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.
Transferals 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 receving rent, fullfiling 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!
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Real Estate Strategies Corporation is a respected corporate advisory and transaction services firm that provides thought-leadership, decision-making, planning, project management, and transaction execution services to finance and senior executives at management team-led public, private, and portfolio companies, and not-for-profit organizations. Under the leadership of its award-winning CEO, Andrew Zezas, RealStrat’s clients engage the firm when acquiring, disposing of, renegotiating, or enhancing occupied leased or owned real estate in New Jersey, Pennsylvania, New York, Connecticut, and throughout North America. By creating and executing Business DRIVEN Real Estate Solutions and identifying hidden Opportunities, RealStrat drives greater operational and financial performance in support of its clients’ stakeholder objectives, M&A requirements, and exit strategies.
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