admin / June 15, 2022
By Kevin Maggiacomo
The clock is ticking on what is a systemic issue in commercial real estate investment sales: Non-cooperation and misaligned incentives create a loophole where brokers’ interests take precedence over sellers’ interests, resulting in an environment where most sellers are selling for less than fair market value. This model and way of doing business means that money is being left on the table by brokers and, more importantly, their clients.
This behavior indicates that when the principle of supply and demand meets the force of misaligned incentive structures in a commission-only environment, the latter wins out. This happens in two main ways.
WHEN THE PRINCIPLE OF SUPPLY AND DEMAND MEETS THE FORCE OF MISALIGNED INCENTIVE STRUCTURES IN A COMMISSION-ONLY ENVIRONMENT, THE LATTER WINS OUT
With no base salary to fall back on, brokers need to be clever when it comes to how they spend their time. Any increase in seller price, although of great importance to the seller, only translates into an incremental increase in the money in the broker’s pocket at the end of the deal. Take a $5 million commercial sale as an example. If you assume a 4% commission, it is clear that if the listing broker hustles hard and achieves $5.5 million instead, they only gain $20,000 in additional commission. To be sure, the $480,000 added to the sale price is significant for the seller but does the slight gain in commission ($220,000 vs $200,000) make sense to a broker, who could be using that additional effort on a new deal altogether? Clearly this structure does not incentivize brokers to get the best possible deal for their seller, no matter how long it takes and how much effort is required. In other words, brokers are not motivated to drive the maximum possible demand for each property. Instead, this structure incentivizes brokers to get a good enough deal by spending the least amount of time, money and effort, and to move on quickly to the next deal. (Top tip: if you haven’t already, dig out a copy of Steven D. Levitt and Stephen J. Dubner’s book Freakonomics to read their data informed discussion about how this incentive misalignment plays out in the residential real estate market. Their final takeaway is that the data shows that real estate agents do not sell their own properties in the same way they sell clients’ properties. When it comes to their properties, they spend the time creating demand and hold out for the best deal.)
No doubt, when asked, some brokers will claim to cooperate with other brokers. But if this cooperation is little more than a referral fee it creates yet another misaligned incentive situation. This is because, yet again, the monetary reward does not match the amount of effort required to earn it, and brokers representing buyers are better off spending their time elsewhere, connecting their motivated buyer to a seller where the deal offers them more than 25% of the commission fee.
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