Recently an affiliate of CBRE, the world’s largest real estate brokerage company, flipped its ownership in 2000 Market Street for a hefty profit after holding it for just over three years. To its credit, it purchased the property in the midst of one of the worst recessions in generations, a very risky proposition under most circumstances. Luckily for them, it was able to mitigate some of the risk.
2000 Market was attractive to CBRE because it presented a “value add” opportunity. The building had significant vacancy and, as a result, its value was depressed. The investment strategy was simple. If they could acquire the asset at a bargain price and make some strategic capital investments to attract new tenants on favorable terms, it could create significant value in a relatively short period of time and turn a nice profit. The key to the strategy was getting new tenants in the building. The better the terms, the more profit CBRE would make.
The transition of a brokerage firm into real estate owner makes sense. They know a lot about real estate markets and, more importantly, they work with lots of tenants who are looking for space. It’s a great opportunity for a brokerage firm to combine all of their competencies and leverage client relationships in order to generate more profits. The problem is it creates an irreconcilable conflict of interest.
Assume a brokerage company (including, for our purposes, an affiliate of the brokerage company) purchases Building A with the intention of leasing up the vacant space and then flipping it for a profit. If a tenant hires this brokerage company to represent it in its search for space and the broker recommends Building A, how can the brokerage firm properly represent the tenant’s interests? The brokerage firm and its tenant client have conflicting interests. The brokerage firm, as an owner, is seeking to maximize the return on its investment which means minimizing its required capital investment while maximizing rents. The tenant, on the other hand, wants to maximize the tenant improvement allowance provided by the landlord while minimizing the rent obligation. It’s a zero sum game.
While it may be possible for a tenant to secure a good deal in this scenario, it is hard to imagine that it can secure as favorable a deal as it would if its requirement were competed in the market place with a truly, unbiased advocate. The inherent conflict destroys competition in two ways; one obvious and one more subtle, yet equally impactful.
Acting against one’s own economic interests is irrational. Acting against the economic interests of your employer is career threatening. As a result, a broker cannot help but hold back at the negotiating table when the party on the other side is signing his paychecks and allocating work assignments. Knowing that every dollar of concession he secures for the tenant negatively impacts his firm’s investment in the building, there is tremendous pressure to get the deal done at the highest common denominator, not the lowest. While this may result in a nice deal, it is unlikely to be the landlord’s bottom line deal. The conflict denies the tenant the benefit of a zealous advocate thereby leaving money on the table.
There is also a more subtle way in which the conflict destroys competition and, therefore, costs the tenant money. If the market knows that the tenant is considering a building that is owned by his broker’s firm, it is bound to chill the bidding for the tenant’s requirement . Because other landlords will assume (rightly or wrongly) that the brokerage firm will ultimately steer the tenant to its building, they are less likely to aggressively pursue the deal. Why expose your bottom line deal when you believe there is little chance of getting the tenant? Whether or not the broker, in fact, steers the deal to his firm’s building is irrelevant; the assumption that he will act in his firm’s best interests is often enough to chill the bidding, reduce competition and, therefore, increase the tenant’s real estate costs.
As many of these brokerage firms are public companies, there is constant pressure on them to grow revenues and, as a result, add new products, services and ventures. Owning property is a logical next step. However, when brokerage firms own buildings and they bring their tenant clients to these assets, the conflict of interest becomes overwhelming and denies the tenant a competitive process. A tenant should never have to wonder about the objectivity of his broker’s advice or recommendations. Yet, when the brokerage firm’s economic interests are directly at odds with its tenant client’s, the tenant will have a lot to wonder about.
For more information contact Glenn Blumenfeld