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Commercial real estate must change its ways

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Imagine hiring someone to help you buy a new car -- a guide to point out the weaknesses and strengths of the vehicles.

This person is a pro and promised to provide counsel to help you make the right decision. After weeks of visiting different showrooms and analyzing automobiles, you finally reach a decision. You and your adviser enter the finance director’s cubicle to sign the paperwork. After the contract is signed, the auto dealer hands over a big check to “your” adviser as he says, “See you at our company-wide staff meeting Friday.”

“You and the finance director work for the same company?” you ask your adviser. After further discussion, you discover that the firm for which your adviser works earns most of its money from selling cars. Your adviser was getting most of his pay from the auto dealer. In fact, the company that employs your adviser actually owns several of the dealerships you’ve visited.

No industry would tolerate this lack of transparency from consultants and advisers, except in multimillion-dollar commercial real estate transactions, where this practice is considered normal. What is considered normal in commercial real estate might be considered a breach of fiduciary duty in many industries. Large users of commercial space are required to conduct their business with greater transparency, and they would benefit greatly if their real estate advisers followed suit.

Attempts to increase transparency are the foundation for the Sarbanes-Oxley legislation passed in 2002, forcing public companies to disclose more about their businesses to investors. Wall Street is now under greater scrutiny than in the past. Bankers and C-suite occupants go to jail for not being transparent. This matters a lot to executives making real estate decisions as leasehold liabilities among U.S. corporations exceed $1 trillion, and on an individual basis can represent a significant cost for most large corporations -- typically in the millions of dollars.

The majority of commercial real estate brokers hired as tenant representatives work for large companies that are also some of the world’s largest agents for leasing and managing property. In San Diego, for example, the five largest real estate companies have hundreds of brokers working as tenant representatives. Their combined firms also manage millions of feet of space for their institutional owners in the San Diego market. On average, these firms receive 50 percent of their total revenues from landlords. These owners sign contracts with large institutional real estate firms to represent their interests in the market, and the brokerage firms have a fiduciary responsibility to represent these owners, often with properties across the nation.

Harvey Pitt, former chairman of the Securities and Exchange Commission (2001-2003) wrote, “Directors and managers who continue to turn a blind eye toward real estate conflicts within their organizations are, therefore, taking a grave — and potentially very expensive — risk.”

How can users of space protect themselves from hidden conflicts of interest?

Determine the total amount of money devoted to leasing real estate within your organization. Many organizations are obligated to significantly more dollars than they would intuitively expect.

Compile a list of your real estate service providers and evaluate which of these firms are also large landlords or landlord agents in the markets where you have locations. Ask your service providers to identify all buildings that their companies invest in, lease or manage. Many users are surprised to learn that many potential landlords have fiduciary relationships with the same providers who claim to be exclusively representing their interests in the market.

Be certain that your procurement professionals evaluate the potential conflicts of interest in your existing and potential real estate service providers as they would for any services or commodities purchased. Make certain those that advise your firm disclose any conflicted interests. Don’t accept the nebulous idea that “everyone has conflicts.” Make a distinction between exclusive tenant representatives with lots of engagements and firms that frequently represent both sides in a single transaction.

Real estate users have the responsibility to protect their firms from these convoluted relationships because under the current model, firms have no incentive to change. Pitt said it best: “There is nothing new about this. Over the last 20 years, aggressive consolidations through mergers and acquisitions have fueled dual representations in the real estate industry. And neither landlords nor landlord-oriented brokerage companies have any incentive to eliminate a structure riddled with conflicts of interest, since it gives them a great mutual advantage in negotiations.”

As with any major procurement decisions, eliminating conflicts of interest, working with truly independent advisers and insisting upon transparency are essential to reaching the most favorable economic transaction. Make certain that the “adviser” at your side in the negotiations is really on your side.

Bogle is executive vice president and group leader for the Strategic Portfolio Solutions group with Studley, Inc. Rolf is vice president and co-branch manager of the San Diego office of Studley, Inc.

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