The Tension Between Quality Tenant Advisory Services and Commissions

The overwhelming practice in all major US Metro markets is for landlords to pay the tenant advisor’s fee. While it’s true the landlord cuts the check, the tenant is actually the payor, as leasing fees are built into the building operating budget and recouped by the landlord through rent in the same way other transaction costs are passed on to the tenant (like landlord-funded tenant improvements, free rent and other concessions). In past issues we’ve written about how this arrangement can create opacity, making it harder for tenants to align advisory fees with specific services. But this unorthodox arrangement can also create unusual negotiating dynamics where certain landlords look to leverage tenant confusion about leasing fees to cause the tenant to sign up for less favorable terms and/or to keep fees otherwise budgeted for the tenant’s advisor.

The classic example is when the landlord approaches an existing tenant and suggests it does not need an advisor and it can save money by negotiating directly with the landlord, since the landlord will not have to pay a leasing fee. This should always raise a red flag. Why? Let’s start with the premise the tenant can save money by not engaging an advisor. How? Or, said differently, how will the tenant know it’s saving money? In order to know, the tenant has to understand the full market dynamic, the available alternatives and the comparative structure of alternative transactions - - - it needs to know the value it could achieve from a properly leveraged market negotiation. Savings that equate to the value of the leasing fee would then be identified by taking the value of the fully leveraged transaction and deducting the fee. Only then has the tenant actually realized the promised savings. Importantly, the instance in which the tenant is negotiating directly, without advisory, by definition, reduces the level of knowledge it has about the market. What is the prevailing market trend in landlord-funded concessions for a similar tenancy? What if the trend is for landlords to fund $100/sf in tenant improvements, but your landlord is offering $20/sf? How do you account for the difference? What about free rent? What about expansion and contraction rights, or termination rights and other flexibility mechanisms you might build into the lease? How should you be thinking about your renewal option in comparison to the market and to negotiations you might have outside the option with the landlord? How should you use time to your advantage, when should you start?

The bottom line, the landlord whom claims they can provide an existing tenant with a “better” deal if they negotiate directly is being disingenuous, at best. More likely it’s a strategic ploy to create more value. On the other hand, it’s also important for tenants to understand that buildings owned in partnership (most) often have asset managers whom manage the assets on a contractual basis. These contracts nearly always have provisions for the payment of market-based leasing fees. However, they also may have carve out clauses that permit the asset manager to keep a larger portion (maybe all) of the leasing fees in the event a 3rd party broker is not involved. Hence there is a material incentive for some asset managers to at least try and dislodge the tenant from its advisor. In this case, not only will the tenant fail to capture the full benefit of its market leverage, it will also redistribute a fee that was otherwise budgeted for its advisor to the landlord’s asset manager. In other words, the tenant pays a fee, gets no advisory services and executes a more expensive lease than it otherwise should…not a good result.

In our practice, we refer to this type of landlord as “oppositional”. You might think we look to avoid oppositional landlords by steering our clients clear of their buildings, but we don’t. Why not? Because it may turn out the optimal leasing solution happens to be in such a building. It’s relatively easy to work around the oppositional landlord’s tactics. Our approach involves taking the fee off the table by transparently identifying the fee as a transaction cost for our client (the tenant). This does two things; 1) it puts the fee where it belongs, as a line item transaction cost to the tenant and 2) it eliminates the power of the fee as a lever for the landlord. Maybe the tenant is paying the leasing fee for a lease extension transaction at its existing building; whereas it would incur greater expense for moving and tenant improvement costs associated with other scenario we’ve negotiated. Or, maybe the cost of the fee is a material factor that renders the existing lease scenario less attractive compared to relocation. At the end of the day, we are driving total transparency of all appropriate leasing solutions so the client can make an excellent, informed decision. And, by the way, even when negotiating for our client to pay the fee directly, we can easily create solutions to mitigate its cost, for example, offsetting the fee with free rent. It’s important to remember that leasing fees are akin to the tail that wags the dog. For a typical 10,000 sf lease of 5 years in San Francisco, the market fee is $3/sf/year, or $150,000. With the market average starting rent at ~$74/sf, this 10,000 sf lease would be valued at about $4M. The fee represents 3.75% of the lease value. It is less than 2.5 months of rent.

As long as tenant advisory fees continue to be paid by the landlord, markets will have a small percentage of oppositional landlords who seek to create tension around the fee to enhance their negotiation position and, in some cases, keep the fees for themselves. Navigating this dynamic is easy when there is total transparency and clarity around the role of the tenant advisor, the services being provided and the value of market-based fees. Successful outcomes begin by having the right conversations with prospective advisors to understand how they define the relationship between their services and the fees they earn.