JF1968: What Is A Fair Commission For An Apartment Broker? Syndication School with Theo Hicks
When you buy an apartment community, you’ll be paying your broker a hefty commission too. So what is a fair commission? Theo will cover how you can find that out, as well as some other ideas for getting the broker on your side. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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“Those are 4 ways to get the broker on your side”
Referenced episode with apartment broker Thomas Furlow:
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Theo Hicks: Hi, Best Ever listeners and welcome back to another episode of The Syndication School series, a free resource to focus on the How-to’s of apartment syndication. As always, I’m your host Theo Hicks.
Welcome to 2020. This is the first syndication school of the new year. So we will be continuing to do these syndication schools into 2020 for the foreseeable future. And we will continue to air the two syndication episodes every week that will focus on a specific aspect of the apartment syndication investment strategy. And we will also continue to offer the free documents that we’ve been offering for the majority of these episodes and series. All of the previous episodes, series and documents can be found at syndicationschool.com.
This episode is entitled, “What Is A Fair Commission To Pay An Apartment Broker?” I interviewed someone on 1813, Episode 1813. And we talked about different ways that an apartment syndicator can win over an experienced broker.
I’m pretty sure I did a syndication school episode on that, but I recommend listening to the conversation on that episode 1813 with Thomas T. Furlow, because we go into a lot more detail, plus it’s a lot better to hear from him, since he’s the one that’s actually telling you, “I’m an experienced broker and here’s what I look for when someone wants to work with me.” And this particularly is applied to syndicators who don’t necessarily have a high level of experience, or do not have a team with a high level of experience… Because as we all know, brokers care the most about closing, because that’s how they make their money, and therefore their main goal is to close on the deal. So if they’re listing a deal, whether it’s on market or they haven’t a pocket listing, they’re going to send that to people they know are going to close.
In that conversation, we talked about different ways that someone who has a little bit less experience, maybe even hasn’t done a single syndication yet, what they can do to position themselves as a person who is credible, and can position themselves as someone who’s able to close in the eyes of the broker.
And the four ways that we discussed was one, a consulting fee, so pay them a consulting fee for their time. When you’re asking all the questions and stuff, rather than just ask for that information for free, offer to pay them a few hundred bucks an hour for their time.
Number two was to visit their recent sales. So ask them for a list of their ten, five, whatever, most recent sales, and then go and visit those properties. Then tell the broker how those properties compare to the type the properties that you’re looking for, and then ask any follow up questions that you might have, just to give them an idea of what you’re looking for, but also show that you are putting forth the initiative. And again, all these things are to display your credibility to close.
Number three is to explain to them exactly how you plan on funding your deals. So how much money you have verbally committed, what types of financing are you pre-qualified for, things like that. And then number four is general, constant follow up. So whenever you perform any sort of task that brings you one step closer to putting a deal, let this experienced broker know, “Hey, I met with XYZ lender, and I told him about my business plan, and they told me that I can qualify for $10 million in financing,” for example.
So those were four ways– again, I kind of brushed over those quickly because we’ve talked about these before on Syndication School, and you can go listen to the 1813 episode where I talked to Mr. Furlow about those.
Now, the reason why I talked about those is because we have a fifth thing to add to this list now, and it has to do with the commission. So if you’ve read the Apartment Syndication Book that we released – I think it might be in 2018, so technically two years ago; it was less than that, more like a year ago, but since we’re in 2020, and it was 2018… Anyways, one of the sections talks about why it can be advantageous to buy and deal off market and not going through a broker in this, because of the cost to pay the broker. And you are able to avoid that cost by purchasing a deal that is off market, directly from the owner.
We had a few conversation with brokers just to get an idea of how much money can be saved by buying a deal off market, and we were told that one common structure would be a percentage of the purchase price up to a certain threshold, and above that threshold it’s a flat fee. Obviously, if you’re dealing with an $8 million property as opposed to a $100 million property, it’s really not that much more work on the broker’s side, but it’s over 10 times the commission. So in the book, we said that a common structure would be 3% to 4% of the purchase price up to $8 million, and then once you hit that $8 million mark and above it’s going to be a flat fee of say $150,000.
Now, one thing that structure is missing is alignment of interest, and we talk about alignment of interest all the time on this show, on the Joe Fairless content in general. So the fifth way to win over a broker is to offer a commission structure that is promoting alignment of interests, and is going to be beneficial to both you selling the property — this is actually on the sales end. So you benefit from the structure and they also have a way to make more money by getting you a better price.
This actually came from one of our consulting clients who has a property for sale for $42 million, and the broker is asking for a commission of 0.8%. So we’re above his $8 million threshold, and it’s actually not a flat fee, it is going to be a much smaller percentage of the fee compared to that 3% to 4% range. And so the client wanted to know, number one, is this fair to me and to the broker; two, “Should we cap that commission at a certain number?” thinking along the lines of our book; and then three, “Should there be any additional bonus structure?”
So right off the bat, you hear 0.8% and it may sound amazing, because you’re used to paying 3%, 4% for your traditional SFRs, your traditional duplexes, quadplexes, and even $8 million and below paying 3% to 4%. So 0.8% sounds great, but again, when we’re dealing with tens of millions of dollars, the approach is different. In one case it could just be a flat fee, but the way to create alignment of interest is to do it a different way.
One way to incentivize brokers to push for a higher price, but to also create realistic expectation is to negotiate a commission percentage that is less than the market commission rate. So in this case, something slightly below 0.8%, like 0.65%. And then base that off of whatever they believe the purchase price is going to be. So if the purchase price is going to be $42 million, that’s what the broker is telling you and that’s what the market is telling you, then you can set this lower commission for the $42 million number and then say anything above that you’ll get a commission that is significantly higher, say 5%. This way, if the broker is able to hit expectations, they’re still getting a fair commission, but they are incentivized to actually go above and beyond that purchase price and grind for the extra $100,000, $200,000, a million dollars because they get a larger chunk of that as a commission.
So in other words, you offer them something that would be slightly below market up to the purchase price, and then anything above that strike price would be offered an additional larger commission structure.
Using this $42 million deal as an example, if the deal were to sell for $44 million, and it was negotiated as, “Okay, the market commission rate is between 0.75% and 0.8%, so I’m going to give you 0.65% up to $42 million. Then anything above $42 million, you’ll take a cut of 5% of that.” So if the deal were to sell for $44 million, then their commission would be the $273,000 from the first $42 million, which is 0.8% of the $42 million, plus an additional $100,000, because of the $2 million above the strike price. And that $100,000 is coming from 5% of $2 million. So in this case, the total commission would be $373,000.
Now, if you were to just do the basic market commission of, say 0.75%, and you were to sell a deal for $44 million, then the broker would actually make $330,000, so about $40,000 less than what they would have made with this competitive structure, even though the initial commission percentage was lower than what they would have gotten if they wouldn’t have that bonus.
So to answer the question about “Is it fair? Should you offer something additional? Should you cap it?”, the compensation structure that is most advantageous isn’t one that’s just a commission up to a certain number and then a flat fee after that, because if that’s the case, what’s the point of selling the deal for, in this case, $44 million? Because it doesn’t matter to them. I mean, yeah, they’ll make slightly more money, because it is percentage based… It is actually probably the worst if it’s a flat fee, because then it doesn’t matter at all. Whereas if they are able to sell for $2 million more, they’re only going to get 0.0065% of that. Whereas if they are given a compensation structure that incentivizes them to get a larger percentage of the moneys above the strike price, the purchase price, the market rate, whatever, they’re more likely to push for that higher number.
So the best way to win over a broker is to offer them some competitive compensation structure. So rather than just offering them a basic compensation structure of a percentage or a flat fee over a certain threshold, offer them a slightly lower percentage up to a certain number, and then offer them a significantly higher percentage commission above that strike price.
So again, now we’ve got five ways to win over an experienced broker. And obviously, you benefit from this by selling your deal for a higher price, which – in turn, your investors benefit by making more money on the back-end, your brokers benefit because they’re also making more money, and it’s just a win-win all around and that’s what alignment of interests are. I win, you win, everyone wins, as opposed to one party winning and the other one not necessarily winning. Because if that’s the case, then sure, they might be a good person who’s going to put forth that effort, but they’re not incentivized to put forth that extra effort.
In summary, the fifth way to win over an experienced commercial real estate broker is to offer them fair compensation. What’s fair compensation? A structure that incentivizes them, that promotes alignment of interests and allows them to take a larger cut of the purchase price above a certain threshold, in this case, the strike price, whatever the list price is going to be.
Again, I recommend listening to the episode 1813 with Mr. Furlow, where we talk about the four ways, and then now you’ve got the fifth way. And we’ve also got a blog post if you’re a reader – Four Ways To Win Over An Experienced Apartment Broker, that is also available on the website. So just google “win broker” actually and then it’ll be one of the first things that come up, and you’ll find the blog post as well as the conversation I had with Mr. Furlow.
That concludes this episode. Until next time, make sure you check out some of our other Syndication School series about the How-to’s of apartment syndication. Make sure you download the free documents we have available. Those are, of course, available at syndicationschool.com.
Thanks for listening and I’ll talk to you tomorrow.