Leasing Commissions

Definition of Leasing Commissions

Leasing Commissions (often abbreviated as LCs) are the professional fees paid by a commercial property owner to real estate brokers for their services in securing a tenant and successfully executing a lease agreement. These commissions act as an incentive and compensation for the broker's role in marketing the space, vetting potential occupants, and negotiating the terms of the lease.

In the context of commercial real estate finance, Leasing Commissions are typically calculated as a percentage of the total aggregate rent over the initial term of the lease. For example, if a tenant signs a five-year lease, the commission is usually paid upfront or in installments based on a set percentage of the total rent the tenant is scheduled to pay over those five years.

Detailed Description and Impact on Commercial Mortgages

For lenders and borrowers involved in commercial mortgages, Leasing Commissions are a critical component of property underwriting and cash flow analysis. Because these fees represent a significant "out-of-pocket" expense for the landlord, they directly impact the net proceeds available to service debt.

Below are the primary ways Leasing Commissions interact with commercial mortgage structures:

• Net Operating Income (NOI) Calculations: When a lender evaluates a property's financial health, they calculate the Net Operating Income. While Leasing Commissions are often considered capital expenditures rather than daily operating expenses, lenders "normalize" these costs by subtracting a per-square-foot reserve from the income to ensure the property can afford to attract new tenants in the future.
• TI/LC Reserves: Most commercial mortgage agreements require the borrower to maintain a Tenant Improvement and Leasing Commission (TI/LC) reserve. This is an escrow account where a portion of the property’s rental income is set aside each month to cover the future costs of commissions and space build-outs.
• Loan Sizing and DSCR: High leasing commissions can lower the Debt Service Coverage Ratio (DSCR) if the lender deducts them as an anticipated recurring cost. A lower DSCR may result in a smaller loan amount, as the lender perceives a higher risk to the cash flow available for mortgage payments.
• Lease Rollover Risk: Lenders pay close attention to when major leases expire. If several leases expire at once, the borrower will face a large "spike" in Leasing Commission obligations. Lenders may structure "cash traps" or specific reserves to ensure the borrower has the liquidity to pay these commissions and keep the building occupied.
• Disbursement at Closing: In some acquisition loans, if there are known vacancies that need to be filled, a lender may withhold a portion of the loan proceeds (a "holdback") until the borrower secures a tenant and pays the associated Leasing Commission.

Ultimately, Leasing Commissions are viewed by commercial mortgage lenders as a necessary cost of doing business. Efficiently managing these costs is essential for maintaining the stabilized value of the asset, which serves as the primary collateral for the mortgage loan.