How do Commercial Real Estate Brokers Get Paid?

Brokers are a valuable resource. I often get asked for details about how they get paid. 

Let’s work through an example of how brokers are paid by commission:

A franchisee has agreed to rent a 4,000-sf space at a rental rate of $25 per square foot. The annual total is calculated by multiplying the square footage of the space by the rental rate:

Annual Rent = 4,000 sfx$25.00 psf                                                 

Annual Rent = $100,000

The landlord and the franchisee agree on an initial lease term of 5 years. Multiply the Annual Rent by the number of years in the initial lease term:

Rent Total for the Initial Term = $100,000×5 Years

Rent Total for the Initial Term = $500,000

Brokers’ commissions are usually 6% of the Rent Total for the Initial Term. Multiply the Rent Total for the Initial Term by 6%

Total Brokers Commission = $500,000

Total Brokers Commission = $30,000

The Total Brokers Commission is typically split between the landlord’s broker, and the tenants broker. Each broker gets 3%. Divide the Total Brokers Commission by 2.

Landlords Broker + Tenants Broker Commission = $30,000

Landlords Broker Commission = $15,000

Tenants Broker Commission = $15,000

If either Broker is a part of a brokerage house or partnership, their commission is split even further.

The Power of a Good Broker

Sage advice in site selection: use a commercial broker that lives in the subject market. There are usually two brokers involved in each transaction; a broker representing the Landlord, and a broker representing the Tenant. It is a common mistake for small business owners and franchisees to forego their representation – to just use the Landlords broker. The reasoning is that they believe they can save money on a deal if they go it alone. What they’re not considering is the value that the Tenant-broker brings to the table. Some of the services that brokers provide are trade area intelligence, current market rates, comparable establishments in the immediate area, a buffer in negotiation with the landlord, utilization of a network, experience with different uses, and the ability to get sales data from direct or indirect competition. They will also save you time by turning up multiple opportunities at once, producing heat maps based on your choice demographics, chasing down the answers to your site specific questions, and hosting you on a thorough site tour of the market.

You should spend some time with your broker before they scout any real estate for you. Make sure the two of you are a good personality fit. You’ll be working with them often throughout the lifespan of the deal. Provide them with information on your brand and your target customer. If you, or your Franchisor (if applicable) have certain site criteria, be sure to let your broker know beforehand so that you don’t waste time looking at sites that will not work for you. 

 

 

Market Development Planning

Some franchisees or small business owners plan to open multiple units. If your goal is to be a multi-unit developer of a business, you’ll want to put together a market development plan or MDP. A MDP enables you to strategically look at a market and decide where you can locate each of your units to maximize profit and minimize cannibalization. Cannibalization in this context, means competing with yourself across two or more units for the same sales. Take a look at the diagram below:

This graphic shows three possible areas that fit  model criteria. The radii in the above diagram represent each location’s (A, B, and C) nominal trade area. If I develop location A, I cannot construct location B without cannibalizing location A. I can however, develop location C and location A without any significant cannibalization.  I could also construct location C and location B with no cannibalization. 

How Dare You!?

Sometimes development can get heated. Blood pressures rise, adrenaline kicks in, ego comes out. Recently I was privy to one of these exchanges. The topic: a radius restriction.

“How dare you tell me that I can’t open another restaurant!?” Jason said. His face was visibly red. Jason tapped his class ring firmly on the table and waited for the Landlord to respond. He stared at the speakerphone waiting for the Landlords reply. “Jason, your lease with us clearly states there’s a radius restriction.” Alex said in a matter-of-fact tone. “You can’t build another {restaurant} that close to the one in our center.” Alex is the Landlord of a very successful lifestyle center in which Jason has an over-performing, and very popular restaurant. So popular, in fact, Jason has started looking for a site to open a second location. Jason’s pick for location number two is approximately 3.5 miles west of his opened restaurant. “Alex, this new site is over three miles away, there’s no way you can tell me that I can’t open another restaurant three miles away!” Jason said clearly frustrated by what Alex said. “Actually Jason, I can. It’s in your lease with us. Read the lease. There’s a radius restriction in your lease!”  Alex said sternly. The room and the speakerphone fell silent. Jason flipped through his lease to the section Alex had referenced in a previous email. “So you mean to tell me, that I can’t build anything within five miles?” Jason said testing the waters. “Yes”, Alex said. “Five miles, as the crow flies.” Uncomfortable silence ensued. Alex was the first to speak again. “This is tied to your percentage rent clause”.

So why do Landlords impose radius restrictions? Generally radius restrictions and percentage rent clauses show up to the party together. If the Landlord is banking on the collection of percentage rent, and will be sharing in your upside, a radius restriction will protect that collection from your own cannibalization. In dense trade areas, radius restrictions can inhibit your growth strategy. Before you agree to a radius restriction, make sure you map out the extents of the proposed radius so you understand the boundaries. If you’re part of a franchised organization, compare the radius the Landlord is proposing as a radius restriction, to your development boundaries outlined in your franchise agreement.

As with most items in your lease if you knowingly act in conflict, you could be placed in default. If you defy your radius restriction you might be liable for ‘damages’ or for any perceivable loss in the collection of percentage rent.

Related: http://www.franchisefrankness.com/blog/percentage-rent

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How Many Bids?

I often get asked for contractor recommendations. I usually provide a short list of contractors that I’ve worked with in the past with success, or whose thorough work quality I’ve witnessed firsthand. When I hand over the list, the next question usually is: ‘Should I contact all of these?’

The answer is more complicated than a yes or no. Some contractors on the list only do work in certain states, some specialize in certain states. Some are headquartered far away from the project site, and would charge for travel to and fro. Some work with unions, some do not. These facts will usually filter down the list to three or four contenders that you can call and talk to about your project.  After that initial contact you should have a feel for the various companies, their ethos, timelines, and whether or not they’d be a good fit for your project.

Generally, my recommendation is to get bids from 3 contractors. Getting 3 bids allows you to make an informed decision on project costs and timelines. Plans get distributed to the contractors at the same time they are initially submitted to the city or county – the plans submitted to the contractors are called a bid set. A good and thorough contractor will take about three weeks to turn a bid around to you. By this time you are close to getting your first round of comments back from the building department (and/or health department if you’re permitting a food use). Barring any substantial comments by the departments, you should have a pretty good idea of the project costs.

I see many franchisees that go with the cheapest bid. But, be sure you are comparing apples to apples. Below are some other items in the bid to consider:

  • Timelines – if a project schedule isn’t provided in the bid, ask for one. Can one of the contractors get you to your opening date a few weeks earlier that the others? Quantify your projected weekly revenue and determine if there’s a decent return.
  • Weekend work – some construction companies work weekends or have provisions for weekend work in the event of weather delays or other unforeseen delays.
  • Dedicated workers on the project – will your project have a designated onsite super? Make sure there is someone to hold accountable if your timeline extends past the projected completion date.
  • Itemized vs lump sum bids – Some contractors will categorize items as ‘lump sum’ while others will categorize that same item as an ‘each’, ‘cubic foot’ or for whatever the situation calls. If you see ‘lump sum’ on one bid and ‘each’ on another, ask questions. There could be some hidden or padded costs in the lump sum designation.
  • Equipment Install – Many times a contractor’s bid will include installation of food service equipment. Be aware that your food service company will likely have a line item in their bid for this service as well. Don’t pay for it twice!

Get Your Permits Faster

Within the Development Process there are three phases that give timing experts a great deal of heartburn: site selection, lease execution, and permitting. These particular phases of the process present variables that can be difficult to schedule against because they depend on elements you cannot control.

Site selection, or the availability thereof, is a function of the market. If we’re in a sellers’ market, then demand is high, supply is low. This makes it harder to find good real estate. The harder it is to find, the longer the site search.

The push to get a lease executed can also be a long road. The road is certainly shortened if you have a detailed (but not too detailed) LOI, but from a timing perspective, you’re at the mercy of the Landlord or signatory. If the decision maker or his attorney decide to go on vacation for a week during your lease negotiation, you’ll have to wait a week for him/her to return.

The third variable is permitting. By the time you get to the permitting phase, you may feel like you’ve been beat up by the development process, you may have some new gray hairs, or have forgotten what is like to get a good night’s sleep. Permitting can be stressful; you now have outside parties looking at your plans, sometimes demanding that you change elements of your design. I’ve lost many nights sleep over permitting deadlines, but I’ve also learned ways to mitigate the timing unknowns. Below are some ideas that will cut down the time it takes to pull your permits.

1)      Schedule a Pre-Application Meeting with the agency that will be reviewing your plans. My first interaction with the AHJ (agency having jurisdiction) usually occurs in the Due Diligence phase. I’ve already talked to these folks once, maybe twice to make sure that my proposed use is permitted in this shopping center, in this area of town, in this PUD, etc… Once my lease is out for signature, I call up these same folks and ask for an in person Pre-Application meeting. It may take a week or two to get this informal meeting scheduled. By this time, I’ve usually chosen which architecture and/or engineering firm I’d like to hire, and I ask them to attend the Pre-App with me. During the Pre-App the AHJ listens to a brief description of the project; the rest of the meeting is them telling you what you need to do to get your permit. Ask them if there are any activities you can run concurrently or if there is any special criteria about which your arch/eng should be made aware. Ask them how long it usually takes to get through permitting based on your use and their workload. And above all, be nice.

2)      Hire an Expeditor to walk your plans through the permitting department(s) for you.  Expeditors come in various forms. Some contractors can act as expeditors. Local architectural firms can also act as expeditors. Even if you are running your plans through a non-local arch firm, a local firm can take on an ‘expeditor scope’, and for a fee, be your local face. I’ve personally had a lot of success with this method. Since the AHJ already knows the local players, they are usually more apt to pick up the phone or respond faster. Local firms also know the loopholes and what obscure items can speed up the paperwork.

3)      Purchase an Expedited Review from the AHJ. This service isn’t offered by all agencies. Basically, you pay a fee to get your permit application moved to the top of the pile.

4)      Ask the Landlord for help with permitting. If the space or center you’re considering is newly built, it’s likely that the Landlord has relationships established at the City or County. Ask the Landlord to come to your Pre-App or make an introduction to the team he worked with to get his center permitted. Since the Landlord wants to collect rent from you as soon as possible, he/she will be more than willing to help you, especially if all they have to do is make a few calls.

5)      Hedge – I only recommend this measure if you are experienced in project management or if you’re up against a deadline (like paying rent before you’re open). The decision to hedge happens earlier in the development process. It puts money at risk by starting your plans before your lease is executed. If you know that permitting will take longer than you have or than you want, starting your plans before lease execution can pick up some time. Essentially you’re running the lease execution and plans generation activities concurrently. You’ll get open sooner, but because you’re starting plans before lese execution, the money that you’re spending on the plans is at risk. In other words, if the deal falls apart, you’ve lost the money you’ve spent on the architectural and/or engineering plans. Be reasonable sure that the deal is material before employing this method.

 Have you tried any of these methods? Join the conversation!

Your General Manager Should Read Your Lease

I heard a funny story recently about a General Manager (GM) that obviously had NOT read their proprietors’ lease. Told from the perspective of an absentee owner of a gourmet burger fast casual restaurant, the story went like this:

                “The plane landed at 6:30pm and I drove straight to my restaurant. My GM, James* wasn’t there. The Assistant Manager informed me that he would be right back, that James had been invited to the friends and family event of a new burger joint in the shopping center. I was dumbfounded. How did I not know that there was another burger restaurant opening in the center? I have a water tight exclusive for burgers in this center! I walked down the sidewalk to the endcap of the shopping center and sure enough, the friends and family event for the new burger joint was in full swing. The parking lot was jammed with people and I was just close enough to have the conga line pass right in front of me. James, my GM was number four in the conga line.”

*Name changed to protect the derp

This story made me laugh. Although unfortunate for the business owner, it embodies an important message. Have your GM read your lease. If James had read his proprietors lease, he would have been versed in the exclusive use protecting the owner’s use from a competing burger business. 

There are many other reasons to have your GM or your Director of Operations read your lease(s). Below are just a few:

1)      Maintenance and Utility Repairs – Knowing who is responsible for these items can save you time and money. Think HVAC, roofing, sewer line blockages. If your GM knows who to call immediately, you as an owner will not have the stress of dealing with this yourself.

2)      CAM Services – an example of this is paying for trash removal out of pocket when your lease clearly states this is included in CAM. Your GM should be able to put two and two together.

3)      Renewals timing – your GM can help keep up with your deadlines to renew your lease.

4)      Opportunities – a good example of this is signage. If your lease states that you’re allowed multiple signs and your GM notices a position available on the multitenant sign, pursue it. You don’t get it if you don’t ask.

Have a copy of the lease (redact the rents and other sensitive material if it makes you more comfortable) on site an accessible to your GM and AM.

Empower your GM with information that can positively impact and protect your business. He’ll gain proverbial skin-in-the-game, and you’ll gain an asset.

 

Don’t Pay Rent Until You’re Open for Business

This piece of advice (refer to title) sounds intuitive enough, but I see many business owners get hit with paying rent before their business is open. How does this happen? Delays in lease execution, permitting, construction, or financing can push back opening dates. Overly aggressive project scheduling or flaws in the initial project scheduling can wreak havoc on your commitment dates as well.

So how can you avoid putting out rent money until you’re pulling in revenue? The answer is simple: hinge your rent commencement date (not to be confused with your lease commencement date) on the opening of your unit.

Now, a savvy Landlord will look at this proposal and say, ‘Nice try, Tenant. How do I know that you’re going to open in a timely fashion? You could drag this out infinitely.’ It’s a valid question.

So I insert another clause with a very conservative timeframe. We’ll insert 180 days in this example. The hinge for this clause is pulling a building permit.

The completed Rent Commencement Language reads:

 “Rental Payments shall commence the later of (a) 180 days after Tenants receipt of all permits, or (b) when Tenant opens for business to the public”

Did you notice the ‘later of’ language I inserted at the beginning of the two clauses? How this language is written is that whichever case is the latest to occur will govern. If I open before the 180 day mark (measured from building permit pull) then I’ve essentially given myself some amount of free rent. On the other hand, if I go over the 180 day mark, and open, say at 210 days, then I’m still not paying rent because of the ‘later of’ clause.

Now, a savvy Landlord will counter our ‘later of’ clause with an ‘earlier of’ clause. But even if they do strike your ‘later of’ clause and replace it with the ‘earlier of’, you should be ok unless you’re building something like a hotel. 180 days is a long time to be under construction.

Who Should Pay the Impact Fees?

In a sellers’ market, like the one we’re in now, negotiation for leased space gets tough. Landlords grant far less concessions on a deal than they did just a few years ago. Inventory for well positioned space is low, demand is high. In the race for space, prospective Tenants sometimes agree to pay for items that they normally would not, such as items that are traditionally supplied by the Landlord.

There’s a catchy adage attached to what items Tenants’ believe are the Landlords responsibility to tender. It goes ‘If it stays, the Landlord pays’. Utilities, structural improvements, and necessary ancillary services (parking lots, etc) are among these items – they ‘stay’ with the space after the Tenant leaves. BUT there is another, sometimes large ticket item, one that rarely gets brought up at the initiation of a deal – impact fees.

Impact fees are imposed by the city or county; as such the rates vary from county to county, from city to city. They are called many things. They are hidden under names like, reservation fees, sewer capacity fees, meter fees, connection charges, tapping or tap-in fees, EDU fees, availability fees, the list continues.

In some cases these fees are zero or negligible. Sometimes there is a moratorium, but in many cases impact fees are an unforeseen cost that blindsides the Tenant when they go to pull their building permit. Some building departments will hold your permit hostage until these fees are paid in full. I’ve personally seen impact fees across the board. I’ve seen some impact fees as high as $300,000 in parts of Maryland attached to the use of a patio. I’ve seen some in Florida that we’re $5,000. I’ve seen some that were $300. It really depends on the location of your project.

If you’re interested in a space, especially if you’re going from one use to a more intense use (for example going from retail to restaurant) inquire about impact fees. Ask your broker to vet this for you. Since these ‘impact fee credits’ (they become credit as soon as they are purchased) stay with the property, they are assets to the Landlord. Get language into your LOI that makes any payment of impact fees or like charges, the responsibility of the Landlord. If this item becomes a negotiation point, be sure that you know the valuation, that your broker or architect has inquired about the dollar amount due and when that amount is due. 

Tenant Improvement Allowance – A Shell Game?

I have many franchisees ask about Tenant Improvement Allowance. It almost sounds too good to be true to those that are just stepping into the world of Real Estate. “You mean the Landlord is going to give me money to help me physically build out my space? Wow! What a good guy!”

The concept of Tenant Improvement Allowance, sometimes called TA or TIA, isn’t about the Landlord doing you any favors. Many call it a ‘shell game’ because it can be used as a way to raise the base rent. In which case, you are essentially financing these ‘free’ improvements through, not only the initial term of your lease, but any future options you exercise.

That being said, TIA can help out those entrepreneurs that start out with only a small amount of capital. It’s a real balancing act. Too much TIA and your base rent is inflated. Watch out for this scenario when a Developer is about to flip the property. To make his or her balance sheet look better with large rent numbers, they’ll flood you with cash up front. Be smart about it. You’ll be paying the inflated rent for 5 or 10 years; this time period can be long enough for you to have paid the original TIA amount back 3 fold.