Every other day you’ll read about a big office building, shopping center or apartment complex being sold to investors from somewhere.
Most of us understand the residential real-estate market, and how people buy and sell homes. It is pretty transparent. Homes are listed with real-estate agents and go on regional and national web sites.
But commercial real estate has been a mystery to me. There are just announcements that a property has been sold, sometimes for how much. But it is never clear to me how the buyer – who may be halfway across the country or the world – knew there was an office building in Charlotte that someone wanted to sell.
I decided to ask one of the most knowledgeable people I know in commercial real estate, Jim Anthony, CEO of APG Capital of Raleigh. He has been working in commercial real estate here for nearly 40 years. He was joined in the interview by John Zemet, his chief operating officer with more than three decades in the business.
They gave me a tutorial on how buying and selling commercial real estate has changed. As in many other sectors, technological advances and changes in the control of information have altered the landscape for brokers, buyers and sellers.
In the old days, commercial real-estate brokers were folks who knew the property owners and the investors who were active in a region. “You basically had to have a relationship with these people to get a listing,” says Anthony. “You’re the broker, and once you got the listing, then you controlled the information. And you could take it out to whoever you knew would be buyers.” And local brokers might cooperate with brokers representing buyers, and split a lucrative commission.
The problem with this arrangement was that it limited the number of potential buyers to only the investors that brokers knew about. “You never knew whether you got the best price you could get,” Anthony says.
“That’s what led to the proliferation of big brokerage houses across the country,” says Zemet. “The Cushmans, Jones Lang Lasalle. The reason they grew was their competitive edge was, ‘We’ll get you a wider set of potential buyers than anyone else, or sellers.’”
“And we’ll get you the bigger price,” Anthony says these national brokers told clients. “Or we’ll get you more inventory if you’re doing buyer representation. We control more product, therefore you should work with us,” was the message. And this disrupted the commercial brokerage industry, putting local firms at a disadvantage, and leading to consolidation.
But this big-broker competitive advantage in information has been disrupted, in turn, by new players who have built massive databases of buyers, sellers and properties. Companies such as CoStar and Real Capital Markets and a couple dozen others will, for a fee, promote properties to buyers all over the world with a few mouse clicks.
“So I can hire Real Capital Markets to push out a property of mine for about $2,500,” says Anthony. “And when I give them a property, they will ask me what buyers I want to submit it to. They have their own opinions about it. They’ll say, ‘We recommend these markets for buyers and we’ll target these people. But if you want us to add any others, send us your people and we’ll put them into [our] database.’ The brokers all over the country submit all their buyers into their database and then they get to reuse them over and over again. So it’s a pretty cool racket. They make good money.”
So that’s how buyers all over the world learn that there’s an apartment complex in Greenville someone wants to sell. Or a shopping center in Winston-Salem. Or an office building outside Research Triangle Park.
As a result, the commercial brokerage industry has to adapt and find ways to remain valuable to clients. It isn’t hard to imagine that many buyers and sellers would just go directly to the CoStars of the world. There are a lot of commercial properties that are not very complicated.
“All the Taco Bells, all the Wendy’s, all the CVS’s and Walgreens can all be analyzed and priced based on their credit, their lease terms,” said Anthony. There are regional differences in terms of what kinds of returns investors would want, based on market risk and expected residual value, but this isn’t the future of commercial brokerages.
Anthony uses the example of travel agents. Online sites took away much of their business. “Nobody calls them to buy American Airlines tickets. They’ve lost control over all that.” They may still handle complex trips, but not a flight from Charlotte to New York.
And he points to the residential real-estate business, which has been disrupted by Zillow and other online sites. “Most people don’t rely on a broker for at least for their first round of shopping for properties. They’re fully capable of finding their own, and the sophistication’s spreading.
“Where that’s happening in commercial is in triple-net investment property sales” – fairly uncomplicated, single-tenant deals – “which is more like buying bonds than it is buying real estate.”
Commercial brokers are still going to be needed in helping clients who invest in more complex real estate – shopping centers, apartment complexes. These are hard to evaluate just by browsing a database. An apartment complex, Anthony said, has “all kinds of moving parts to it.”
“How many units have been renovated? How much deferred maintenance is there? How many air-conditioning systems are going to fail in the next 10 years? When’s the asphalt going to croak? Roof replacement.”
The same is true for shopping malls, which have high overhead, an ever-changing roster of stores and a variety of lease terms.
“So what I’m saying is that people are moving into the consultative aspect of brokerage,” Anthony says. “The really, really, top, top brokers are the ones who understand how the buyers evaluate properties and how to underwrite. So they have large teams of people that can do this work for them.”
Commercial brokerages are also having to deal with smaller commissions in this more competitive environment. If one important value of a broker once was tightly controlled knowledge of buyers and sellers, that has obviously changed with the new digital platforms. “There was a day, when I first got in the business, that sales commissions on investment property sales were very large numbers,” says Anthony. “A $10 million deal could have a 5% commission on it, or a $50 million deal could have a 4% commission on it. I mean, just huge numbers. Two-million-dollar fees are gone now. It just doesn’t happen.”
The problem that the CoStars have, however, is that disruptors can get disrupted. First-mover advantage doesn’t last. Someone will develop a better, cheaper database. Washington, D.C., based-CoStar acknowledged as much in a February 10-K filing with the Securities and Exchange Commission. Companies such as Bloomberg, Google and Zillow could become formidable competitors, CoStar said. That’s not just 10-K risk boilerplate, I don’t think.
Google has a market cap of more than $1.8 trillion; CoStar’s nearly $35 billion is a Google rounding error. Bloomberg has six times CoStar’s revenue, and Zillow already knows how to create a real-estate database. And those are just the obvious big potential competitors.
The key for commercial brokers is to focus on their strengths and not try to compete in commodity lines of business.
“If you can parse data to make an informed decision, then the big aggregators can do it. But if it takes analysis and judgement, they can’t do it,” said Zemet. “So that’s really the level that we’re at and that’s where the consultative value of brokers will never go away.”