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 because 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.
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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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