How standard commission agreements work for the broker but not always for the client – Part I

Monty Hall - Lets Make A Deal

Monty Hall – Lets Make A Deal

As a consumer of real estate services, it’s in your best interest to understand what motivates your broker. If commercial real estate is a game played by brokers and developers, then it is important to know how they decide who is winning and who is losing.

While many brokers might tell you they have a fiduciary responsibility to you, incentives in the industry often work against your best interests. And it can be hard for brokers to resist the lure of larger fees, even if it hurts their client.

Brokers, for example, earn bigger commissions when you pay more in rent. This can translate into you signing on for more space than you need or paying a higher rate because your broker didn’t “go to the mat” against the landlord on your behalf. Why would she if it was not in her financial best interest?

People often choose their broker using the classic mix of commerce and camaraderie: They pick the guy they know from the country club because they see the broker service as a commodity and figure they’ll chose someone they know. But by doing so, they could be hurting their bottom line because brokers, by their very nature, respond strongly to incentives. And there are a lot of incentives at play when a commercial real estate deal is being transacted.

Consider this example, where a broker snagged a $21-million commission when Macy’s renewed their lease earlier this year:

The department store renewed 647,000 square-feet at 11 Penn Plaza in New York city in the first half of 2013. Their arrangement called for an effective rent in the high $40s and a lease term of 20 years. To figure out what commission might have been (and potential conflicts of interest), let’s calculate an example fee structure that is representative of one commonly in tenant representation assignments:

  • Assume fees paid by the landlord are as follows:

    • 4% for Years 1-10

    • 2% for years thereafter

  • Part I: 647,000 (square feet) x $49 (rent/sq. ft) x 10 years (term @ 4% commission) x 4% (commission)

  • Part II: 647,000 (square feet) x $49 (rent/sq. ft) x  10 years (term @ 2% commission) x (2%)

  • Sum up the two numbers from Part I and Part II

    • $12,681,200 + $6,340,600 = $19,021,800

It is important to note that commission structures range wildly from market to market. Regardless, that’s an incredibly large commission, almost enough to buy an entire office building!

If in the 12th hour Macy’s decided it wanted to secure a 10-year deal with options to renew instead of a 20-year deal, it would have cut the commission by nearly 30 percent–or $6.3 million.

Consider the following:

  • Negotiation Fatigue Syndrome: There have been many studies that show how fatigue, or simply wearing someone down, can weaken a broker’s resolve to fight for his client’s best interests. In the example above, how tenacious would the broker be, especially if the “victory” resulted in $6.3 million in his pocket?

  • Negotiations with strangers: You may feel that hiring a broker that performs only tenant representation is a good idea, but does he have a better relationship with the landlord that he has knows from deals in the past, or with you? There have been studies that demonstrate that common negotiation adversaries lead to faster deals – but they are far less creative.

How hard do you think the broker would have fought for those terms over the more lucrative ones?

As you can see, understanding how the broker is compensated can help you spot potential conflicts.

The good news is you don’t have to blindly accept what is offered as a “standard” commission arrangement–often 4 percent to 5 percent of the lease. With some understanding of the real estate process, you can structure your broker’s compensation based on your goals.

In our next blog, we’ll explain how you can move away from traditional agreements, and we’ll share examples of alternative fee structures that can better serve your needs and help boost your bottom line.

Space. The final frontier (trends in alternative workspace management)

DM-Squirrelcagecubicles

Click to see Steven M. Johnson’s awesome workplace images!

Everyone in the development community is watching what large business is doing with their hoteling efforts. There has been discussion about this for 20 years, but the impact is not being felt.

Why? What qualifies as a job that is good to be “hoteled”. Wells Fargo and other companies have created a questionnaire that helps employees and managers determine if theirs is a job that may be better done from home. The questions asked are similar to the following:

  • Are you in a supportive role?
  • Determine if part of your value is as a mentor and organizational leader that is needed for office morale and client meetings.
  • What percentage of your time is away from the office?
  • Are you using equipment that is located in the office?
  • Is the work that you are doing secure and confidential?
  • How much paper shuffling is required to get your job done?
  • Are you consulting clients in the field?

When you think about it, much of the work that can be taken out of the office is pretty intuitive. But it is interesting to me that a questionnaire is created as a way to help decide if an employee who wants to work from home is allowed to do so. It is management 101 to establish guidelines that are practical for all to follow, but I can see the conversation now: “I am sorry Mr. Janitor Assistant Manager, you job is too secure, encrypted and paper process critical to have you clean the office from your south Charlotte home.

However, we will reconsider the issue with you again at next year’s review.” I can see why others want to work from home. Here is what Bank of America has discovered with their “mobility program”:

  • It is saving a ton of space. The current ratio of B of A employees who are working remotely is 1:19. Assuming that the bank has nearly 90,000 employees, that is 18,000 B of A employees who are working in their pajamas.
  • It is green! Really, it saves LOTS of cash to lend to small businesses. The initiative has sustainability written all over it. With the time saved commuting, and being flexible to work around other priorities, the Bank estimates that it has, “given 9 million hours back to its employees.” And you know what that means, a lot more time for Facebook!
  • I want to work from home for Bank of America!

This initiative has to result in happier employees, higher job retention and overall increased efficiency and production. Does anyone know how the office real estate development industry is responding to this? I got one developer on his cell phone (he was working from his home). He loves the idea.

How the little guy gets duped in commercial real estate deals

2010-04-26 19.25.44There is a very specific kind of client who gets duped in commercial real estate deals. And it’s not Bank of America or any other large corporation.  Any company that’s big enough to have its own in-house real estate department is generally savvy enough and commands enough business to dictate its own terms to the brokers.

It’s the mature, small and mid-sized company with very specific real estate needs, where a single CFO or COO is tasked with figuring out the space problem (often in addition to staying on top of the books or coming up with an operational efficiency strategy). It’s a family office or family-owned business. It’s the growth-stage business that thinks it might needs to increase office space by 10x over the next three years, but with some flexibility to ramp up or down, depending on what the company’s growth looks like.

These are companies with complicated needs and executives who want a real estate solution but don’t have time to become experts in the field.  Facility costs often are the largest or second largest asset on the books, but (perhaps because it is everywhere) real estate is easy to take for granted. And managing a real estate transaction can be a nightmare, with a multitude of stakeholders, including employees, customers, investors, regulators and neighbors.

These companies — probably your company, if you’ve read this far — need brokers who will:

  • Clearly define expectations: The best of the new breed of brokers work with their clients at the outset of a process to define goals, then adjust as the objectives inevitably shift.
  • Agree to be “partners”: The client has to agree to share key information about facilities, business strategy and functions, and IT. The agent-advocate’s focus must be not just on fees, but also on long-term goals like facility flexibility, cost reductions and employee satisfaction.
  • Structure a tailored process: Like you, I hate checklists. They run entirely against my intuitive DNA. However, the reality is that a good checklist keeps you from making common, stupid mistakes. They free you from the worry that you might be forgetting something, allowing you to think creatively and make decisions with confidence.
  • Define key criteria and analytics: These become the basis for making a final decision in a transaction.
  • Manage the transaction: A well-run process will hit all key transactional benchmarks on the way to a streamlined, efficient close.
  • Behave like an agent-advocate: The solution to the traditional agency problem lies in linking the agent’s fee to the long-term success of the transaction. Long-term is the key word here: Do you want to hire a broker who is looking for short-term gains? Or do you want to find the agent-advocate who is focused on long-term relationships?

Today’s best brokers thrive on working with people to provide clarity to complex real estate transactions. These brokers put money where our mouth is and use innovative consulting tools to provide an experience to our clients that they say they actually enjoy. You will be comfortable having them report to someone in the company’s C suite. These men and women are trusted advisors and the transactions they thrive in are almost always complex and involve some element of consulting. Rarely is there demand for the broker for an off-the-shelf, “just get it closed in a hurry” deal.

Is there too much sharing online?

ImageBack at the beginning of my career, commercial real estate brokers still played a critical role as keepers and guardians of valuable market information.  The best brokers knew — whether in their head or in well-kept files — where the available space was in a given market, who controlled it and what general terms the market would bear.

The Internet and the age of Big Data have changed all that forever. The same tools that allow homebuyers to sort online residential real estate databases and see what every person on a block or in a neighborhood paid for their home and when they paid it — a reality that has fundamentally altered the role of the residential broker — are widely available in the commercial real estate world. The commoditization of market data on the Internet threatens to mercilessly disintermediate the traditional broker, who is no longer the keeper of the keys to the kingdom.

These days, any traditional broker who describes their primary role in a transaction as “knowing the market” is irrelevant. In an age of Information Overload, the broker’s primary function has shifted from being a broker/”market maker” to serving as a client’s advocate and guide through a complex transaction, with a laser focus on providing wise counsel. This new-style broker – what I describe as an “agent-advocate” – clarifies a client’s needs and advocates relentlessly on behalf of the client all the way through a transaction. When an agent advocate is compensated at the end of a transaction, they are being paid for their ability to provide clarity to a complex transaction.

This won’t win me any industry Broker of the Year awards, but the reality is that traditional commercial real estate brokers share a set of traits that are particularly unhelpful for clients in the current environment. Here is my list of the most obvious problems in the commercial real estate brokerage game:

  • The classic “agency problem”: Traditional brokers operate under a compensation structure that motivates them to operate in their own best interest — not that of their client. I refer to brokers who are willing to sacrifice their near-term self-interest to benefit their client’s best interest (with the knowledge of earning a fee, obtaining a referral, and future reciprocity) as “agent-advocates.”
  • Trusting their intuition: Traditional brokers are not analytical or data-focused. With a flood tide of data washing over them, few traditional brokers have the interest or skills to analyze the numbers and objectively interpret how they can be put to work on behalf of clients. Like the traditional baseball scouts in “Moneyball,” determined to keep making gut-level decisions based on what their eyes tell them, they’re being left behind.
  • The rugged individualist: Years of working in an “eat what you kill” environment has conditioned traditional brokers to operate as lone wolves. Such a broker struggles to assemble a team that can bring diverse skills to bear on a complex transaction, including something as simple as involving brokers in other markets where a client might need to lease space.
  • Lack of formal training: Professional development and skills training — which in most other industries would help professionals adapt to a changing environment — is almost non-existent in the industry (partly a function of the Lone Wolf Syndrome noted above). Commercial brokers do receive training from their State regulatory agencies, but most syllabus are targeted to residential brokers who work with first-time home buyers.
  • “Slamming deals”: Compensation structures and the nature of the industry motivate brokers to close deals as quickly as possible. That leaves little room for creative solutions, application of detailed problem-solving processes and proper due diligence.

To me, traditional brokering is an unrewarding profession. Clients are understandably suspicious of their brokers; many of them believe their broker is overcompensated for driving little, if any, value in the deal process.

There are ways around the agency problems and there are many modern brokers who take pride in being agent-advocates for their clients. See the posts below about how to hire a broker and the next post to the Strategic Tenant Advocate™ to gain tips on the right team to put in place to solve any real estate decision with which you are faced.

Lease Renewals: 7 Surprises to Avoid

Five years ago, few anticipated that the commercial real estate market would collapse. In some markets rental rates dropped by more than 25%. It is a good idea to review your lease renewal rights to make sure you have an equitable deal and to avoid surprises at renewal time.

Your landlord will be aware that the market has improved, but are you prepared to get the best deal possible? Having a specific real estate negotiation strategy for when a lease is up can provide a way to facilitate successful negotiations that will give you a lot of confidence when trying to get consensus with your team.

Here are 7 tips to avoid surprises at lease renewal time. Watch the video to learn tips and ensure that the negotiation process goes smoothly.

  1. The lease critical dates “gotchas”: Know your lease’s renewal language 18 months in advance. Often leases have to be renewed with a 12-month notice. Establish ticklers for critical dates and discuss your options with your broker and attorney.
  2. Your new neighbor negotiated a better deal than you did: Collect recent market comparables and know what the new tenants nearby are paying in rent. The past three years have been a tenant’s market and your new neighbor likely won concessions related to lease term, free rent, improvement allowances and sublet flexibility.
  3. Changing trends in office space requirements: What functional elements will you need in the space three or five years from now? Office trends have changed a lot – consider hiring a space planner to help you understand your future critical needs.
  4. You will find that it is a volatile market out there: Issue a detailed RFP to other landlords, and to your current landlord. Always get two or three other proposals from competing properties, and then perform a discounted cash flow analysis—you will be surprised at what you learn.
  5. Your landlord has a plan for your renewal that is a lot different than yours: Develop a negotiation strategy before contacting your landlord about your intent to consider other options.
  6. The renewal provision in your lease is a lot different than the deal you will ultimately negotiate: If you have a renewal option in your lease, decide if you are going to accept it or challenge it.

LUCKY YOU! Number Seven. Your team will have unrealistic expectations about the value you can claim at lease renewal time. I suggest that you first work with your team to reach conclusions on your optimum real estate negotiation strategy in terms of what you want in relation to the length of the lease, rental rates, responsibility for repairs and maintenance, and sublet options. Having this set in your mind prior to negotiation will help you maintain your position during the negotiation.

7 Good Ways to Terminate Your Lease

arrivederci'One of the biggest issues in all of lease negotiations are termination options. Tenants want them, landlords fear them, and brokers don’t want to have anything at all to do with them. The reasons why are based in common sense.

•                Tenants want the option to terminate their lease agreement at any time and are willing to pay a lot of money to exercise the option. Still, it’s not something that’s commonly agreed to by landlords, and commercial real estate agents resist them.

•                Landlords view a lease termination option in a wholly negative light and are frequently resistant to negotiate this into the terms, even if it results in a deal killer. Often a landlord is between a rock and a hard place. The landlord’s lender gets to approve any substantial lease, and if there is a provision that will affect the landlord’s ability to pay its mortgage, the lender will likely not approve the lease.

•                Traditional commercial real estate agents see negotiating the ability for a tenant to terminate a lease agreement as counterproductive to their personal goals of earning a living. Working a termination option into a lease can have a significant negative impact on the commission of a broker, as it can impact the fees they earn by as much as half.

So what does a tenant have to do in order to gain the option to terminate their lease agreement?

  1. The tenant can pay for their own improvements and for their broker’s fee. After all, if the tenant can terminate the lease before the landlord can break even, the landlord would be making a very bad deal.
  2. The tenant can offer to give ample notice of their intent to terminate, which will allow the landlord to find a replacement tenant. Common termination notices provisions range from 6 to 12 months. However, they can be up to 18 months. We have also seen where the option period opens and closes during a short period of time, a trick that the landlord will use to catch a sleepy lease administrator off guard.
  3. The tenant can offer to pay the landlord’s unamortized expense of doing the deal. In this instance, the landlord might send a check to the landlord at the time that they exercise their termination right in the amount of the sum of the unamortized brokerage commissions and tenant improvement allowance. Sometimes tenants will include any free rent that they may have received in the calculation of the unamortized deal costs.
  4. The tenant can pay a fee that is equal to some number of months of rent. This is typically designed to reimburse the landlord while the space is empty.
  5. A combination of some, or all of, the above. In landlord-friendly markets, getting a termination is tough. The tenant may agree to pay the landlord for its unamortized deal costs, provide 12 months advance notice (but only during the week prior to), pay six months of rent, reimburse the landlord for the free rent the tenant received and the right completely goes away if the tenant is ever in default (or more than 1 day late with its rent).
  6. If you are in dire straights, look at the tenant default, bankruptcy and mitigation sections of your lease – then talk to a good attorney. Each different, but you may find that your state will force the landlord to mitigate the lease burden if you can’t pay the rent.
  7. Short of hoping against all hope, tenants have to align themselves with a commercial real estate brokerage that pays their agents based on performance. Although finding such an organization can be on a par with finding the Holy Grail or hunting down Bigfoot, there are tenants who have been able to accomplish this task. As a result, they’ve emerged from negotiations with a renewed perspective on what the relationship between tenant, landlord, and commercial real estate broker can be about, and what they can result in: a mutually beneficial solution for everyone involved.

The Employee Commute Impact Analysis – Finding Office Space with the Workforce in Mind

Employee Harmony

Employee Harmony

There is a heuristic that brokers who have been in the business for a long time understand, which is: the location closest to the most senior level executive’s home is the location that will be chosen. Other companies are very sensitive to the drive times of all their employees and great pains are taken to reduce time spent behind the wheel, at least for the most valuable employees.

Finding office space within a specific geographical location can present a range of issues. Many executives in the process of uprooting to another location have to take into consideration the needs of their workforce when finding viable locations for office space, and this important detail can throw a wrench in the works – or, at very least, make things a lot more difficult for everyone involved.

For this reason, ask your real estate broker if they are willing to conduct an Employee Commute Impact Analysis prior to presenting you with a list of potential lease properties. This is an integral part of the kind of strategic planning that has to take place, and the establishment of certain criteria that will ultimately inform which properties are considered. To do this, the following is needed:

•             The total number of employees the company has.

•             How many of those employees work onsite full-time versus how many of them telecommute.

•             The transportation patterns of the company’s workforce (for example, how many drive, how many carpool to work, and how many take the bus or train to work).

•             The current distance of the nearest train or bus stop.

•             Average commute times for employees.

 There are many different online mapping resources, like Google Maps, that will make this work relatively easy.

Gathering this information is vital to finding office space that will minimize any negative impact that a company move will have on its workforce. This information may even make it possible to improve upon the current situation, making it far more likely for a smooth transition into a new office.