Why Some Commercial Real Estate Lease Structures are Better than Others

There is an art in negotiating a lease in the best interests of your company or customer. As commercial real estate professionals, in order to create great work, we need to be armed with the right tools to understand the operational and financial aspects of the agreements to which we are binding our company or customer.

You may have heard this line from someone recently: industrial and commercial real estate is becoming a commodity. Corporate real estate, the real estate investment trusts, brokerages, industrial properties, and others are all headed towards service and product standardization. Unfortunately, due to market forces and participants pushing us to accept the “market” way of structuring lease agreements, we may eventually get there.

However, there are several reasons to doubt the commodity-theory in the near future. One reason is companies and customers need customization in their lease agreements, achieved through creativity in negotiations, in order to meet their very real financial and operational requirements. They may have near-term capital requirements, concerns about sublease risk, cash flow requirements, and better use of capital outside of real estate.

This article is the first of a series of posts about using the variability of lease terms in order to meet company or customer requirements. It is also about creating awareness of what happens to cash flows when standard lease elements, such as the length of a lease term, are adjusted in isolation and with other lease elements to reach a desired outcome.

Measuring

Ultimately, each commercial lease transaction is an opportunity to create a financial obligation for the company or customer, which will be profitable after considering the operational cash flow generated by the occupying business unit, debt, and any tax consequences. Ideally, commercial real estate professionals would include their company or customer’s operational, debt, and tax information into their analysis of the financial impact of a lease. Otherwise, the lease cash flows will be negative and there will be no ability to determine the profitability of the prospective lease commitment.

However, even if operational and tax consequences are not part of the financial analysis of a lease, it is important that commercial real estate professionals ask their companies or customers for any guidance regarding structuring such real estate cash flows. Often finance professionals with the business operation understand the proforma cash flows for a prospective operation and can convey how the operation might benefit from certain lease elements, such as rent abatement or a tenant improvement allowance for certain requirement improvements. By understanding how the certain lease elements might benefit them, we can pursue better lease structures for the customer or company.

Most companies use depreciated cash flows, or cash flows discounted to present value, when evaluating the financial impact of business decisions. Often called DCFs for short, these cash flows are the prospective financial performance of the company for a particular investment or project. DCFs are typically for a set number of years, depending on the project length and operational considerations involved. Some operational cash flows will be considered in a DCF for a period longer than the initial lease term and even beyond the terms of any options to renew. In such instances, commercial real estate professionals may be asked to make assumptions regarding real estate cash flows into the distant future.

Since this post deals with lease cash flows, I will address the metrics that will help us evaluate leases independent of any operational cash flows, debt, and tax consequences. Fortunately, there are several ways to assess lease cash flows for commercial real estate professionals to consider. I have outlined several metrics commonly used to assess leases with some of their positive and negative attributes, followed by a short summary of when and how to use them.

Initial Month or Year of Base Rent: Base rent can be net of operating expenses or gross, which includes of all or parts of estimated operating expenses. Since gross base rents often include different levels of operating expenses and may not include charges such as common area maintenance (CAM), for comparative purposes it is important to make sure the operating expense categories included in gross rents are the same among the different options. In addition, since operating expenses can account for a significant portion of the gross base rent, it is important to include them in any comparison analysis to understand the total real estate costs.

Start Rate (or coupon rate): The start rate or coupon rate is the initial month or year of base rent divided by the rentable unit of size of the premises being leased. As mentioned above, the start rate is a more accurate metric when it is derived from a gross rent versus a rent net of operating expenses.

This metric is very common and simple to obtain. When most lease terms are the same, it can be an effective barometer of cost per unit of size per unit of time. However, the start rate does not provide any information about the other elements to the lease structure, such as rent abatement, rent escalations, and tenant improvement allowances. As such, when there is variability in lease terms between options, the start rate is likely not a good metric to use.

Total Consideration: The total consideration of a lease is the sum of all the base rent to be paid under the term of a lease. Sometimes, total consideration can be reduced by any cash inducements such as a tenant improvement allowance or moving allowance. As with the initial month or year of base rent, total consideration is a more accurate estimate of costs when shown as a gross amount. However, unless the base rent is already on a gross basis with fixed increases, additional assumptions may need to be made about the rate of growth, if any, in operating expenses over the term. When comparing total consideration for different space options on a gross basis, it is important that the operating expense assumptions remain the same across all options.

Straight-line Rent: The straight-line rent is the total rent paid during the term of the lease divided by the number of months in the term. Straight-line rents are commonly used for accounting purposes. Straight-line rents typically account for rent abatement and rent escalations, but not cash inducements.

Effective Rate (or average rate): The effective or average rate is the total consideration divided by the rentable unit of size, divided by the number of years or months in the lease term. This metric can be shown as net or gross of operating expenses and, unlike the Start Rate, will account for rent abatement, rent escalations, and sometimes cash inducements (e.g. tenant improvement) if included in the total consideration calculations.

Discounted Cash Flow (DCF): The positive and negative cash flows during a specific period of time, discounted to their present value based on a selected discount rate. DCF periods are not necessarily tied to lease term length and may also incorporate operational cash flows, debt, and before/after tax analysis in addition to real estate cash flows. DCFs are typically viewed as a better financial measurement than total consideration since it incorporates the time-value of money. However, since they are based on assumptions of future performance and appropriate discount rates, DCFs are subject to being inaccurate, especially as the DCF period grows and the risk involved is unclear.

Net Present Value (NPV): Net present value is the sum of the present value of all cash flows during the cash flow period, net of any initial cash outlays or receipts. A positive net present value indicates whether future cash flows are profitable after considering an initial investment while the negative shows the opposite. In evaluating a prospective lease’s cash flows, NPV will generally be negative for a tenant and positive for a landlord due to the payment (negative) or receipt (positive) cash flows for each. Any cash inducements from a landlord, such as a tenant improvement allowance, will typically be shown at Period 0, and will be positive or negative amounts depending on whether viewed from the tenant’s or landlord’s perspective.

As a stand-alone metric, NPV’s utility is in comparison with alternative lease cash flows. A smaller negative NPV is desirable from a tenant’s perspective while a larger positive NPV is desirable from a landlord’s perspective.

As with DCFs, NPVs are often viewed as financially more accurate than total consideration because NPV accounts for the time-value of money. The discounting of future cash flows is especially useful when considering leases of different length. Normally longer leases would typically be at a disadvantage when using total consideration or effective rates because the rent many years from now has the same value as the rent today, even in a lease with no increases. NPV accounts for the fact that a $1.00 today is worth more than a $1.00 five years from now, and therefore presents a more accurate financial picture of leases with different terms.

However, NPV’s are subject to the same downsides as DCFs. Selecting the appropriate discount rate is not always clear and may be disputed among different parties. Many companies or customers may suggest an appropriate discount rate to use when calculating NPV. Often this is their weighted average cost of capital or WACC. However, others might suggest tying the discount to a perceived risk during the lease-which may change over time. You can start with a discount rate of 6%, which is equal to the firm’s WACC, but maybe later on in the term you want to use a higher discount rate to account for more uncertainty with the property’s utility or some other factor. Since the discount rate is often determined by the company or customer and has a significant impact on the NPV, it is worth making sure interested parties are aware of what discount rate(s) were used so all can agree it is the appropriate discount rate to use.

Net Present Value Rate (NPV Rate): The net present value rate is the net present value of lease cash flows divided by the number of years or months in the initial lease term. The NPV rate has the upsides and downsides of net present value. However, the NPV rate addresses a challenge of using net present value to compare leases for different sized buildings and proposed lease terms. The NPV will tell you which option has a larger discounted cash flow but it doesn’t tell you what the discounted cash flow is per unit of space per unit of time, which would average out the differences in size and lease term. The NPV rate provides the net present value as a per unit of space and time (typically per square foot/meter per month or year). Therefore, the NPV rate is very useful in comparing multiple prospective locations and leases proposals.

When to Use Certain Lease Metrics

Selecting when and how to use certain metrics to measure financial aspects of a lease is extremely important. Using the right metrics with the right audience can lead to a better terms in a negotiation, a useful variable to “goal-seek” using different lease structures, and ultimately the success of a leasing project. Obviously, the converse is true as well.

What constitutes the right metric with the right audience? It depends on the objective and ability for the parties to consent to certain assumptions. For instance, if my objective is to compare several different lease scenarios with varying terms with my internal finance team, NPV and NPV rate would be much better metrics than start rate or even effective rate. NPV and NPV rate would be more accurate financial measures of such leases and my audience would presumably be very familiar with their use.

Conversely, if my objective is to negotiate a fair market rent for a renewal option with a landlord, it probably makes sense to only focus on the start rate. The other lease terms are likely dictated in the lease and the landlord will certainly be aware of what a start rate is and not question its use in the negotiations.

Sometimes we want to use a metric to function as a financial target for adjusting terms of a lease, what you might call to “goal-seek”. Goal-seeking is useful when you have a proposed lease structure that has an acceptable metric, but not necessarily an acceptable structure. For example, a proposed lease could include no tenant improvement allowance from the landlord but has an effective rental rate which is acceptable to all parties. If the tenant wants a tenant improvement allowance, their corporate real estate professionals or consultants may adjust the cash flows to add in the desired tenant improvement, and then adjust the other lease terms until the effective rental rate equals the effective rental rate prior to the tenant improvement allowance. An argument can be made to the landlord that based on the effective rental rate, the revised lease structure should be acceptable.

The following chart plots the metrics discussed based on their complexity on the y-axis and whether their use is more likely to be exclusively internal. A metric becomes more complex when it involves a calculation, assumptions, or both. For example, NPV, NPV Rate, and DCFs involve calculations and discount rate assumptions where effective rate involves calculations. A metric is more likely to be of internal use only when it is challenging to use in discussions with an outside party, such as in a lease negotiation. Challenging could mean there needs to be agreement on assumptions, such as the appropriate discount rate with NPV, NPV Rate, and DCF, or the metric is not typically used to only analyze lease cash flows, such as a DCF.

Depending on the requirements of the lease analysis and audience, this chart can help determine an appropriate metric to use in a given situation.

One final word on measuring lease value; if you are evaluating a lease for your business or customer internally I would strongly suggest you use the appropriate sign in your cash flows. For example, rent paid to a landlord should be a negative cash flow from a tenant’s perspective while a tenant improvement allowance would be positive, and vise-a-versa from the landlord’s perspective.

Using the correct sign in lease cash flows makes it easier to avoid making mistakes when evaluating leases and combining with operational cash flows. Showing a positive cash flow from both rent paid to a landlord and a tenant improvement allowance will result in an incorrect net present value. Furthermore, a prospective lease with a positive net present value from the tenant’s perspective may lead to wildly unrealistic results when combined with the tenant’s operating cash flows.

Avoiding Negative Outcomes: Risks to Consider in Industrial Real Estate Transactions

In my last post I made the case that the most important objective of any industrial real estate transaction is to avoid negative outcomes. Since risk is the probability of a negative result, evaluating and reducing risk is the way to reach the most important objectives in industrial real estate transactions. In general, a mindset which prioritizes risk avoidance is one that maintains company purpose, relationships, and leads to the best results overall.

But such a mindset is not simplistic in the sense there is more to evaluating risk than not doing or doing something. Risk avoidance in industrial real estate transactions often involves weighing a multitude of risks at the same time to understand the best course of action. Some risks, like environmental liability, can be existential risks for some companies while other risks, like opportunity risks, can be almost neutral in nature. Therefore, if you wanted to avoid a negative outcome, assuming the preceding sentence was true, you wouldn’t assume higher environmental risk just to lower your opportunity risk.

In order to properly weigh risk in an industrial real estate transaction, it is helpful to think about specific risks as relating to common elements of industrial real estate. Such common elements may include:

  • Property condition
  • Workplace environment
  • Location
  • Legal nature of agreements
  • Government or utility impacts
  • Opportunity risks

Although every transaction is unique, the type of risks are relatively constant from transaction to transaction. It is the amount of risk within those categories that must be assessed, weighted, and reduced if possible.

In this post I will cover risks and risk reduction relating to the condition of a property and the workforce environment. Subsequent posts will cover the other categories mentioned above.

Property Condition

Risks related to property condition include functional obsolescence, deferred maintenance, environmental, soils, and location-specific property condition concerns such as seismic retrofitting. Unlike some of the other categories of risk, property condition risks can usually be quantified using proper due diligence prior to entering into an agreement.

For example, functional obsolescence is usually identified when evaluating potential sites and is more likely in situations where there is a long-term hold for existing buildings being considered. Reducing the risk of functional obsolescence may include eliminating properties with older construction from consideration or adhering to a certain standard for amenities.

Many industrial properties without significant functional obsolescence may still have substantial deferred maintenance. Force majeure aside, the most consequential events during an industrial firms lease or ownership of a property are from deferred maintenance. They typically impact the utility of the property and, if the industrial firm is responsible, the overall operating costs of the operation. Consider what an electrical panel malfunction does to a manufacturing operation or what a roof replacement means if the tenant is responsible for the replacement cost. The early use of landlord questionnaires, property condition reports, and negotiating business and lease terms accordingly are a great way to reduce deferred maintenance risk.

As with deferred maintenance, reducing environmental risk should be prioritized in any real estate transaction. Due to the extremely costly nature of environmental liability, industrial firms who are exposed to environmental risk can experience a resource-draining remediation process and sometimes are forced to enter bankruptcy.

Environmental risks can also be reduced through the use of due diligence practices prior to entering an agreement with a landlord or seller. At a minimum, both prospective buyers and tenants should hire an environmental expert who will study the property’s potential for environmental liability and provide a baseline for future reference before purchasing or leasing a property.

Soil conditions are not always of concern in industrial real estate transactions. Typically, soils or geotechnical studies are recommended when there is a known concern, such as liquefaction in the area, or new development is anticipated.

Similarly, location-specific property risks are not always pertinent depending on where the property in question is located. In California, for example, seismic retrofitting may be required for certain industrial buildings to prevent their collapse during an earthquake. The best way for industrial firms to mitigate location-specific property risks is to investigate local and regional requirements which may impact the specific properties they are considering purchasing or leasing.

Workplace Environment

Risks associated with workplace environments would have been mostly addressed in property condition-related discussions in the past. Industrial firms would have sufficiently reduced the known risks to their workforce by making sure the property was in physically safe, there were no toxic or irritating substances present, and oversight agency guidelines were being followed for additional safety features.

With the advent of COVID-19, limiting the risk of illness to employees clearly requires more than just these measures. Although improvements and practices to mitigate sickness in the workforce are evolving, some of the best practices released by health and commercial real estate professionals include:

  • A workplace that can be easily and routinely cleaned
  • Isolation areas or rooms for workers who become sick on the job
  • Designing worker areas to provide isolation and physical distancing
  • Increasing ventilation and installing negative atmosphere areas where needed
  • Separate entrances and exits

This is a rapidly changing area of risk for industrial companies. Firms should continually be consulting experts in workplace safety and following their recommendations to mitigate the risk of infection to their workforce.

Avoiding Negative Outcomes: How to Focus on What is Important in Industrial Real Estate Transactions

If you were to choose the most important objective of any industrial real estate transaction, what would it be? Spectacular savings compared to market? Getting acceptance on all the important legal terms? Above market tenant improvement allowance? Operations is happy with the property condition? On-time occupancy?

While all those results would be fantastic and are certainly worthy objectives, they are not the most important objective of any industrial real estate transaction. The most important objective is to avoid negative outcomes. Why?

Because deep down in our collective psyche, avoiding negative outcomes is what people, and thus organizations, care about the most. We care about winning, but not as much as avoiding losing. In real estate terms, we care about positive results such as beating the market on pricing, but not in exchange for terms which increase risk.

This is the essence of our negativity bias and its impact on industrial real estate transactions. A negativity bias or negativity effect is when, all else being equal, things of a negative nature have a stronger impact on us than things of a neutral or positive nature. In fact, experts say that it can take five positive events to outweigh a negative one. In industrial real estate transactions, this ratio is probably understating the impact of certain negative events on what the firm would consider a successful project.

Since industrial real estate’s value to the industrial firm is largely its utility, the greatest risks lie in the inability to secure and utilize such assets while it is owned or leased. Therefore, we should focus our efforts to reduce the possibility of negative outcomes within the transaction process, both for the risk to utility but also because the industrial firm will most likely judge project success on the lack of negative results.

In other words, we should employ risk mitigation strategies to the extent they are reasonable and possible. Risk mitigation strategies are processes whereby risks are identified, prioritized, and reduced. In industrial real estate transactions, such processes should be defined and a part of the real estate organizations best practices or playbook.

COVID-19 and CRE

Corporate real estate often plays an important role in ensuring the safety and security of corporate employees, not just the real estate itself. Efforts such as increased cleaning of work spaces, remote worker infrastructure, security/screening of office employees and visitors, and other seemingly non-real estate related functions often are lead by corporate real estate professionals. As the COVID-19 virus spreads in the U.S. and world, I thought I would take a moment to recognize and thank the corporate real estate professionals who are leading the way in efforts to minimize the virus’ impact to their companies and everyone else.

Keeping Track

Everyone seems to have different ways of keeping track of their obligations, daily events, etc. so I thought I would share what I am currently using today. Of course, I am always open to suggestions for improvement.

Evernote

Every morning at 5:45 AM I have a scheduled block of 15 minutes to create a note within Evernote for the day. That note is a template which has four sections:

-What did I learn yesterday?

-What kind of experiments do you want to run today?

-Today’s most important question

-Today’s notes

The first three sections incorporate some of the best suggestions for awareness and learning I have run across. The fourth obviously is to keep track of what happens during the day.

Evernote also allows you to upload handwritten notes in searchable formats, which is a necessity because I often am unable to take notes within the program for various reasons.

Salesforce

My company has a customized version but most companies I encounter these days use Salesforce for customer relationship management. I keep all of my business related information and task-tracking here.

Things

Things is a task tracker I use on my iPhone to keep track of mostly personal tasks I need to complete during the week. I have tried so many task trackers over the years and Things provided the most utility and functionality.

Gantt Charts in Excel

Over the years I have utilized gantt charts for numerous projects because they can accurately delineate, schedule, and track each step in a project timeline. The excel templates made by Vertex42 are really good and worth the money if you use gantt charts frequently.

Why Split Roll Taxes will Drive More Business Out of California

On November 3rd Californians will decide whether to partially remove property tax protections, granted under Proposition 13 in 1978, for most non-residential properties. The initiative they will vote on, the California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020), would amend the state constitution to require commercial and industrial properties be taxed at their market value.

Currently all property in California is protected by Proposition 13 (1978), which limits property taxes to 1% of the purchase price plus up to 2% of inflation per year. By removing such protections for commercial properties, some estimate the initiative will generate another $13 billion of property taxes in California. While not arguing the merits of the initiative’s objective, should the initiative pass I do think it will negatively impact California businesses in ways familiar to corporate real estate but perhaps not the general public.

The obvious impact of increasing property taxes on non-residential property is on the non-residential property owners themselves. Some of the largest commercial employers in California also have large property holdings in California. For companies who own their real estate, an increase in property tax is shown on income statement as an increase in operating costs. Which means when property taxes are increased, all sorts of indicators of company health are negatively impacted like EBITA, profitability ratios, price-earnings ratios, etc. That may be acceptable if you are a tech company whose investors may focus more on the cash flow statement, but not OK if you are an established aerospace company heavily penalized for any indication of being unprofitable.

Perhaps less known are the impacts on companies leasing space when property taxes are increased. The vast majority of leases stipulate that any increases in property taxes are “passed-through” to the tenant leasing the space. This means the tenant, not the landlord, is responsible for the increased tax. For the impacts to corporations who lease space, the negative impact of property tax increases on their income statement is the same as the ownership example above.

While proponents of this initiative have argued the initiative will target wealthy investors and large corporations, small and medium sized businesses will likely get impacted the most. Small and medium sized businesses in office buildings, multi-tenant industrial parks, and shopping centers likely do not have any protections from property tax increases in their leases. Their landlords will pass along the cost of the additional property tax to them.

Do you know who is much more likely to have protection against tax increases in their leases? Typically large corporations, who had substantial negotiating leverage with the landlord when they entered into their lease, and wealthy investors savvy enough to include them in leases when they purchased a business and leased back from the Seller.

2020 Ballot Initiatives by State

To help companies understand their potential exposure, the following are the published 2020 state ballot initiatives which could impact industrial firms and industrial real estate.

Arkansas

The Arkansas Transportation Sales Tax Continuation Amendment (2020) would continue to amend the state constitution to make permanent a 0.5% sales tax towards the funding of state and local tax infrastructure. For more information, click here.

California

The California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020) would amend the state constitution to require commercial and industrial properties to be taxed at their market value. Currently, California Proposition 13 limits all property assessments to 1% of the purchase price at the time of purchase and then the lesser of 2% or inflation per year thereafter.

Should the Initiative pass, it is estimated to cost companies and commercial real estate property owners $6.5 to $10.5 billion per year in additional property taxes. For more information, click here.

Florida

Amendment 2 would raise the minimum wage from $8.56 in 2020 to $15.00 by 2026. For more information, click here.

Idaho

The Idaho Minimum Wage Increase Initiative would raise the minimum wage incrementally to $12 per hour by 2023. For more information, click here.

Illinois

The Illinois Allow for Graduated Income Tax Amendment would repeal a state constitutional requirement that the state personal income tax be flat and instead allow the state to enact a graduated personal income tax. It also would change the limits for corporate income taxes to a ratio based on the highest personal income tax rate. For more information, click here.

Nevada

The Nevada Renewable Energy Standards Initiative would require electric utilities to obtain a minimum of 50% of their electricity from renewable sources by 2030. The increase would come in increments as follows: 26% by 2023; 34% by 2026; and 42% by 2029. This would amend the current standard which requires electric utilities to obtain a minimum of 25% of their electricity from renewable sources by 2025. For more information, click here.

CRE Services

Corporate real estate has developed distinct service categories to meet the real estate needs of business units and organize talent by skill sets. These services often work closely with each other. Portfolio administration continuously interacts with transaction management, facilities management and legal. Facilities management can frequently work with project management and space planning, or assume their functions within the facilities management department.

These services will often report directly to the corporate real estate management or account leaders in CRE service organizations, who can monitor their success with clearly defined key performance indicators or KPIs. While the names of the services may vary by organization, in practice they have similar functions in today’s CRE.

Portfolio Administration

Portfolio administration creates, manages, and communicates real estate information accurately and effectively to the entire corporate real estate organization. Referred to as lease administration in some companies, portfolio administrators can have many responsibilities other than managing contractual data. Today’s portfolio administrators can also share responsibility for strategic oversight, accounting, legal, and human resources functions in the modern corporation.

Transaction Management

Transaction management’s general function is to achieve company objectives through the oversight of real estate events. Rarely is transaction management only responsible for the successful completion of a real estate transaction. Most transaction managers today are tasked with assisting with strategic oversight of the company’s real estate portfolio and have a “cradle-to-grave” process for real estate events which involves responsibilities before and after transactions are complete.

Facilities Management

Facilities management has evolved from a property management function to becoming an increasingly important part of a company’s success. Today’s facilities management professionals are tasked with creating and maintaining environments in which company employees and equipment can thrive. They often track a variety of measurements of company space and how it is being utilized. Such data creates visibility in the organization about how space is being used. It allows the organization to communicate important messages to outside parties about its role as a caretaker of shareholders, employees, society, and the environment.

Project Management

Project management is the oversight of the design, build, furnish, redevelopment, re-furbish, and budgeting for company real estate projects. When corporate real estate needs real estate to be built or altered, a project management team usually is responsible. Project managers are also important resources for the other services. For example, project management can supply improvement costs, project timelines, and other construction related information to help transaction managers negotiate effectively, and facility managers plan for future upgrades.

Space Planning & Design

Space planning and design may be a function under project management or facilities management, but could also be a separate function in some organizations. Space planning can involve many different types of space. While many may think of space planners as designing office and site plans, space planners are also critical in manufacturing and warehouse environments as well.

Legal

Legal departments are typically responsible for the review of contractual agreements and hiring of outside counsels. Whether legal is a part of the real estate organization or a separate entity can have a significant influence on its function. Attorneys in legal departments which are separate from real estate often have responsibilities for documents outside of just real estate related contracts. With the possible exception of space planning, legal services usually interact with all of the other service lines and are a critical part of the overall success of the CRE organization.

Selecting and Hiring a Market Brokerage Partner

The selection and hiring of a market broker to represent a client as a fiduciary is one of the most significant responsibilities of a corporate real estate account manager. A market broker is typically an expert in a given geographic market or vertical, such as cold storage or truck terminals, while the corporate real estate account manager oversees the overall real estate services to the client.

Without the proper process in place, the odds of selecting the wrong market broker greatly increase along with the chances of frustration for the client, the market broker, and the account manager. There are a host of variables to consider in any market broker selection process. Without a defined process in place, many account managers simply do not have the time or resources to appropriately conduct a market broker search from scratch.

That’s why it is important for the account manager and the client to have an agreed upon plan and process for selecting a local brokerage team. Such a plan would ideally be simple, adjustable guidelines for selecting and working with market brokers. Some of the plan elements usually would include:

  • Criteria for market broker selection
  • Brokerage standards of conduct
  • Responsibilities of the client, account manager, and market broker
  • Confidentiality
  • How requirements are presented to the market broker
  • Expected compensation structure including fee sharing

Most clients want the best broker for their requirement in a given market. For the account manager, fulfilling this requirement means considering market brokers affiliated with their firm and those who are not affiliated with their firm.

Practically speaking, most account managers affiliated with large national brokerage firms will limit their search for market brokers to those within their company. Exceptions to this include areas where their company has limited coverage, such as tertiary markets, and when the client directs the account manager to use a certain local market broker.

Whether the account manager considers market brokers outside if their firm is ultimately not as important as making sure the selected market broker meets the client’s agreed upon criteria. If such standards are not met, the account manager should be responsible.

Brokerage standards of conduct and market broker responsibilities should be clear and concise. They should be communicated in writing shortly after initial contact and certainly before engaging the market broker. A brief summary of expectations, such as reporting, confidentiality or dual agency concerns, along with a matrix showing the responsibilities of all relevant parties is usually sufficient.

Client requirements should also be communicated clearly and in writing to the market brokers prior to engagement. It does not make any sense to hire a market broker for an assignment until the account manager can accurately describe what the client needs. This communication is sometimes assisted by visual aids such as prototype site plans, maps, and photos of current properties similar to the required facility. Once a market broker understands the requirements, the account manager should allow them the opportunity of declining to be considered for the assignment.

Lastly, the account manager should communicate the anticipated brokerage fee sharing along with the standards of conduct and client requirements in writing. This includes the nature of any exclusivity, fee sharing with a client, and other matters related to their compensation. It is vital that the market broker and account manager have agreement on compensation concerns prior to the hiring of the market broker for the assignment.

The above does not include every consideration for selecting a market broker in every situation. Therefore, it is critical that the account manager and client have a general plan in place to review and modify prior to starting the search for a market brokerage partner. By doing so, they will greatly increase the likelihood of hiring a qualified, motivated, and invested market brokerage partner to work on their behalf.

Avoiding the Bad

Last week I was listening to the Art of Manliness podcast with guest John Tierney, who recently co-wrote a book called The Power of Bad: How the Negativity Effect Rules Us and How We can Rule It.

As the title would indicate, John and host Brett McCay discussed how humans are much more sensitive to bad events than good ones, and how this sensitivity shows itself in our daily lives. For example, John cited research that showed that it takes at least three good events to outweigh one bad one in our minds.

As companies consider future real estate decisions, it may be helpful to think about how to avoid bad outcomes before achieving outstanding ones. Most of us are in positions where we are in service to something or someone else, whether it be a business unit, client, or shareholders. While it may not fit our current narrative to the customer, the truth might be that the customer really wants to avoid negative outcomes much more than receiving great service.

Avoiding negative outcomes and great services are not mutually exclusive. But if we can design our systems, processes, and tasks in a way that protects against negative outcomes first, at least the research shows that we are tailoring our services to what people care about most.