Choosing A Broker
At one time or another nearly all tenants encounter a situation wherein they require a broker's services. For those tenants who have not previously worked with a broker, the job of choosing one can be a confusing task, especially if the tenant wants to maximize the value it will obtain from its office space facility. The choice can be formidable also for the tenant who has previously worked with a broker, even if that broker was considered to have done a good job. Such is the case because brokerage techniques, systems and resources are constantly changing and improving, and many tenants understand that not all brokers keep pace with those changes and improvements. Thus they believe that only by evaluating a few outstanding brokers can they assure themselves of choosing the one who is most capable of handling their work. We have met many tenants facing this evaluation process and have developed an appreciation of what's involved. The following discussion is designed to help tenants make the best possible choice.
The office space market in a large metropolitan area like Chicago often exhibits a confounding array of characteristics:
Many tenants with widely differing requirements reflecting a broad range of creditworthiness.
Many dissimilar buildings having a great deal of available space configured in a huge variety of shapes and sizes.
Many landlords exhibiting disparate attributes of size, real estate sophistication and financial strength.
Many lenders exerting varying degrees of control over buildings in which they have an interest.
Many real estate firms marketing space in differing fashions.
Many sources of information about market happenings that are frequently confusing, misleading, inaccurate and self-serving.
Such a market presents a substantial challenge to the tenant seeking to maximize the value of its leasehold. Because it is so complex and dynamic, there exists no easy way to “use” the market to the tenant's advantage. The only way to do so is to conduct a comprehensive evaluation of suitable alternatives and then, using those alternatives to provide negotiating leverage, to craft an agreement representing the highest possible value.
Tenants thus face a time consuming activity in which they typically have little experience. Most rely on the services of a commercial real estate broker for help. However, because tenants get involved in such an activity only once every several years, at most, they are often unfamiliar with the most important qualifications that should be considered when selecting a broker. Frequently the perception of an effective broker is someone who is glib, who knows all the “moves,” who claims knowledge about “market deals” and who projects some inexplicable aura. While some of these characteristics may be useful, the most important qualifications bear little relationship to them. These qualifications, however, become apparent when considered in light of the tasks the broker needs to perform while working on your situation. These tasks, described in the following material, require the broker to perform in the roles of project manager, financial analyst, negotiator, marketer, and educator.
On the surface the basic steps within an office space project appear simple and straightforward, as summarized below.
Determine space and location needs, timing requirements, and desired amenities.
Develop a strategy to achieve facility objectives suitable to the financial and operating environment of the tenant's business.
Define and schedule all tasks in the process.
Identify and inspect all suitable properties.
Solicit proposals from owners of properties in which serious interest exists.
Evaluate those proposals from both financial and non-financial standpoints.
Conduct preliminary negotiations and make a preliminary selection.
Negotiate final business issues for space in the property selected.
Review legal issues for negotiation by tenant's attorney.
Facilitate, coordinate and expedite all activities to be completed subsequent to lease execution.
However, when each of these steps is broken down into its underlying tasks and the people responsible for performing those tasks are identified, as shown in the Project Activities and Responsibilities
chart, the process takes on a distinctly different appearance. Rather than being simple and straightforward, it appears as a mix of highly time sensitive and interdependent activities that must be performed by numerous individuals. Just to mention some of them, the tenant's broker, architect, accountant, and attorney will each have to participate; a number of people from the tenant's organization will typically be involved; and multiple leasing agents, property managers, construction contractors, landlords, and landlords' attorneys will all have to contribute work before the project is concluded. When you consider that all these individuals work for different firms, and that all are subject to different demands upon their time, the complexity of the project environment
If an office space project is to result in the highest possible value for the tenant, all of the people upon whom the results are dependent must perform their individual tasks at the right time and to an appropriate degree of excellence. This never
happens without the planning, guidance, monitoring, prodding, persuading and leadership of a skilled project manager. In order to fulfill that role, the broker must have excellent organization skills, a clear understanding of who has to do what and when, the wisdom to prescribe the caliber of the work associated with each task, and a system for tracking and reporting progress against a schedule
. Additionally, the broker must be able and willing to invest the time to follow up on all details and expedite every task.
Not too many years ago many office leases were “gross” leases. This meant, and still means, that the tenant paid an agreed-to rent, with no additional amounts for such things as real estate taxes, operating expenses, index related escalations, or other expenses associated with occupancy. Comparing total occupancy costs for each of the buildings under consideration was very simple. All the broker had to do was multiply the square footage by the rent per square foot for each year of the lease, add up the results, subtract concession amounts from the total, and the job was done. Although a simple calculator was useful, it wasn't necessary if one could multiply, add and subtract.
Not so any more. True gross leases have become rare, as landlords are unwilling to assume the risk of forecasting taxes and operating expenses many years into the future. Additionally, they want to protect the earning power of their invested capital against the erosion of inflation. As a result, leases typically now reflect a “net” form, or some variation of it. Under this form the tenant pays, in addition to a base rent, an amount to reimburse the landlord for the tenant's share of the building's taxes and operating expenses. Furthermore, many landlords escalate the base rent in relation to changes in the Consumer Price Index (CPI) or other inflation measures. Finally, depending upon the type of building, the tenant may have to pay directly for the energy, janitorial services, electricity, or other expenses relating to his suite.
Thus the translation of economic proposals from different buildings into realistic estimates of total occupancy costs over the lease term has become a fairly complex mathematical exercise. Because different lease structures affect when costs are incurred, and because the timing of lease concessions varies, the time value of money becomes a key factor in the analysis. Present value calculations are necessary to produce valid comparisons and to reflect the true financial impact on the tenant. Since future taxes, operating expenses, inflation levels, energy costs, interest rates, and other economic factors affecting occupancy costs cannot be forecast with certainty, building proposals must be compared under various possible economic scenarios. The sensitivity of each building's proposal to variations in future economic conditions can be an important factor in the comparison of total occupancy costs.
The only practical way to perform all the calculations required to compare the various proposals is to model them on a computer. A number of standardized lease analysis models have been developed which can be run on a personal computer, and most brokerage firms have adopted one or another of them.
Their widespread use has had two significant effects. First, the models provided real estate people with the capability to handle complex financial structures. In turn, those people used that capability to design creative financial structures that would satisfy requirements of both landlords and tenants. At least some of the resulting complexity is now common to most leases. Second, the ease of use of many models — requiring only that one enter the data the computer asks for — has allowed people with little or no financial background to produce reports having the appearance of sophisticated financial analyses. Thus the models can camouflage a broker's lack of background in the mathematics of finance. In such a situation, unless the tenant devotes substantial time, effort and skill to audit and verify the model's output, very expensive errors can occur.
Although generating the highest value from an office space project entails much more than financial analysis, all tenants put great emphasis on this function. Before making decisions, tenants want to be confident that the financial analyses influencing those decisions are comprehensive and accurate. It is consequently incumbent upon the broker to assist the tenant in understanding the model and in validating the outputs.
Finally, most tenants would insist that the broker negotiating economic terms for them be able to analyze the effects of each and every provision put on the table during the negotiation process. Both a strong financial background and a good understanding of financial modeling are prerequisite to this ability.
Entire books have been written on the subject of effective negotiating and the characteristics associated with good negotiators. Even a summary is beyond the scope of this discussion.
However, regardless of the approach and style of the negotiator, the most important ingredient in the negotiation of an office lease is broker preparation. Negotiating strength is built through the development of solid alternatives. Without having appropriate alternatives, even the most skilled practitioner will have great difficulty in increasing value through negotiations. In fact, the essence of getting the best possible deal is to create and nurture an environment wherein several landlords compete for the tenant's occupancy. The only way to create such an environment is to go through the process of obtaining comprehensive and meaningful proposals from several landlords — proposals which address completely the tenant's financial and operational requirements. It is this process that places the greatest demands upon the broker's time and upon his understanding of how to use the market to generate value in the ultimate transaction. Nothing can substitute for up-front research and evaluation prior to engaging in negotiations.
Since the development of mutually acceptable financial terms is key to successful negotiations, financial acumen follows closely behind broker preparation in importance. Developing an economic agreement that will result in the lowest possible total occupancy costs, meet the tenant's cash flow objectives, and still be acceptable to the landlord often depends on the broker's financial creativity. Many landlords are quite sophisticated insofar as the financial effects of interest rates and the timing of revenues and expenses are concerned. Consequently, the broker must be equally sophisticated. He must be able to structure new alternatives to overcome economic sticking points that would otherwise interfere with productive negotiations.
While landlords and their leasing agents are normally thought of as the marketers in an office space project, three significant marketing challenges face the tenant's broker.
The first is to ensure that both financial and non-financial information provided by landlords and their leasing agents is focused, complete, and in a usable form. Sometimes landlords, leasing agents, and building managers are not as familiar with the facts about their buildings as they should be. Additionally, they are regularly barraged with requests for information and proposals. The combination of these two conditions can make it difficult to obtain all the information required to make objective and meaningful evaluations of the buildings under review. Gathering the necessary data and putting it into effective formats provide a considerable test of the broker's skills in compiling marketing materials. Failure to do intensive research to uncover all the information about each property can lead to some very unpleasant surprises later on.
The second marketing challenge facing the tenant's broker is to represent the tenant to prospective landlords so as to generate enthusiasm for the tenant's occupancy while, at the same time, not making any misrepresentations. (At the risk of stating the obvious, a landlord will not aggressively pursue a deal unless he has been convinced of the desirability of the tenant. Even in times of high vacancy rates, landlords and their leasing agents often do not take the time to research the backgrounds of prospective tenants until the attorneys are working out final lease language — a point in time after the major lease provisions have been negotiated.) Thus, unless the tenant is a well-recognized organization with unquestioned creditworthiness, landlords do not get excited about a prospective tenant without first being convinced to do so by the tenant's broker.
Thirdly, before a final building decision is made, the person responsible for real estate within the tenant's organization must usually present a recommendation to higher authority for approval. Because of the impact of an office decision on an organization's fixed costs for a number of years, and because of the effect on the everyday environment in which the top management functions, this presentation usually receives careful scrutiny from the highest levels. Very effective marketing materials are thus imperative. If the broker fulfills his role as a marketing professional, he will have prepared and produced nearly all of the materials needed for such a presentation. By so doing the broker can greatly simplify the job of the responsible individual within the tenant's organization.
Real estate, like all other businesses, has its own jargon and technicalities. To enable a tenant to make the decisions and value judgments necessary to proceed effectively through an office space project, someone has to eliminate all misunderstandings and confusion associated with real estate terms and practices. While many of the people involved in an office space project will contribute to the tenant's knowledge and understanding, the broker carries the primary responsibility for that education. The best way to avoid being “steered” toward any particular alternative, whether inadvertently or purposefully, is for the tenant to make sure that the broker has both the ability and the commitment to educate him on all aspects of the process.
Interestingly, there is another party that often needs to be “educated” during a typical office space project — the landlord's representative. In today’s market, most buildings are owned by large institutions who use local brokerage firms, or the institutions’ own staff people, to handle the communications and negotiations with prospective tenants and their brokers. Gone are the days when most negotiations took place directly with the individual who owned the building. Rather, most negotiations dealing with the economic terms of a lease are now handled between the tenant's broker and someone representing the building owner. Thus, it is that someone who has the responsibility of effectively and persuasively communicating the tenant's positions, as put forth by the tenant's broker, to the landlord. We have found that this often requires detailed explanations of various financial calculations, along with the rationale underlying them. If the tenant's broker cannot appropriately educate the owner’s representative in these respects, the results of the economic negotiations are invariably less favorable for the tenant than would otherwise be the case.
There are, of course, considerations in addition to individual broker qualifications that should be addressed by a tenant during the selection process. No discussion of the subject would be complete without mentioning them.
Personality, style and reputation
Since the broker must become a key member of your project team, his ability to grasp your organization's culture and to work within it is significant. The broker's personality and style should be such that all parties can relate well. Throughout the project you will be in continuous contact and will be dependent upon each other for information and direction. Thus the broker should have a reputation for consistently establishing mutual trust and confidence among all the parties.
The broker's commitment
When you consider that brokers are generally compensated in relation to the number and size of leases they complete, it's easy to understand that they are under great pressure to finish your project and get on to the next. However, the process involved in executing a successful brokerage assignment is involved and demanding. Events frequently occur that cause the required amount of time and effort to expand greatly beyond that originally contemplated. Thus the broker may find himself squeezed for time. How he resolves that situation can be very significant to you.
The evaluation process
While the qualifications discussed in this material are extensive, it should be neither difficult nor time consuming for a tenant to evaluate several brokers before choosing one with whom to work. The evaluation can best be done through questioning each broker regarding his or her qualifications to perform in each of the five roles already described. To evaluate true performance, as contrasted to the perceptions thereof that can be created by the broker's eloquence, the tenant should insist on reviewing actual work products generated during past assignments.
The evaluation of personality and style, sometimes called “chemistry,” is purely an emotional call, but one that should be based upon more than a cursory interview. Reputation should be evaluated by talking to other organizations served by the broker, as well as some landlords, attorneys and architects with whom the broker has dealt. Lastly, the broker's commitment to perform should be fully documented in a proposal containing examples of all work products that will be furnished during the project.