In last week’s post, I reviewed a number of issues concerning the transfer of cost and risk from one party to another in business transactions, specifically in commercial real estate deals. That post received a number of interesting comments. There’s more to this story.
When landlords find prospective tenants to be unacceptable risks, those landlords should consider the multiple risk mitigation alternatives available to them, including accepting the risks as they are, working with prospective tenants to minimize risk or to enhance the tenants’ creditworthiness, modifying the terms of the transactions to support acceptable risks, or electing not to complete those transactions becuase of the existing of too much risk.
When landlords complete lease transactions, a large number of service providers may be involved on both the landlord’s side and that of the tenant. That list could include: lawyers, accountants, space planners, architects, engineers, asset managers, construction contractors, plumbers, electricians, HVAC installers, drywall contractors, carpenters, flooring installers, ceiling installers, elevator technicians, painters, other sub-contractors, property managers, asset managers, mortgage bankers and brokers, delivery contractors, administrative assistants, cleaning contractors, trash haulers, landscapers, snow plowers, and all others involved in completing a transaction or in maintaining the landlord’s property.
Like a tenant’s broker, none of the above service providers are responsible for assessing a tenant’s creditworthiness nor for the future performance of the tenant or the property. So, if a landlord wishes to shift the burden of its transaction costs and risks from itself to an entity other than the tenant, and since shifting that burden to the tenant broker would be unfair, then the cost and risk should be shifted to the entire list of service providers involved in any aspect of the property and its corresponding transactions. Adjusting the payment of other service providers based on the landlord’s interpretation of a tenant’s risk would actually be unfair, too. However, if a landlord’s policy was to compensate all of its service providers on a risk adjusted basis, then only in that instance might it be reasonable to compensate the tenant’s broker in that manner.
Interestingly and consequently, if a landlord did attempt to compensate its other service providers in the above fashion, that landlord would likely be out of business. (I have this vision of big burly union contractors showing up at the landlords office to collect their pay, when told they won’t get their money because the tenant didn’t pay its rent!) Under that scenario, most service providers would probably find work elsewhere, leaving the landlord with no services to receive or to offer, no ability to conduct business or lease any space, with ALL of the risk for EVERYTHING borne by the landlord, and no one to transfer that risk to.
So, what quid pro quo could a landlord provide to a tenant’s broker in exchange for accepting greater risk? Could the landlord offer:
- An insurance policy to protect the tenant broker’s compensation in the event of the tenant’s default?
- The opportunity to participate in the landlord’s future equity appreciation?
- Some other incentives?
But, the above might more closely align the broker and landlord, and could create a conflict-of-interest for the tenant / broker relationship. Now, that wouldn’t work. Resolving this issue using the above approaches could become very complicated…probably more so than is really necessary.
I’ve got a great idea for those landlords that seek to mitigate their cost and risk by shifting that burden to tenant brokers. Since commercial real estate brokers, especially those that represent tenants, are not in the tenant credit guaranty business, your best bet will simply be to follow the lead of the better quality landlords with which you compete.
Aportion the cost and risk of your transactions appropriately between yourself and your prospective tenants. Make as many deals as you can. Don’t unfairly shift your transactional burdens to anyone who shouldn’t participate in them, including tenant brokers and your other service providers. Life will be a lot simpler that way. Tenant brokers will be more comfortable dealing with you, and will likely bring you more tenants. Guess what? You will almost certainly receive more interest from tenants, because they’ll see you as fair and equitable…the way most tenants like their landlords!
Risk is a funny thing. When minimized by one party in a negotiation, risk never really goes away…it just goes somewhere else. Be sure to transfer risk in the right direction. And, remember that Real Estate Brokers Are Not in the Tenant Credit Guarantee Business!
Read Part One of this Post. http://wp.me/py4BE-1N
Copyright Real Estate Strategies Corporation 2009. All Rights Reserved.
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Corporate Advisor 
Andrew,
First, I would like to thank you for giving all of us a forum to voice our opinion on a very much needed debate regarding Broker Compensation. I normally do not respond to ANY Blog, but I have very firm opinion about this topic.
I have carefully read your article entitled “Real Estate Brokers Not In The Tenant Credit Guarantee Business; as well as your quid pro quo suggestions. Having worked in a Landlord/Developer capacity, as well as a Corporate Retail Real Estate Director/Manager for several big box creditworthy chains. I have tremedous respect for what brokers do, and have engaged them to exclusively represent me and the companies I have worked for, and all have performed above expectations. My following comments should NOT BE CONSTRUED AS A KNOCK AGAINST REAL ESTATE BROKERS in general, or more specfically, TENANT REP BROKERS.
Before one addresses the issue of Risk , we should address the more systemic issue of whose paying the commission/fee; and examine how Tenant Rep brokers are compensated for a lease transaction.
The issue of Tenant Reps/Brokers compensated by the Landlord has always been an enigma in retail real estate. Real estate guidelines require that whomever is receiving the fee, has a FIDUCIARY responsibility to the principal paying said real estate commission/fees. As I indicated I have spent several years on the Tenant side of the business and have never, ever paid a broker that represented me; so how equitable is it then, in the context of fiduciary responsibility, when the landlord is solely responsible for compensating the broker? THIS IS NOT A RISK/REWARD ISSUE!
To reinforce my implication, The Tenant Rep Broker, for fear of losing the Tenant as a client, works harder on behalf of their Tenant/Client than they do for the Landlord: e.g. hours upon hours in preparation and conduct of site tours, assembling site tour books, trade area analysis, etc… HOWEVER, it is the Landlord who pays the Tenant Rep, and in most cases, the Landlord has its OWN REAL ESTATE LEASING STAFF, WHOM ARE ALSO COMPENSATED.
Moreover,industry practice has created this “Tenant Rep COMPENSATED BY LANDLORD” system; sure they all court each other during the honeymoon and lease-up stage, but afterwards…?
The only one at risk in the Tenant Rep. scenario, is both the Landlord and Tenant. And if the Tenant doesn’t work out, IRRESPECTIVE OF THEIR CREDIT QAULITY, the Broker has still been compensated,partially or in whole, even though the Tenant may not have taken occupancy. Take Steve & Barry’s, as an example; I know of several transactions where the Tenant Rep was partially compensated (upon lease execution), but this retailer never operated at all in the Landlord’s shopping center. And how many broker fees were paid, under the above scenario, by Landlord’s on development projects that found themselves a victim of various economic crisises, including our most severe and current down turn?
No, we MUST ADDRESS THE FIDUCIARY SIDE of this issue, prior to crying foul on who has not lived up to the Broker’s compensation expectations. Perhaps both PRINCIPALS (LL/Tenant) should share the Broker’s compensation; and in many cases, with the exception of anchored positions, the Tenant pays it as part of its rent calculation, as Landlord’s factor it into their projected proforma. But it doesn’t help the landlord if the Tenat goes “south”.
You suggest, appropriately so, that one potential solution would be to provide an insurance policy to protect the tenant broker’s compensation in the event of the tenant’s default. Conversely, why not an insurance for the Landlord and/or Tenant to recoup their payment of fees, in the event either of these PRINCIPALS default; why is it that the Broker should be the only one concerned on losing? Giving a Broker Equity, as you alternatively suggested, is not appropriate, unless the broker agrees that his total fee goes at risk. After all, the only ones taking risk in a transaction is THE TENANT AND LANDLORD.
I firmly believe in an eqitable arrangement for both Landlord and Tenant and believe that many of the Landlord’s issues concerning broker compensation could be softned by re-examining the Fiduciary aspect of our industry.
MR
Dear MR:
Wow! That was great! And, I thought I had alot to say! 🙂 I truly appreciate when readers take the time to think through their ideas and post them intelligently, like yours and a lot of others I’ve received.
My first response is that if I had my way AND if the entirety of the corporate and landlord worlds were at all interested in my opinion, then we’d completely change how the commercial real estate business is conducted. Under a changed system, landlords would pay their brokers and tenants would pay their advisors. Then, the entire discussion about how landlords should pay tenant brokers would go away. But, no one seems interested in my opinion on this matter.
The issue of being a fiducciary to the entity paying your compensation is a real one. However, when in a transparent manner, a broker discloses to the landlord that it is contractually bound (I’m only talking about written representation agreements here!) to represent the interests of the tenant, then the landlord should have no expectation of being represented by or having any fiducciary relationship with that broker, irrespective of the landlord’s willingness to pay the advisor’s compensation.
The issue of insurance to protect the interest of landlords makes as much sense as policies to protect brokers…why not?
While I feel bad when anyone loses money on a business deal gone sour, it must be noted that landlords are in the business of managing and profiting from risk. That’s how they derive their compensation. If they’re very good at it, and if the real estate gods smile on them, they profit handsomely. Some aren’t that good and haven’t been smiled upon. Real estate brokers do not derive their compensation by managing and profiting from risk. They provide a service and are entitled to be paid once that service is complete (See my response to an earlier post from a reader who compared real estate brokers to plumbers…I absolutely loved that one!). Remember, too, that every landlord has the ability to reject any deal.
Better quality tenant advisors counsel their tenant clients about the impact of their credit on their ability to make a deal. Solid advisors caution tenants that they must be the masters of their own destinies. And, as such, if the tenant’s credit is in question, then the tenant can expect to pay higher rental rates, provide more security, achieve less favorable terms, and maybe, not be able to complete the deal they prefer. A good tenant advisor must provide that guidance.
A tenant that has poor credit is usually well aware of their profile. When they borrow money, their terms aren’t as favorable as those achieved by companies with favorable credit. Real estate is no different. Neither the landlord, the tenant advisor, nor anyone else should be responsible to enhance the tenant’s credit.
Thanks very much for sharing your ideas.
Andy,
I just read through a couple of these responses as well as your original commentary. Interesting.
Although the Landlord writes the check to compensate the service provider for diligently bringing the particular Tenant to its door, it is not their money behind that check. The check is based on the Tenant’s present and future obligation (Contract & Consideration) to the Landlord. The rent is based on the building proforma and market conditions, the lease is based on the market rate coupled to negotiations between the Tenant and the Landlord( mutual consent). The Tenant Representative is impartial to the relationship, acting as the facilitator to the completion of the assignment (exclusive Representation agreement). The Landlord is therefore writing the check to the Tenant Rep to complete the transaction on behalf of the Tenant.
The risk of the Landlord and Tenant are protected by a series of controls. The License of the Broker, the fiduciary contract between the broker and the Tenant, the agreement established between the Landlord and the broker rendering the obligation to compensate the broker through the Landlord on behalf of the Tenant, and the contract between the Owner/Landlord and the User/Tenant.
My two cents, Best Ed
Ed:
Those two cents are worth a lot! Thanks for ante-ing up!
As long as landlords pay the broker’s fee this is going to be an ongoing, legitimate, and negotiable issue.
All these discussions about how other service providers are compensated are interesting but ultimately irrelevant. We are in a market economy and each service provider niche has its own supply and demand dynamics.
Often tenant representatives will have information about the tenant that the landlord will not know and will not be able to find out. Ultimately, the landlord has an economic incentive (based upon the potential of information asymmetries) to place incentives upon the broker regarding tenant performance.
The above blog states, “And, remember that Real Estate Brokers Are Not in the Tenant Credit Guarantee Business.” Unfortunately this statement is only aspirational, each tenant rep. deal is unique and the contract they negotiate with the landlord decides what lines of business they are in.
I’m not primarily a tenant representative, but in the past I’ve found myself using the arguments espoused in the last two blog postings (and comments). The really smart landlords know that all these arguments don’t have too much weight. It all comes down to the unique dynamics of each deal.
Dear Informed Skeptic:
Thanks for your comments. I acknowledge your ideas, but disagree with your point “these arguments don’t have too much weight.” They do for many, and they appear to have more and more weight these days.
Hope to hear from you again!
Great Blog!……There’s always something here to make me laugh…Keep doing what ya do 🙂
Thanks very, very much!