Why Landlords Want to Pay Commissions
Every now and then, someone who hasn’t worked with us previously will ask:
But, if my landlord doesn’t have to pay a broker, won’t he give me a better deal?
Let’s just make believe for a moment that landlords don’t pay other entities (both in-house and third party) more when a tenant representative is not involved. Let’s further assume, for the sake of this analysis, that the tenant representative isn’t able to negotiate any monetary savings (let alone several multiples of the commission, as is typically the case). The single biggest driving force for any commercial real estate investor is maximizing return; therefore, consider two scenarios from the landlord’s perspective:
Landlord Pays Tenant Representative
Landlord Reduces Tenant’s Rent Instead
[The above models hold the basis ($1 million), square footage (10,000 SF), rate ($30/SF), escalation (3%), term (10 years), disposition cap rate (6%) and debt service (5% interest) constant, while comparing a 4% commission in the first case versus spreading the commission over the term as rent reduction, escalating both at the same rate.]
The landlord’s return is greater when it has to pay the commission. More pronounced, the landlord’s total cash flow is 10% more when it pays the commission, and the cash flow upside is 5x the commission. When one pro formas the deal structures from the landlord perspective, rather than relying on an isolated anecdote, it becomes obvious why landlords would rather pay a tenant representative than give a tenant a discounted rent—a landlord’s profit is derived from the long-term capitalized value that leases create, not from year to year cash flow.
Landlords that don’t budget in commissions went out with wood paneling, but if you are around long enough, you may actually encounter one that claims they don’t pay. Why? Because they know what hidden risks, costs and facility deficiencies we will uncover during any negotiation. It’s our ability to negotiate that costs the landlord several multiples of our fee and compels the landlord to settle for a more reasonable return.
There are simple solutions to answering the archaic myth, if ever espoused, but it’s important to understand the real reason why a landlord may employ the tactic. Such landlords hope that this divide & conquer strategy will dissuade a tenant representative from negotiating a more balanced lease for the tenant that saves the tenant several multiples of the fee.
This article originally appeared on EzraCompany.com.