If it ain’t broker
The industry may be changing, but there is still room for the traditional commercial real estate broker. Experts explain where and how they fit in
Senior director and head of the Americas for capital markets research
Cushman & Wakefield
NAI Mertz (The NAI Global office for Mt Laurel and Philadelphia)
Managing director and CEO
Are the investors you work with confident in commercial real estate as an asset class?
David Bitner: Confident but cautious, which is to say, prudent. Many of the investors I work with have substantial capital to deploy and are cognisant that, while the economic outlook is positive, the cycle is maturing and valuations in many geographies and product types are high relative to history—as they are in most every other asset class. Commercial real estate is especially attractive in such an environment because of the diversity of opportunities still remaining to investors.
Some investors are responding by shifting towards strategies that rely more on income returns, while others are adapting their acquisition profiles to take advantage of the many opportunities still offering attractive valuations. Everyone is cognisant—now more than ever—of the importance of selecting the right assets in the right markets and having the right operational strategies.
This underscores the enduring advantage of commercial real estate compared to many other asset classes: it offers significant opportunities for producing uncorrelated returns or alpha.
Scott Mertz: They are. I work almost exclusively in the industrial sector and my clients all remain bullish on the outlook for at least the next two to three years.
The challenge at this time remains in too much demand chasing too little inventory, and it’s the lack of inventory restraining what would be an even more robust market at this time.
Samantha Mueting: iCORE, and in particular myself, works almost exclusively with private funds, including high-wealth individuals and consortiums as well as some sovereign funds.
It is very infrequent that we will elect to work with an institutional fund. Therefore, all of our investors are very confident in their decision to invest into commercial real estate.
iCORE has been through a few name changes, growth, mergers and demergers like most firms. However, we have not suffered from change of management. Subsequently, we have had the benefit of 30 years in this practice under the same leadership, the entire time being in the advocate seat for our clients and forming, expanding, contracting, remodelling, and optimising commercial real estate portfolios. This is longer than any of our competitors. Further, our clients’ confidence is supported by more than 30 years of year-over-year performance.
Yes, some of our competitors have a higher degree of brand in any given market, publicly traded, and in many cases have more clients or more brokers than we do.
That said, what we hear most often from our clients are statements like this one from a large portfolio: “When you committed to being our advocate, we had heard that so many times before we had no expectation of improvement, change, or otherwise. Our experience with you has been extraordinarily different from the other firms we have hired. The attention, focus, commitment to what is best for us, and the programs you built for us were truly for us.”
How can brokers help with diversification away from higher pricing and lower yields?
Bitner: To achieve that kind of diversification, investors will increasingly need to look at product types, classes and markets where they have traditionally not trodden—or at least not in the current cycle. With that in mind, I believe that brokers have the potential to add far greater value to their clients if they take a forward-looking view at their client’s portfolio needs, act as scouts to find the opportunities that fit those needs, and come back prepared to make the case for the investor to make the move out the risk-spectrum.
In order to do this, brokers need to understand their clients even better and develop still greater trust, because the relationship entails becoming, in a sense, extensions of their diligence and research teams.
Mueting: From my perspective, it is this very thought that takes the traditional brokerage mentality out of the race, literally causing their position to be less and less important. Frankly, it is less of action and more of a state of mind.
As indicated in parts of my opening response, iCORE and myself in particular have been through myriad experiences. I have a few quotes I would like to point to, as they make my point. It isn’t pricing or yield, it is preparing what we need to be building going forward, and actually stopping to learn from what we have done wrong.
Kevin Mulcahy, co-author of The Future Workplace Experience, explained that “your culture is shaped by the worst behaviour you tolerate”. His advice as an HR expert that “people don’t leave jobs, they don’t leave people—they leave behaviours” was a timely reminder of why some workplaces misfire.
Similarly, Tara Carcillo of management consulting firm The Clearing told us: ‘Don’t confuse people being polite in a room with collaboration”. She helpfully identified the corporate characters (such as the ‘scene shifter’, who constantly changes his/her mind) that are obstacles to making progress. Nicola Kahn of designer and innovation expert IDEO urged companies to lead through experimentation, saying: “Even if eight out of 10 ideas fail, a 20 percent success rate is worth celebrating.”
Mertz: Brokers remain the eyes and ears on the ground for value proposition in the industrial sector. Be it cheaper—yet well positioned—land, adaptive re-use, sublease prospects, and/or knowledge of pending moves, consolidations or expansions, it’s the well-networked and seasoned broker that is locating the future investment and user-buyer location. Our clients benefit from executing deals that never even hit the ‘public’ market.
Which sectors are really thriving? Where can brokerages achieve the cutting edge for investors?
Mueting: I believe this is again the traditional brokerage approach: we believe it is an outdated approach.
If I understand the question correctly, you are asking how do we find, or rather deliver on, that cutting-edge advantage for our clients. I would be fiscally irresponsible— perhaps even negligent—if I answered that in an open panel, in that our strategies that are delivering very high yields for our clients are, of course, highly confidential.
Further, we see every portfolio as its own, a standalone collection that must perform to its best ability. It is malleable, breakable and, of course, improvable. In summation, to take a traditional approach, almost a cookie cutter assumption, is truly what is pushing yields in the wrong direction.
Mertz: The lion’s share of activity for our company (covering Southern New Jersey and Eastern Pennsylvania) is undeniably industrial-based. Bourgeoning retail and logistics demand remains strong, constrained only, as stated above, by the lagging inventory.
That said, our agents covering the national territories are finding remaining health in multi-family and retail, though these are becoming spottier, with an eye towards quality product in primary markets.
Bitner: Let’s start out with the obvious one: industrial, in particular the ‘last-mile’ fulfilment warehouse. Everyone wants it, but there is only so much product coming to market. One way that brokerages can add value for investors is constantly thinking outside the box in terms of redevelopment opportunities, and putting these properties in front of investors.
Creative office space is another area attracting substantial interest from tenants and investors alike. However, as a category, it is still in its infancy. Brokerages can be at the forefront of defining, tracking and analysing this subtype. As a result, brokerages can provide their clients with the information they need to refine their strategies.
Finally, reading the headlines, you would think that all retail was a little shop of horrors. This is far from the truth, as many areas continue to thrive, namely grocery-anchored and experiential retail. Even in the much-maligned segments, there are segments where fundamentals are quite strong. It is exactly in such an evolving market, with confusion about fundamentals and values, where brokerages most assist investors.
As a broker, how are you differentiating yourself to attract more cautious investors?
Mertz: While we bring technology to bear in vetting opportunities, we also remain ‘old school’, coupling old-fashioned canvassing with and urgency and a rigorous work ethic. Clients know that I’ve been in the markets, in the projects, and in the buildings, and that I know the owners, users and sellers. We don’t use second-hand information vetted by freshmen brokers and analysts, it’s first-hand guidance from a veteran in the market. We’ve been at this for over 35 years.
Equally, I know that if I don’t answer the phone on a weekend or evening, someone else will. We work 24/7.
Bitner: I’m going to make what might seem a bold statement—risk preferences haven’t ‘mattered’ much during this cycle, because buying prime product in prime markets has delivered such incredible returns. Accordingly, investors could optimise their risk-adjusted returns by essentially concentrating capital in the same assets. That is changing.
As brokers, we will need to be much more discerning going forward in matching products to investors’ risk preferences. This applies as much to the more cautious investors as it does to the more opportunistic, and it goes hand-in-hand with what I said earlier about how brokers need to increasingly anticipate these newly-evolving portfolio needs as the cycle matures.
Advancements in technology are making commercial real estate data more ubiquitous and transparent. Are these changes threatening the traditional brokerage model?
Bitner: Consider the following. A hacker breaks into a brokerage’s systems and releases all of its proprietary databases to the world—how much of the brokerage’s value as an intermediary does it lose? Not much.
It isn’t that the data isn’t valuable—quite the contrary—but the competitive advantage lies in the local knowledge, expertise and relationships of the firm’s people, and consequently the scale leverage it is able to provide its clients.
In this context, I believe that more data improves the decision-making at all levels and is driving brokerages to focus on their strategic assets that are and will continue to be most important.
Mertz: I don’t think so. Transparency and data are but two pieces of a complex puzzle that combine to conclude any transaction. There remains a critical need for experienced talent to not only help interpret the data and plan and recommend accordingly, but also that can usher, and more importantly expedite, the deal to fruition.
For reasons stated previously, even the newest technology such as immersive technology, drones, and so on, cannot supplant ‘feet-on-the-ground’ in many instances.
Mueting: Yes, it has threatened the traditional brokerage model. However, what is the threat is not specifically technology’s impact on our commercial real estate data alone. It is the impact on society, and on all business practices throughout a multitude of industries.
Again, it is a mindset change that has run through the global market place, reaching all socioeconomic environments and global markets, educated, professional or otherwise.
The simple concept of controlling a client with a single flow of information—as if that broker is the only source of information, and as such that broker maintains control of his or her client—is truly an absurd concept in today’s marketplace. Moreover, before technology, this concept only somewhat held its ground when Phone Books started getting tossed on everyone’s steps.
Accordingly, it is our obligation to look beyond the traditional approach, well beyond; to embrace technology to its fullest, to create, to innovate, and to sincerely have a positive yet disruptive result. Our industry is the largest in the world, second only to government yet it has suffered from a refusal to grow, to collaborate and to evolve!
Therefore, we celebrate these changes, and further celebrate how far out in front we already are. As it relates to technology, iCORE has its own technology firm within our firm. Why? The question is why not—technology is a game changer, so shouldn’t we want to be at the forefront and build that flagship? We say yes. You will often here me saying: “The best defence is a diversified, strategic, and agile offence.”
With the continued low CMBS issuances and banks tightening lending standards across all commercial real estate loan categories, what alternative sources of financing are there?
Bitner: I would in part challenge the premise of the question. Debt capital remains quite plentiful and on attractive terms in general. By contrast, there has been a marked reduction in availability and terms of construction financing owing largely to the institution of high-volatility commercial real estate (HVCRE) loan regulations on bank financing. We have indeed seen continued low commercial mortgage-backed securities (CMBS) issuances, but this is actually a consequence of the plentitude of capital from other sources that do not have the assumption issues entailed with CMBS. We are actively monitoring any initiatives to either clarify HVCRE regulations or make CMBS modification less onerous for borrowers.
That aside, we have seen new sources of financing becoming increasingly visible in the market. Local and regional banks may not be ‘new’ but they have been increasing their share of lending activity in the last two years.
Should US Dodd-Frank reform lessen regulatory demands on these smaller institutions, then that would add further impetus to this trend. Private debt funds have also been raising capital aggressively—dry powder has increased 20 percent since the beginning of the year to $42 billion.
Mueting: It is true, each year we are all riddled with the new compliance guidelines, the latest in governance, in addition to tax updates worldwide. Commercial real estate is a complicated industry when you peel all of its layers back and try to design true optimisation strategies—and deliver on them.
Take this question for example. This isn’t a new issue at all. We have been addressing it since 2007, or even earlier. Directly, yes of course there are myriad lending, funding, and very specific financing mechanics we have built and successfully delivered on for our clients.
We have been in designed investment mechanics finance structuring since the very beginning. Again, this is always a critical aspect of real estate, but it’s much broader than imagined in most parts of the world—it isn’t just financing a deal. This is not how to close a deal, as most would immediately surmise.
I have so many examples from speaking to people in the UK. Dilapidations are a clause in leases that rarely exist outside of the UK. Subsequently, if you take a lease management system or team that is not well versed in international practices and collaborating with teams worldwide, they will miss the fact that that deposit the CFO is going to report as an asset is actually set aside and likely not enough to complete those dilapidations.
Therefore, the deposit is not an asset. In fact, an estimated future liability needs to be reported and utilised by the tax teams.
Whether it be about the financing, or any other facet of a transaction, it is never about just closing the deal. It is a new mindset you must be in. That said, transactions and long-term performance for the company, and the purpose the company defined as its objectives, remain the focus. Those objectives can, and must, be met as far as I am concerned.