Real Estate Brokers Are Not in the Tenant Credit Guarantee Business – Part One

In every kind of business transaction, whether real estate or otherwise, the wise approach to increasing profitability is to reduce costs and risk.  Risk is an interesting concept, in that even when avoided, it never really goes away. Risk remains…always, only in different forms and quantities, and in different hands.  If one party in a two-party transaction reduces its risk, it is likely that the avoided risk simply transferred to the transactional opponent.

Transferrals of risk are a reasonable part of every negotiation, so long as such obligations are not unfairly thrust onto others.  But, like investment in a risky stock or placing a risky bet, an increase in risk must be accompanied by additional opportunity as an offset. Otherwise, the risk receiving side of the transaction loses by virtue of taking on a bigger burden with no potential increase in profit or other benefits, and the transferring side of the transaction experiences a dramatic win as the result of paying no cost in exchange for minimizing its risk.

In lease transactions, commercial landlords must manage their risk in order to compete profitably and to sustain their own businesses.  Transaction related cost and risk should be borne either by landlord, tenant, or both, depending on various considerations.  However, lesser quality landlords will attempt to reduce their cost and risk by shifting some of those burdens not to tenants, their transactional opponents, but instead to tenant brokers. This usually comes in the form of an insistence by the landlord to:

  • Lower commission rates
  • Calculate commissions on phantom rent amounts and other discounts
  • Calculate commissions on shorter lease terms that aren’t applicable to the corresponding transaction
  • Propose payments over periods of time
  • Avoid or suspend payments or require paid commissions to be returned in the event of tenant default
  • And, plenty of other reasons that serve only to unreasonably benefit landlords

Transactional cost and risk should only be borne by transactional participants. Transferring cost and risk to service providers, those who seek to perform a one-time service, collect their compensation and move-on, is unfair and inappropriate, especially when forced. Tenant brokers, like other service providers involved in various stages of real estate transactions do not belong in the chain of risk. Interestingly, landlords rarely offer tenant brokers an upside quid pro quo in exchange for a proposed increase in risk.

The existence of a tenant broker in a transaction means that the tenant will be better advised as to its in-place transactional alternatives and those associated with relocating.  It is for this reason and others that most landlords would prefer that tenants not utilize the services of tenant brokers. So, when landlords attempt to shift cost and risk to tenant brokers, they typically feel little sympathy for the impact their actions have on them.  Moreover, many landlords assume that if they can shift cost and risk from themselves without placing additional burden on their prospective tenants, they’ll have a greater likelihood of completing more transactions.

An experienced tenant broker will advise its tenants in advance that, because landlords must focus so intently on managing risk, especially in the current economic environment, the tenant’s creditworthiness will play a significant role in the structure of all components of the transaction they seek. The tenant broker must make it clear that, like in other financial transactions, the tenant will be able to achieve certain terms or not, based on the landlord’s interpretation of the tenant’s financial condition. A reasonable tenant will recognize these facts and will proceed accordingly.

The role of the tenant broker is not to analyze nor qualify the quality of a tenant’s credit. Since that responsibility should fall to the landlord, and since the tenant broker is not a direct participant in a transaction between landlord and tenant (paying or receiving rent, fulfilling lease obligations, etc), the tenant broker should not be expected to shoulder the burden of the tenant’s creditworthiness in how it receives its compensation.  Interestingly, landlords rarely offer tenant brokers higher compensation when their tenants have excellent credit!

In next week’s post, I’ll write more about specific issues associated with the transfer of cost and risk in lease transactions.  Please send me your comments and check back again!

Read Part Two of this Post.  http://wp.me/sy4BE-187

Copyright Real Estate Strategies Corporation 2009.  All Rights Reserved.

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22 Responses to “Real Estate Brokers Are Not in the Tenant Credit Guarantee Business – Part One”


  1. 1 Evan Glanz September 22, 2009 at 1:39 pm

    All good points Andy. Clearly tenant credit risk is one of the paramount concerns and the focul point of the negotiation (i.e.: Who has more leverage?). A landlord must properly evaluate credit on its own, and exacting commission reductions is not a fair way to proceed. That being said, I do believe it is the tenant’s broker’s responsibility to properly provide the landlord with the information necessary to evaluate credit. A landlord should be presented with a tenant’s financials and/or tax returns up front and if applicable a D&B report. This streamlines the process, properly manages expectations, and allows the landlord and its consultants to understand the negotiating positions of the parties.

    A good credit tenant in the current market is gold, and landlord’s have to be more flexible in accepting weaker credit. A tenant will also need to post more security in exchange for weaker credit. A tenant that refuses to post more security (assuming the request is reasonable) raises an immediate red flag to the landlord.

    • 2 realstrat September 22, 2009 at 10:51 pm

      Evan:

      As for the tenant’s broker providing the landlord with the tenant’s financial information, so the landlord can properly evaluate the tenant’s creditworthiness…I complete agree with you. But, I only agree on the presumption that the broker would merely be conveying the tenant’s information. Moreover, it is imperative that the landlord be solely responsible, with the tenant’s cooperation, for evaluating the tenant’s credit risk. Any diminusion in the tenant’s value, as perceived by the landlord, should be addressed only between landlord and tenant in the lease terms to which they would ultimately agree.

      The fact is that brokers have no ability to change the creditworthiness of any tenant, and should not be impacted by a tenant’s lack of credit. Furthermore, an unsavory landlord should not be permitted the opportunity to capitalize on a tenant’s lack of creditworthiness at a broker’s expense. Better quality landlords understand this and place risk where it properly belongs.

      Thanks for writing in. Please keep sending me your thoughts.

  2. 3 Bg September 24, 2009 at 9:00 pm

    Do those same landlords seek similar discounts, payout terms and rent guarantees from all of the other providers in connection with the lease? The attorney drafting the lease. The drywall guys. The locksmiths. The painters? No way. Only the broker!

  3. 5 pikerbro September 24, 2009 at 10:17 pm

    This would not be an issue if the tenant’s paid their consultant rather than the landlord.

  4. 7 Jeremy Cyrier, CCIM September 25, 2009 at 1:02 pm

    When a Landlord asks us about assuming risk and liability in any form or fashion, typically out of fear of a tenant default, etc, we tell the Landlord that they bring up a very good point. We then ask the landlord, “Do you buy and sell stocks? If so, when the stock market bottomed out in February of 2009, what did your brokers and financial advisors who sold you financial products say when you asked them them for rebates of their fees?”

    • 8 realstrat September 29, 2009 at 6:07 pm

      Jeremy:

      I love it! We ask them if they also seek discounts and claw backs from their attorneys, accountants, drywall contractors, landscapers, etc. As a tenant rep, my role is not to work for the landlord, but to represent the tenant. If anyone cared for my opinion, landlrods would pay their brokers and tenants would pay theirs. Until change takes place, I am of the opinion that the landlord should seek such discounts from ALL of its service providers, but only from those who work for the landlord. Thanks for your comments.

  5. 9 Geoffrey Kasselman, SIOR, LEED AP September 25, 2009 at 3:36 pm

    Andy, your knowledge of the corporate real estate business is impressive. In this instance, your ability to articulate this issue so well is uncanny. Thanks for shedding light on a dicey topic that is often experienced, but just as often unspoken. Let’s hope enough users, landlord and tenant brokers read this post! Keep up the great work, I am learning a lot! Best, GK

  6. 11 TRH-Baltimore September 25, 2009 at 8:14 pm

    As a landlord rep for about 11 million sf in this region, we pretty regularly pay a premium leasing commission to tenant rep brokers who deliver a credit tenant, as opposed to the tenant which lacks a substantial balance sheet or track record.

    When a less creditworthy tenant is introduced, the premium is held back, pending performance.

    The difference in commissions is not meant to be a reflection on the tenant rep broker’s efforts or skills, but an objective decision in providing compensation for providing an enhanced value for our client.

    Our stable of clients is made up of both institutional landlords, as well as high net worth individuals, and our shared experiences in this industry over the years have shown this to be well received by those in the industry who are relationship driven.

    There are certainly brokers who do not like this policy, but with an occupancy rate of over 92% in our core of 1500 tenant spaces, most seem to be ok with it.

    If a tenant rep broker does not understand the creditworthiness of it’s client, they will probably be wasting their own time as well as their client’s, in a critical part of the process. The best tenant rep brokers are equal to the task of understanding and explaining financials , not leaving it to the landlord to interpret.

    • 12 realstrat September 29, 2009 at 6:04 pm

      So, you pay a standard commission to brokers who bring you tenants, and a premium to those who bring you tenants with superior credit? That’s a smart approch to attracting brokers. I haven’t heard of that approach too often. That’s the opposite of what many brokers experience when some landlords seek to discount commission for what they perceive to be risky tenants and then also seek to discount for solid tenants! 🙂

      Thanks for sharing your ideas!

  7. 13 logout September 26, 2009 at 10:06 am

    The old days a broker was paid a larger fee, 6% of the rent monthly as received over the lease term and often on renewal terms as well. The alternative “cash out” commission of 4.5% was paid at the time of the lease execution which gave tenant brokers a large amount of cash at lease execution. I believe this cash out commission vs a fee paid over the lease term has become the standard and really serves tenants poorly. If a broker reps a tenant with marginal credit, the broker should be willing to accept a lower fee or a fee paid over the lease term. It is a risk sharing strategy that spreads risk across the parties in the transaction. A good broker understands this value proposition and if he has ever been a landlord will understand that we all benefit or are dinged for the credit of the tenant. Ask the bank who financed the property why they are advancing lower loan proceeds at higher interest rates due to a lower vs higher credit tenant. Also, the cap rate and sales price are dramatically lower for non-credit tenant leases.

    Bottom line, if you are representing a tenant with poor credit you should not be paid the same as you would for an investment grade tenant. Its all about the quality, durability and sustainability of the income stream you are selling to the landlord.

    • 14 realstrat September 29, 2009 at 6:21 pm

      I completely disagree! Risk sharing, in any circumstance, also suggests a quid pro quo in exchange for taking on more risk. Under your suggestion, what does the broker receive in exchange for taking on more risk? Moreover, whether the broker is paid upon execution or over time really has little impact on the tenant and little on the landlord, especially given how most landlords finance their properties.

      Read the comments posted by another reader who said that his landlord pays premium commissions for good credit tenants and offers his/her standard commissions for all others. Your way, the commission is either standard or discounted. Go figure! If you insist on a discount for poor credit, wouldn’t it be fair to offer a premium for great credit?

      Not all landlords offer a two tier (up-front vs over-time) commission scale. In many markets, customary practices are based on one commonly applied commission rate, either paid upon execution or over time.

      By the way, brokers don’t decide whether the landlord will interpret a tenant’s credit as good or bad, any more than brokers can change a tenant’s credit. The terms of the deal between landlrod and tenant, and only the terms of the deal, should properly reflect the tenant’s creditworthiness.

      Here’s another one for you: Given the current economic environment in which we now find ourselves, should a good credit tenant be entitled to pay a lower rent if the landlord’s credit is less than desirable? Talk about risk mitigation!

      Hey, just because we disagree, that doesn’t mean I don’t enjoy and appreciate your thoughts. Thanks for writing in!

  8. 15 Jeremy Cyrier, CCIM September 27, 2009 at 2:09 pm

    In our experience with landlord representation, our clients want tenants. If tenant risk is at question, the landlord prices that premium into the rental rate offered and pays the tenant rep broker a market fee. If there are performance concerns, the tenant is asked to reimburse for unamortized broker’s fees in the event of default.

  9. 17 Peter September 28, 2009 at 2:53 pm

    Like TRH-Baltimore above, I’m an owner. The owner pays the broker’s fee but the broker represents the tenant. You have a conflict there and as long as this continues, owner’s are going to attempt to incentivise brokers via contractual agreements. If you don’t want to deal with these issues get the tenant to pay your fee.

    • 18 realstrat September 29, 2009 at 6:22 pm

      You said it…loud and clear! And, I’ve been offering that to our clients for years. Now, if only we could get the entire U.S. real estate community to change how they do business….. 🙂

      Thanks for your thoughts!

  10. 19 CM September 29, 2009 at 10:28 am

    The question about whether to pay brokers more or less (or in different methods) based upon tenant credit is a fair one. The examples cited in the commentary (attorneys, plumbers, drywall hangers, etc.) are not paid on the relative tenant credit because their compensation is not based upon the fact that the tenant will, in fact, pay the full rent for the full term of the lease. The plumber is paid to fix the pipes, right? He’s paid on how long it takes him to do his work, and good work begets more work in the future, so he is incentivized to both do good work, but also be fair about pricing his services so that the customer feels he is receiving a good value for the services provided. Pretty simple model.

    However, the broker is paid a commission that is typically a percentage of the EXPECTED rent stream – prior to that rent stream being realized. The broker expects to be paid out, up front, whether or not the income stream materializes. How is this fair to the landlord?

    I am certainly not advocating paying brokers less, nor am I questioning the fact that good brokers are an excellent (and necessary) transactional partner and resource during deals. I consistently am willing to stand up against my partners to pay more than my partners believe our brokers should be paid.

    I am, however, questioning the chest thumping that suggests brokers are somehow immune and isolated from the larger question of whether or not their compensation (and the method in which it’s calculated) is fair and equitable. Obviously transactional participants should (and do) share the bulk of the risk/reward. But brokers should realize too that it’s not unfair to have the questions asked – and to get off the high horse that I see in these comments – that somehow it’s sacrilege to even broach the issue.

    • 20 realstrat September 29, 2009 at 6:34 pm

      Your post is very well thought out and well written. But, I strongly disagree with your foundational argument that a broker’s compensation is based on whether the tenant will pay its rent. The tenant promises to pay rent, and the landlord accepts that promise and secures its deal…period! The broker is a facilitator, working for one side or the other, but not a guarantor of either sides’ performance.

      Interesting that you mentioned plumbers as an example. If plumbers were brokers and some landlords had it their way, plumbers would receive a check every time the landlord turned on the water or flushed! Then, when the drain got clogged, the landlord would withhold the check. Plumbers install fixtures that are made by someone else. Plumbers only guarantee their work, not the products they install. Brokers guarantee their work, not their tenants’ creditworthiness or ability to perform as THEY promised. If the fixtures installed by the plumber don’t last as long as they were supposed to, the landlord may call the plumber/broker, but should rightfully take up the issue with the manufacturer/tenant.

      Your idea also raises the question about how a discounted commission should be readjusted when the tenant’s credit improves, especially when some landlords seek to suspend, delay, or further discount commission payments when tenants’ credit deteriorates.

      Like some of the other posts we’ve received on this topic, if landlords offered both premiums for great credit and discounts for poor credit, then I’d buy that argument. But, when the movement goes only in one direction (down), it’s unreasonable. I’m not advocating a multi-tiered commission scale, but this issue cannot be one-sided as it often is. Keep in mind, that there exists no such thing as commission standards. Landlords decide what they’ll pay, and brokers decide what they’ll accept…and, then they agree or disagree.

      I love analogies! Thanks for your ideas, and keep them coming!

      • 21 CM September 29, 2009 at 10:13 pm

        I love the debate, too. So here goes:
        I don’t understand your disagreement that “a broker’s compensation is based on whether the tenant will pay its rent” – if this weren’t so, brokers wouldn’t be paid a percentage of rent. Many markets have moved to paying on a psf basis – which is better – but still has its flaws.

        My analogy re: the plumber was borrowed from another comment here – bottom line is that (no disrespect to tradesman here) brokers are either value providers or service providers. If they want to be excluded from the value proposition argument, they should be compensated as service providers (plumber, in my example): bring me a tenant, I pay you a fee for your referral/time/contact, etc.).

        If, however, brokers want to be value providers – and be compensated as such – then they can hone their skills (and differentiate themselves against their peers, frankly) by learning HOW to evaluate credit and focusing on ways to attract business to themselves of higher credit “customers.”
        I have no sympathy whatsoever for the broker who claims that they couldn’t possibly offer an opinion on a tenant’s creditworthiness because that’s “not their role/job/skillset.” if they expect to be paid on that “value” basis – ie, if the full VALUE of the lease is realized, then the commission equates to x%. Note, however, if only half of the income is realized, their percentage doubles!

        How is that fair? The answer (in my opinion) is that it’s not. The commission is a percentage of an income stream – and so if the income stream isn’t there (through no fault of either the broker OR the owner, by the way), why should the commission be?

        Bottom line: good brokers can and do evaluate credit – and the market knows it. Brokers who are nothing more than a rolodex card, and who handoff the deal as soon as their is even a modicum of agreement between the parties, but of course eagerly awaits the commission at the closing of the transaction (even though they might not have done much more than answer an email or phone call or two in 60-90 days), are the ones to which my comments are directed.

        We all have responsibilities to stand behind our “product” – no matter what industry we are in. Brokers can, and should, take pride in doing something more than “dialing for dollars.”

        (all my prior disclaimers are still applicable, including the ones where I routinely argue for commissions higher than my partners like, and sometimes I pay fees even if a transaction goes a different way because that’s the right thing to do. So no flaming me! 🙂

      • 22 realstrat October 1, 2009 at 12:27 am

        You will get NO ARGUMENT from me about rolodex brokers. They give the brokerage industry a bad name (As if it needed another push in that direction!).

        Should brokers and advisors provide an evaluation or an opinion about a tenant’s credit? Perhaps, but only if they are qualified. I don’t know too many real estate brokers who are qualified as financial, investment, or credit analysts. And, frankly the idea of relying on real estate brokers to make credit assessments opens up a whole new conversation about liability….yuck!

        I believe whether a broker’s compensation is based on a percentage of the transaction value, a flat fee, a dollar amount per square foot, or some other agreed upon or locally based standard, is not relevant. What I’m seeking to shed light on in this discussion is the issue of whether the tenant should shoulder the burden for anyone else’s financial challenges. By the way, I also don’t agree that landlord brokers should bear their landlord’s risk either. Accepting a burden of greater risk in any transaction, whether it be real estate or otherwise, is only reasonable when the increased risk is accompanied by an equivalent quid pro quo. While we’re at it, is there a scenario where a landlord might be asked to take on additional risk that rightfully belongs to the tenant? I’m not sure. But, that wouldn’t work either. Punchline: Everyone should be responsible for their own risks!

        Your point about brokers being service providers versus value providers is an interesting one. But, remember the role of the tenant advisor. His efforts are not focused on providing value to the landlord, although that is typically the result nonetheless. The tenant advisor’s role is to provide service to, and create value for, the tenant (See my reply to MR’s post earlier this evening).

        Note that earlier this week, a reader commented that perhaps landlords should offer a multi-tiered compensation structure: Normal commissions for normal credit (whatever that means!), lower commissions or less favorable terms for less creditworthy tenants, and premium commissions for better credit tenants. My whole issue here is that the changes in commission rates, payments, etc, only appear to go in one direction…down. Mysteriously, yet not surprisingly, that favors landlords, not brokers, and not tenants.

        Great ideas. Thanks for writing again. Looking forward to hearing from you again!


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THIS WORK IS DESIGNED TO PROVIDE PRACTICAL AND USEFUL INFORMATION ON THE SUBJECT MATTER COVERED AND REPRESENTS THE OPINION OF THE AUTHOR. HOWEVER, IT IS PROVIDED WITH THE UNDERSTANDING THAT THE AUTHOR IS NOT ENGAGED IN RENDERING LEGAL, FINANCIAL, ACCOUNTING, OR OTHER PROFESSIONAL ADVICE TO THE READER. IF LEGAL, FINANCIAL, ACCOUNTING, OR OTHER PROFESSIONAL ADVICE IS REQUIRED, THE SERVICES OF A COMPETENT PROFESSIONAL SHOULD BE SOUGHT. THE AUTHOR SPECIFICALLY AND EXPRESSLY DISCLAIMS ANY LIABILITY THAT MAY BE INCURRED AS A RESULT OF THE USE OR APPLICATION OF THE INFORMATION THAT IS CONTAINED IN THIS WORK.

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