and buyer will pay the broker a commission fee. If there are two brokers involved with the deal, they will split the commission between each other. However, the amount in which the broker is paid varies due to anti-trust laws.
Due to anti-trust laws, it is illegal to set a commission rate across a market or industry. This means the commercial broker and their client need to negotiate a commission rate before agreeing to work together. Negotiating a price for a commission can be great for both the client and the broker, as the costs of different properties vary greatly. Additionally, some properties are easier to find than others, which changes how difficult the broker’s job is. According to our partners at SVN | Southgate Realty, most commercial brokers get paid between four percent and eight percent of the sale price from the property. However, this may increase or decrease based on the complexity of the deal. So, be sure to consider how hard the broker will need to work when negotiating their commission rate.
In commercial real estate, a property can be sold or leased. The amount a commercial real estate broker earns is based on the price of the property. So, if the broker and the seller agree on a seven percent commission rate and the property purchased was $1,000,000, the broker would earn $70,000. However, if another broker was involved to represent the buyer of the property, the $70,000 would be split between the two.
For commercial real estate, because leases are typically paid on a monthly basis, there is a different way to calculate the commission of a broker. With leases, the broker is paid based on the length of the lease agreement and the monthly rate. For example, if a property is leased for three years at $15 per square foot, and it is 2,000 square feet, the lease value would be $90,000. We find this from 3 years x ($15 x 2,000 SF). If the seller and broker agreed on a seven percent commission rate, the broker would make $6,300.
Assume that Corporation X just leased 3,000 square feet to Landlord Y’s Shopping Center. The lease is for 4 years, starting at $15 per square foot with $0.40 annual rent escalations. Here is how you break this deal down.
Year One: $15 PSF x 3,000 SF = $45,000
Year Two: $15.40 PSF x 3,000 SF = $46,200
Year Three: $15.80 PSF x 3,000 SF = $47,400
Year Four: $16.20 PSF x 3,000 SF = $48,600
The total lease consideration from all four years amounts to $187,200. If a broker gets a 6% lease commission for this deal, this percentage is multiplied by the total lease consideration amount. The total commission is $11,232. The landlord and tenant representative brokers split the commission 50/50, receiving $5,616 each. Also assume that the broker gets a 60/40 split with the brokerage firm. The broker then walks away with $3,369.60, or 60%, from this deal.
In most cases there are usually two kinds of brokers involves in a sales transaction. You have the seller’s agent and the buyer’s agent. Commercial real estate sales usually have a longer timeline than what you would expect, so expertise on the property and area should be extensive. There are differences between investment sales and owner occupied deals. Sale transactions involve the title, inspections, environmental conditions and entitlements. It is important to note that closing on a commercial real estate sale cannot occur under 60 days. It will often take 3 to 6 months until all parties reach an agreement.
Brokers that represent sellers will have a pre-negotiated listing agreement in place with commissions already revealed. Commissions from a sales transaction will range from three to six percent, but it isn’t uncommon for sellers to only pay their own brokers, and not the buyer’s broker, on larger investment sales. In this scenario, commissions may be lower, such as 2%.
It must be understood that most commercial real estate brokers will work as independent contractors. This means that they are contracted employees. They have a written contract in place with a brokerage company and will be paid accordingly as a W-9 employee. However, the brokerage firm will not withhold taxes, holding independent contractors responsible for addressing matters related to the IRS. These matters include taxes, social security, medicare, and health insurance. Independent contractors are self-employed, though the brokerage firm will still have significant input.
The relationship between brokers and independent contractors must remain steady. If both sides correctly follow the terms of the Independent Contractor Agreement for Sales Associate (TAR 2301) and the Statement of Understanding (TAR 2302) they can reduce their risk of facing penalties from the IRS. The rights and obligations of a broker and an agent will be defined by the Independent Contractor Agreement. Provisions that clarify the agent is not an employee will be outlined in this document. The agent must agree to terms provided in the Statement of Understanding, which will help legally confirm the independent contractor relationship. It is recommended to annually complete this document to reaffirm between brokers and independent contractors.
If you are looking to save money by acting as your own representative in a real estate deal, then you will be disappointed. If you do not have a tenant representative broker before going directly to the landlord, you can expect the end result to be the landlord saving money and you losing money. Without expert knowledge of the market or the many traps that are part of commercial leasing, the landlord can manipulate negotiations and take advantage of you. Tenant representative brokers guide you through the process of finding property space and will negotiate with the landlord for the best deal that works for you.
If you know how appraisals work, then you will discover that a Broker Opinion of Value (BOV) is very similar to an appraisal. An assessment of a property’s value is known as an appraisal, which analyzes the condition of the property as well as its amenities, location and comparable sales in the area. A Broker Opinion of Value is a general estimate of value for a single commercial property. Investors, property owners, lenders, accountants and real estate attorneys are just some of the real estate professionals that will use a BOV. The level of a BOV ranges from a simple document of two to three pages to a more complex book of 40 to 50 pages. Brokers can get paid by banks anywhere from $250 to over $1,000 to publish an opinion of value on a property.
The person who usually pays the broker(s) involved with commercial real estate transactions is the property owner or landlord. Almost always, the seller or landlord will pay both brokers who are representing clients in the commercial real estate transaction. This is because the landlord wants to get the property off their hands and needs the help of the broker to do so. If you are looking to purchase a property, do not skip out on using a broker because you think you will get a better deal. Brokers are very resourceful, and you typically won’t spend any money on their services when you are buying the property.
We hope this blog post cleared up any confusion you had about how brokers get paid. If you are looking to buy or sell a commercial property in Salt Lake City and need assistance from a broker, please feel free to contact us. Our highly skilled and experienced advisors will help you get an excellent deal and can answer any questions you may have. We always strive to make the transaction process as easy as possible for our clients. So, please feel free to reach out so you can work with one of our advisors today!