I love it when some commercial landlords claim that the commissions they pay to commercial real estate brokers should be conditioned on whether a tenant performs or defaults under a lease.  Some landlords insist that they should not be required to make future commission payments if tenants default.  Some go so far as to demand reimbursement of commissions by real estate brokers when tenants default.

Many commercial landlords argue that commissions should be paid based on the value landlords derive when tenants pay rent.  Those landlords claim that if a tenant defaults in paying rent, then the landlord's value is diminished, and the commercial real estate broker should somehow be responsible for that default and should not be entitled to its full compensation.

This is simply an issue where commercial landlords attempt to pass on their risk to real estate brokers, as a result of landlords not performing the due diligence necessary to protect their own interests.  Do landlords really believe that real estate brokers are capable of analyzing the financial abilities of commercial tenants?  Do landlords really expect brokers to act as credit analysts and insurers of tenant creditworthiness?

Sure, the compensation of commercial real estate brokers is performance based.  But, to who's performance does that relate?  Not the tenant's performance!  Real estate brokers are not compensated based on the performance of their tenants. That's why most courts of law have found that a real estate broker's commission is due when the lease is executed by landlord and tenant, not at the end of the lease after the tenant has performed its obligations. So, from a landlord's perspective, a commercial real estate broker should be paid for its own performance, for "delivering" a tenant, not for what that tenant does or doesn't do after the landlord has accepted the tenant and after the landlord has freely elected to enter into a transaction with that tenant. 

In fact, a commercial real estate broker working on behalf of a tenant may receive payment from the landlord, who is, in turn reimbursed by the tenant for the cost of the broker's compensation along with other costs through payment of rent.  So, because tenants reimburse landlords for real estate broker compensation, some courts of law have held that, in fact, it is the tenant that actually pays the broker's commission.

The world has changed and business, especially commercial real estate, has become a riskier industry.  Companies that appear to be healthy may not be, or may become unhealthy and default on their obligations at a later date.  This puts more burden on commercial landlords, and the necessity for them to take greater steps to protect their interests has become even more important.  For the record, it is not only tenants that can become unhealthy....

The issue of whether landlords should place the burden of tenant default on the backs of commercial real estate brokers has been an on-going source of debate, both in this blog, in LinkedIn, and in the commercial real estate industry.  And, so long as some commercial landlords, not the best or strongest landlords, mind you, unfairly attempt to shift their obligations and risks onto commercial real estate brokers, unfortunately this discussion will continue.

However, as the commercial landlord industry consolidates and becomes more sophisticated, that out-dated mentality of "stick-it-to the-real-estate-brokers" appears to be fading away, as greater numbers of commercial landlords recognize the benefits they derive from commercial real estate brokers representing tenants and the commissions to which those brokers are rightfully entitled.

Copyright Real Estate Strategies Corporation 2011.  All Rights Reserved.

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