You Would Never Agree to This – Or Would You?
For some reason, many tenants continue to put themselves in conflicted situations with their brokers that they would never allow or even consider in any other aspect of their life or business. Is it because they see other tenants doing the same thing, which lets them believe it must be ok? Or have clever marketing pitches from brokers convinced them that real estate is somehow different from everything else? To shed more light on how brokerage conflicts of interest hurt tenants, let’s look at some similar examples outside of commercial brokerage and see if you’d ever agree to them.
You have a major fire in your home that is covered by your insurance company, XYZ Insurers. Harry Brown, an insurance adjuster, contacts you and says he actually represents a lot of the insurance companies including XYZ and would be happy to represent you in your claim against XYZ. Because XYZ paid him $75,000 in fees last year for work he did on their behalf, he tells you that he knows how they operate and can get you a good settlement. His fee from you will probably only be about $5,000.
Why You Would Never Agree to This: What are the odds that Harry will aggressively pursue your claim if it upsets XYZ, a much larger client? Of the following three potential outcomes, what likelihood would you assign to each for your insurance settlement with Harry?
- He aggressively pursues your claim and gets you an extraordinary recovery that leaves you ecstatic but XYZ very upset.
- He recommends an average or “market” settlement where neither party is thrilled but neither is upset.
- He recommends a settlement that leaves you somewhat frustrated but XYZ thrilled.
It’s a zero-sum game. Whatever he gets for you is taken away from XYZ. Given Harry’s larger relationship with XYZ Company, will you feel completely comfortable with his final recommendation when he tells you “Take the deal, it’s a good deal”?
Why It’s the Same with Brokerage: The same issues apply in brokerage. Most brokerage firms make the majority of their money representing landlords as leasing agents, building managers, mortgage brokers, project managers and investment sales agents. For most tenants, you only provide fee opportunities once every five or ten years. The landlord, on the other hand, provides a steady and diverse stream of major revenues for your brokerage firm. How would you rank the probability outcomes above if Harry were your real estate broker?
You are considering buying a Toyota Camry from Bob’s Toyota and are working with John Smith, the salesperson. You tell Bob that you’re also considering a Honda Civic from the dealer across the street. John tells you “I used to work with that dealer and am very familiar with Hondas. I’d be happy to evaluate both cars for you and help you decide.”
Why You would Never Agree to This: The fact is, John has quotas to make and he’s not outcome-neutral here. Even if he’s a great guy, human nature will make it difficult for him to be completely objective in his advice. If you buy a Camry, he makes money. If you buy a Honda, he makes nothing. As a result, most people wouldn’t want to rely on John for this decision. Further, how will John’s sales manager respond to John when you tell him, “You know, I was strongly considering your Camry, but John convinced me that the Honda was a better value”? That’s a conversation John would want to avoid at all costs.
Why It’s the Same with Brokerage: As silly as this example may seem, this scenario is actually very common in commercial real estate. If you’re looking at Buildings A, B and C, and your brokerage firm also happens to be the listing agent for Building C, aren’t you in the same position as the above Toyota/Honda hypothetical? If you end up at Building C, your brokerage firm makes two commissions as opposed to only one commission if you end up at Building A or B. Your brokerage firm is not outcome-neutral. In addition, how uncomfortable will it be for your brokerage firm to explain that, based on their advice, you didn’t choose Building C?
You enter into a commercial contract to buy a small company from the mega conglomerate, ABC Company, and they breach the contract. You suffer $100,000 in damages. Attorney Jones calls you up and says “I understand you have a breach of contract claim with ABC Company, and I’d be happy to represent you. Now, in the spirit of full disclosure, my partner, Sally Smith, did $1 million of business with ABC Company last year, but don’t worry – I’ll keep her out of this completely and I’ll be your advocate. Also, because our firm obviously has a great relationship with ABC, the case will go very smoothly.”
Why You’d Never Agree to This: Are you convinced that by attorney Jones merely insulating his partner, Sally, from the case, that there is no longer a conflict to worry about? Does the $1 million a year in fees his firm stands to lose from ABC magically disappear from the equation when attorney Jones enters the courtroom to face ABC Company? Probably not. You see, the conflict here cannot be rectified merely by isolating one member of the firm from the case. It’s not really a matter of preserving confidentiality. It’s the risk of jeopardizing a much larger economic relationship ($1M) that creates the real conflict, and that will ultimately make it impossible for attorney Jones to be a zealous advocate for your case.
Why It’s the Same with Brokerage: Again, the same holds true in brokerage. Most brokerage firms who represent both landlords and tenants claim that there’s no problem representing both parties to a transaction because they create a “Chinese Wall” between the tenant and landlord brokerage teams. By doing this they argue that the two brokerage teams can’t share confidential client information that could potentially benefit the other party. The problem is, confidentiality is a Red Herring. The potential exchange of confidential information is not the problem. In fact, by law, brokers are not allowed to share a client’s confidential information. The real problem, as with attorney Jones above, is that human nature makes it very difficult to act in a manner that is economically irrational; i.e., favoring a very small clients’ interests over a very large client’s interests. Conflicts of interest that have material economic consequences to an individual will influence his or her behavior and ultimately, they will act in an economically rational manner.
(and this one really happened)
You’ve decided to sell you mother-in-law’s home and, after getting recommendations for some of the best-known brokers in the neighborhood, you decide to interview two. The first broker comes in, assesses the house, and quickly recommends a listing price. Immediately thereafter, she informs you that she just so happens to have a redeveloper client who she is sure will pay that price tomorrow, thereby avoiding any closing risk or lengthy marketing period. “If you hire me today, I’ll have this sold for the asking price by tomorrow evening,” she says. [Note: In real life, we selected the second broker who suggested a listing price that was $75,000 higher. After a bidding war, the property ultimately sold for $25,000 above that higher list price and $100,000 above the first broker’s suggested listing price.]
Why You’d Never Agree to This: What is the risk here? The first broker was attempting to represent both you and your potential buyer. How comfortable would you feel about the recommended list price she gave you? If she can really sell it tomorrow at that price, is it a good price for you or is it a great price for her other client? Remember, if you sell to her other client, she gets two commissions AND she’ll get to relist the property for that redeveloper client once it’s been renovated. Further, if she can get that redeveloper client a quick purchase at a discounted price without having to get into a bidding war, she earns brownie points with that client and increases the possibility of future business. You, however, are a one-shot deal.
Why It’s the Same with Brokerage: At some point in every lease transaction, the tenant will need to look his or her broker in the eye and ask, “Is this the best deal I can get from the landlord?” If the brokerage firm is representing both sides, who is getting the great deal and how can you get comfortable with the recommendations you receive? In sum, it’s just impossible to represent both sides of a transaction when each side has completely opposite economic objectives; the advisors are not outcome-neutral.
Every day people make rational decisions not to expose themselves to business situations that create obvious conflicts of interest. In all of these cases, it’s just common sense that you don’t want an advisor representing you when they also represent the other party whose economic interests are completely adverse to yours. This is especially troublesome when the other client is a much larger one with the promise of significant future business. We also want our advisor to be completely objective, which is very difficult when they are not outcome-neutral.
Nevertheless, many tenants continue to believe that these problems don’t exist when hiring real estate brokers. Unfortunately, they do. In a world where conflicts of interest are getting more common and the financial entanglements with landlords are growing and getting deeper and more substantial, more and more tenants are starting to wake up and realize this is no different than the insurance adjuster, the car salesman, the lawyer or the residential realtor.
This blog was written by Glenn Blumenfeld, Principal at Tactix Real Estate Advisors in Philadelphia, PA. The blog originally appeared on the Tactix blog on January 30, 2018.