CRE Frequently Asked Questions (part 2)

11. How much does it cost to use a broker?  Most brokers will tell you that their service is free; their fee is paid by the landlord and it doesn’t cost you, the tenant, anything. Generally, we agree with this statement. To understand why a broker may not always be free, we must look at each of the four most common type of leasing scenarios:

  1. You hire a tenant rep broker and lease space in a listed property.
  2. You don’t hire a tenant rep broker and lease space at a listed property.
  3. You hire a tenant rep broker and lease space directly from an owner.
  4. You don’t hire a tenant rep broker and lease space directly from an owner.

Scenarios 1 and 2 are by far the most common, as most commercial space is listed by the owner with a real estate agent. In Scenario 1, your tenant rep broker is indeed free. This is because when you sign a lease at a listed property, the listing agent is required to split the commission due on the lease with your tenant rep broker. If you did not have a tenant rep broker (Scenario 2), the listing agent would have kept the entire commission for himself; hence the split results in your broker being free. There is a bit of gray area here, which happens when you are leasing space in a soft market. Since tenants are at a premium, the market dictates that a full commission is paid to your tenant rep broker. This adds 2-2.5% percent to the cost of the transaction to the owner, which the owner will try and recover in other areas of the lease. It is unlikely that you will pay a higher rent, as your alternatives in the marketplace prevent that. You may end up with a lesser tenant improvements, but your tenant rep is there to make sure you don’t.

Scenarios 3 and 4 offer the most debate. Under Scenario 3, while you don’t pay the tenant rep broker directly, the owner does. This adds cost to the lease and the owner will try hard to recover that cost, either with a slightly higher rent or lower lease incentives (i.e., one less month of free rent provided). However, we would offer that a good tenant rep broker will negotiate for a better lease than a typical tenant can achieve without representation. Clearly there are savings under Scenario 4, but it takes a lot of work by the tenant to be able to receive the full benefit of those savings.  

12. How do I hire a broker?  The best way to get a broker to work for you is to hire them as your exclusive tenant representative. Most brokers have representation letters for you to sign and once they know that you are committed to them, they will work hard for you.  

13. How can I put myself in a priority position with leasing agents?  There are two primary reasons leasing agents do not return calls. One is that they are too busy and the space you are interested in is simply too small and the other is that they perceive you to be a flake. There is not much that you can do about the agent being too busy, but there is everything you can do to be convincing. Put yourself in the leasing agent’s shoes and then compare the following messages:

“Hi Bob. I drove by your leasing sign that was on a building that I can’t quite remember. I’m thinking about starting a new business and am trying to get a feel as to what’s out there. Can you give me a call back at 555-1212 and let me know what spaces you have for lease?”

“Hi Bob. I found your listing on OfficeSpace.com. I’ve been looking at my options for a while now and am very interested in viewing the 915 square foot space that you have listed on the 2nd floor of the Atrium Building. Can you please call me at 555-1212 to set up a time when I can tour the space?”  

14. What is a representation letter and should I sign one?  A representation letter is something a tenant rep broker will ask you to sign. It has several purposes. First and foremost, it demonstrates your commitment. Once the tenant rep broker has that letter from you, they know that are much more likely to get paid a commission on your lease. This means that they will work hard for you. In fact, a good tenant rep broker will not do much more than a simple market survey without a signed letter. If you want to get the most out of the brokerage community, we recommend that you sign an exclusive agreement rather that working with several different agents on a non-exclusive basis.  

15. Is finding a space without hiring a broker a good idea?  Generally speaking, the answer is no. You as the tenant enter into a lease once every so often. A broker negotiates for space on a daily basis. Would you go into an IRS audit without having your CPA by your side? Same reasoning applies here.

Now let us examine a couple of cases where you might lease space on your own. The biggest driver is the dollar value of the lease commitment. The less space you lease and the shorter the term, the less rent that is due under the lease. Less rent means a smaller commission. A listing agent is much more motivated to lease space directly to a tenant versus having to share their commission. This is especially true for small spaces that generate small commissions. Also, if you are leasing a small space, you sometimes can’t get a tenant rep to work for you because it is simply not worth their time.  

16. What is the best way to select a broker?  There is no one best way to select a broker, but there are several things to avoid:

  1. Don’t choose a broker without first checking client references
  2. Understand what properties, if any, a broker has listed that could create a potential conflict of interest
  3. If a conflict does come up, how is your broker prepared to handle it?
  4. If you haven’t hired a broker, only let a broker show you spaces that they have listed
  5. Don’t hire a broker if you are unsure about moving  

17. Now that I’ve hired a broker, what should I expect from him/her?  A broker is like any other service professional. You should expect them to represent your interests, to give you good advice and to help you through the first phase of the leasing process; that is helping you determine how much space you need, what are your most important selection criteria, and then finding and negotiating for the space that best meets your needs. Don’t be afraid to ask your broker all kinds of questions. Know how much money your broker is going to make on your lease. That will help you determine just how demanding you can be and how much work you should expect. Remember that your broker doesn’t get paid unless a lease is signed, therefore their primary aim will be to make the transaction happen. No matter which broker you hire to represent you, the person who cares most about your interests is you. Ask questions, know your options. Make sure your broker understands what is important to you in the lease negotiation.  

18. My broker doesn’t have much experience; should I be worried?  The answer to this question depends on the size of your lease. If your plans call for a large space with a long lease term, then your broker’s experience is a very important consideration. On the other hand, if you are leasing a small space, then you may be better off using a broker that is fairly new to the business. The reasoning here is that a younger broker is looking to establish himself and will work harder for a small commission. As the tenant, you need to know how much commission your lease is going to generate and then determine how to best get your money’s worth from your broker. If you are working with someone that is new to the business, then you need to understand what kind of training the broker has had. It is also important to know if the broker is working together with an experienced broker or is totally on his own. You need to know what resources the broker has available to him, particularly if he has never leased a space from the landlord and/or listing agent you are negotiating with.

19. What is the difference between a large and small space?  Opinions vary on the answer to this question. We like to think of a small space user as any company with an office space need that is 3,000 square feet or less. A medium space user has a space need between 3,000 square feet and 10,000 square feet, while a large space user needs more than 10,000 square feet.

The definition also changes based on space type and metropolitan area. The numbers tend to be bigger for industrial users, where 5,000 square feet or less is considered to be small. In New York City, 10,000 square feet is considered small. On the other hand, 5,000 square feet is huge in a city like Albuquerque.

It is also important to answer this question from the building owner’s perspective. For example, a 3,000 square foot space user is much more important to the owner of a 20,000 square foot, 2-story building than the owner of a 500,000 square foot, 25-story building. Some owners prefer to have large space users so as to limit the number of tenants they have to deal with in any one building. Other owners prefer smaller space users, as this reduces their vacancy risk when it comes to any one tenant moving out of the building. Generally speaking, small tenants tend to be the most profitable type of tenant for the owner. They tend to be less sophisticated and therefore less demanding. A full floor tenant is much more likely to require a specific and therefore costly build-out, while a small user can often take possession of a space with a simple painting and re-carpeting.

When you are negotiating for a small space, it is important to understand the nature of the space that is available. Often times, significant discounts can be achieved on niche spaces. Depending on your flexibility, you can usually get a deal on an “option” space; that is a space where another, usually larger, tenant carries a right to lease that space in the future (in which case you will be forced to move). Another example might be in leasing a slightly larger space than you really need. If you are looking to lease 1,000 square feet but the landlord can only offer you a 1,200 square foot space, he may be willing to come down in price to meet your budget.  

20. Now that I’ve found a space, how long of a lease should I sign?  This can be one of the most difficult decisions you will need to make. There are a number of factors that come into play here (yes answers are more indicative of a longer lease term, while no answers indicate that short term lease flexibility is more important):

  1. Is my business stable such that I don’t expect my future space needs to change?
  2. Does the space that I am leasing require a substantial investment in tenant improvements?
  3. Do I expect rents to increase significantly in the future?
  4. Is the location of my new space very important to the success of my business?
  5. Is relocating my business hard to do?
  6. Is my rent lower if I sign for a longer term?

The first two items are the most important points to consider. If you have a start-up business, then a shorter lease term is most likely better. However, if your start-up business requires significant improvements, then you may be forced into a longer term lease by the simple economics of amortizing the improvements over a long term so that your base rent is affordable. One potential pitfall to avoid is bad advice from your broker or the property’s listing agent. Remember, the longer the lease term, the more money is paid out in commission. While that may be good for the broker, it might not be what is best for you. Ask the question, “What is the difference in rate between a three year and a five year lease?” Once you have that answer, then decide.

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