How to Compensate a Commercial Real Estate Broker
When you decide to list your apartment deal with a commercial real estate broker, the are paid a commission. Unlike residential transactions where the realtor’s fee is essentially fixes, the commission on commercial real estate transactions is negotiable. However, depending on the size of the deal and if it will be listed on-market or kept off-market, there are general guidelines for the commission structure and amount.
The information used to create this blog post is based on an interview I did with commercial real estate broker T Furlow. You can listen to his full podcast episode here.
Here are the three main structures for compensating a commercial real estate broker:
Compensation Structure #1 – Percentage of Sales Price
The percentage-based commission is the most common structure for on-market deals. The percentage generally decreases as the purchase price increases.
Sometimes, the commission is split between the buyer’s agent and your listing agent. This is referred to as co-brokerage split. But it isn’t uncommon for your agent to also find a buyer and receive 100% of the commission.
It is uncommon to see a commission of 6% (the standard fee on most residential transactions – 3% to each realtor), unless it is a very small deal under $1 million. Generally, the commission is 3% to 4% of the sales price. And the commission is capped at a certain amount. It is possible but rare for a broker to receive a commission of $300,000+. For larger deals, the commission can be less than 1% of the sales prices.
Generally, the percentage-based commission is set by the market and the sales price.
The advantage of the percentage-based commission is that your broker or a buyer’s broker is incentivized to maximize the sales price. The higher the sales price, the higher their commission.
The advantage of the co-brokerage split is that it increases the number of potential buyers. Rather than one broker – your broker – finding buyers, any broker in the market can find buyers for your deal. Plus, your broker is incentivized to put forth a greater effort to find a buyer so that they receive 100% of the commission.
Compensation Structure #2 – Flat Fee
The flat fee commission is the most common structure for larger apartment deals. T considers sales prices of $8 million or more as large deals. Once the sales price exceeds $8 million, a flat fee commission between $150,000 and $250,000 is standard, but may be lower or higher depending on the market.
Flat fee commissions are also common if you want to sell your deal off-market with a broker. Expect to pay a higher flat fee for a large on-market deal than a large off-market deal since on-market deals require more effort on the part of the broker.
Generally, the flat fee is negotiated between you and the broker.
The major drawback of the flat fee compensation structure is that it doesn’t incentive your broker to maximize the sales price. No matter what the sales price is, they are paid the same amount.
Compensation Structure #3 – A Hybrid Structure
A hybrid compensation structure can be negotiated for any sized on-market or off-market deal.
Once you determine a strike price (i.e., the expected sales price), you offer a commission that is slightly below the market commission rate. Then, offer a significantly higher commission on any amount above the strike price.
This compensation structure is better than the percentage-based structure because your broker is incentivized even more to sell the deal above the strike price.
Let’s say you are selling a deal on-market and you determine that the strike price is $42 million.
Compensation Structure #1 – Let’s say that the market commission rate is 0.75%. If the deal sells for $42 million, the broker makes $315,000. If they can sell the deal for $44 million, they make $330,000.
Compensation Structure #2 – Let’s say you negotiate a flat fee of $275,000. If the deal sells for $42 million, $44 million, or even $50 million, the broker makes the same $275,000 commission.
Compensation Structure #3 – Let’s say you negotiate a 0.65% commission up to the $42 million strike price and 5% thereafter. If the deal sells for $42 million, the broker makes $273,000, which is less than Compensation Structure #1 and #2. If the deal sells for $44 million, the broker makes $373,000, which is higher than both Compensation Structure #1 and #2.
This example illustrates why I prefer Compensation Structure #3. If the deal sells at the strike price, you pay the lowest commission. However, if the deal sells above the strike price, you and the broker make more money! So it is a win-win.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.