Companies today are extra cautious about their real estate plans in the face of the financial meltdown. Another reason for concern is the recent trend toward industry consolidation. As a result of this double whammy, more companies are questioning whether their real estate broker has their best interests at heart.
In regard to the credit crisis, companies are wise to take a wait-and-see attitude. But they also should take advantage of the fact that it is now a tenants’ market, giving them more leverage in negotiations with landlords.
In regard to the consolidation trend, the merger between Jones Lang LaSalle and The Staubach Co. in particular raises important issues. Mergers of this sort are not surprising, since consolidation allows companies like Staubach, previously the largest tenant representative firm, to become bigger and generate more revenue. But what’s good for a brokerage’s bottom line isn’t necessarily good for tenants.
As a result of the JLL/Staubach merger, one less corporate advisory firm now serves as an advocate for tenants. Why is pure tenant representation so important? Because you can’t have it both ways. Some traditional real estate firms representing landlords have a separate division that is supposed to represent tenants; other firms say they integrate tenant representation within the larger group. Either way, an inherent conflict of interest results if brokers represent two masters in the same market. When this happens, brokers may lose their objectivity, and the interests of tenants may be compromised.
Even before consolidations started making headlines in the wake of Sarbanes-Oxley, corporate America started practicing more due diligence in outsourced relationships. As new business reforms were enacted in response to corporate scandals, CFOs began to assume more oversight for real estate decisions and become more mindful of sweetheart deals and murky relationships. In fact, senior management in all industries is now more sensitive to even the perception of impropriety.
With perspectives changing, the Watkins Research Group surveyed corporate real estate executives (CREs) to determine preferred business models. They found that 70 percent of CREs surveyed cited “no conflict of interest” as a significant criterion in selecting a real estate service provider.
Doing The Math
In addition to ethical considerations, let’s take a closer look at the financial picture.
The largest real estate service providers derive about three-quarters of their revenue from owners and investors, only one-quarter from space occupiers. It’s only natural that they try to maximize the terms of each transaction and fortify long-term relationships with landlords, knowing they may never have to deal with the tenant again. In contrast, tenant firms can more objectively push the landlord for better terms and not worry about burning bridges.
In standard commercial real estate transactions, conflicts are often commonplace. But sometimes, hidden agendas are less apparent—for instance, leaseback arrangements may tempt brokers to cross the line in an effort to earn more commission or win additional business from the investors.
Conflicts are not only pervasive; they can also be very costly for companies seeking the best terms and conditions. Today, the stakes are even higher with fewer tenant advocates and more potential for conflicts. With independent firms, companies can generally bank on greater objectivity, more personalization, and more efficient communication through single points of contact.
Old School Challenge
So why haven’t tenant representation firms gained a greater foothold in the marketplace? As we’ve seen, landlord clients tend to provide greater revenue to listing brokers than tenants do; accordingly, brokers often prefer to work with traditional brokerages. Not surprisingly, they are motivated to make fast commissions for transactions and enhance their future listing opportunities.
In contrast, in addition to handling transactions, tenant advisory firms go “beyond the deal,” focusing on start-to-finish corporate services like strategic planning and project management, which includes space programming, construction and move coordination. While these offerings are typically lower on the priority lists of traditional brokers because they aren’t as lucrative as transaction-based services, they are critical to corporate clients.
Another deterrent to would-be tenant-only firms is tied to marketing considerations. Brokers that represent landlords get valuable visibility, since they can install their signs on their clients’ buildings to advertise the availability of space. Tenant representatives typically don’t enjoy this spotlight and resulting brand-name awareness.
Protecting Your Interests
Yet, as the market grows more savvy, the corporate landscape may still become dotted with more tenant advisory firms. As part of a changing mindset, many tenants are discovering that their interests are best served when they have their own advocates that provide ongoing corporate services. Often, tenant rep advisory firms operate as an extension of their clients’ real estate departments—or as the outsourced department itself. We have seen that clients tend to value long-term relationships built on trust, and relationships of this kind evolve more readily with real estate service advisors rather than listing-oriented brokers.
We recommend that tenants raise the issue of conflict from the get-go, starting with RFPs. We advise clients to ask for full disclosure from brokers, including listings, fees, and commissions; ask for references; and ask for a complimentary audit of their real estate needs.
In the final analysis, tenant advisory firms and traditional firms are industry colleagues, and despite differing philosophies, they can complement each other. For example, tenant advisory firms don’t provide services such as property management and income property investments. Indeed, we value our associations with both landlords and their brokers. And we respect the work that competing brokers do. Yet what traditional firms can’t do easily is represent two masters.
Looking ahead, real estate challenges will become more complex as we deal with the economic crisis. Especially during this time of uncertainty, tenants need to leverage every advantage. Real estate still represents a corporation’s number-two operating expense. Protecting your interests should always be your number-one priority.
