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

Making sure your broker’s interests are aligned with yours

Considering the thousands of commercial real estate transactions that occur each day, you may find it surprising how much mystery remains around how broker fees are calculated.

Typically, a client leasing office space might be told by their broker that there’s a “standard” 4 percent to 5 percent commission based on the value of the lease. But it is important to note that despite what brokers say, there are no “standards” for establishing these fees – they should always be a point of discussion; however, they rarely are by commercial real estate laymen.

As we mentioned in the first part of this post, commissions often are paid in a way that is not aligned with the client’s best interest. Under the traditional model, for example, brokers earn more on larger deals (i.e. when the client pays more), which can result in the client being dissatisfied, paying extra in rent or leasing more space than they may want or need.

Real estate is ubiquitous and most people take it for granted, but there are deals happening in your market every hour. It’s hard to know how many commercial real estate transactions are done each year. But we know from their annual report that CBRE, the world’s largest brokerage firm, closed $189 billion in sales in 2012.

That’s a lot of clients who are paying fees or commissions. I would argue that often, especially in the instance of tenant representation, that the client does not entirely understand how the brokers are getting paid, and how the broker’s actions are effected by their compensation structure and the push to get revenue to the shareholders.

Think for a moment: Have you ever had a bad experience with a broker? What if that broker had only been paid if you were 100 percent satisfied, instead of earning a commission simply based on the deal’s value. Do you think the outcome would have been different?

In his book “Antifragile,” author Nassim Nicholas Taleb discusses this inherent conflict of interest (also known as “the agency problem”) from a slightly different perspective. To Taleb’s way of thinking, the problem with brokers is they don’t have “skin in the game” in the same way that their clients do. Like an unethical defense attorney who pressures clients to cut plea bargains to clear his overloaded docket, the influence exercised by a broker has a much greater impact on his client than on himself. It’s another way that misaligned interests do disservice to the client.

So, what to do?

If your are considering engaging a broker, you should inquire whether the broker is willing to consider an alternative arrangement that puts your interests in line with his or hers.

At Cardinal, for example, we tie our commission to meaningful indicators of the deal’s success. In essence, we put our fees at risk to ensure the best outcome for everyone involved. We are not the only firm that does this, the largest real estate service providers offer this paid for performance mechanism to their largest customers.

Using key performance indicators (KPI’s), we monitor how well the broker and the clients are achieving quantifiable objectives. We talk to the client, they tell us what’s important and we work toward that.

Our experience shows these customer-specific performance indicators motivate the broker and client to drive down costs and improve customer satisfaction. To learn more about this process, called the Value Creation Review Process(™), click here.

The bottom line: You are best served when you truly understand how your broker is earning their fee and whether their motivations are truly matched with yours. If you find or suspect they are not, then you should look elsewhere.