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New FASB Lease Standard Targets Real Estate Conflicts of Interests

It’s time for CFOs to act to protect themselves from brokers who are working both ends of a real estate deal by securing a “No Conflict Assurance Statement” from their agents.

Q3 2017
In most industries, there’s one straightforward ethics rule: If you represent one side in a deal, you shouldn’t represent the other side. It creates a conflict of interest. The American Bar Association’s Model Rules of Professional Conduct prohibit law firms from representing both a landlord and tenant negotiating a lease. But, until recently, the Financial Accounting Standards Board (FASB) Lease Standards have failed to address potential conflicts of interests for real estate brokers.

In the world of corporate real estate, brokers working both ends of a deal have long been considered acceptable. That practice has gone on for far too long and needs to end. With the introduction of the new FASB lease standards, which are set to take effect shortly, hopefully it will. That’s because these guidelines will usher in a much-needed era of transparency about leasing practices, since they require companies to state all leases upfront on their balance sheet rather than bury them in footnotes. …working both sides of a deal benefits brokers - not the companies who need impartial advice on whether they should lease or buy space.

This means that CFOs must present their company’s leases to lenders and investors not as an expense, but as a liability, just like their capital borrowing. Whether to buy or rent office space used to be a decision companies made based in part on their balance sheet. Buying property resulted in a liability when debt was incurred. But the new FASB standard makes leases a liability as well.

Conflicts of Interest
This is where conflicts of interest come into play. Companies need brokers willing to advise them on whether to buy or rent space for their business needs based on what is best for the companies’ needs. But working both sides of a deal benefits brokers — not the companies who need impartial advice on whether they should lease or buy space.

The harsh truth about commercial real estate is that it has never been built on trust. In Illinois, for example, brokers can represent both sides as a designated agency or dual agency and their goals are the same in every transaction: close the deal, earn the commission, meet contract deadlines, and maintain deal flow. Brokers representing building owners just want to push leases, sign as many tenants as possible, raising occupancy quickly and, in the process, earning hefty commissions.

In fact, according to National Real Estate Investor, many of the biggest American commercial brokerage firms are also among the top-10 largest office holders in the U.S. This is an obvious potential conflict of interest, but the ramifications are troubling given the amount of office space controlled by large commercial brokerage firms. For instance, Brookfield Properties owns and manages 125,000,000 square feet of office space globally.

And it only gets uglier. One of the dark secrets of the industry is that a brokerage that represents developers can sweeten deals for their tenant reps who bring in renters. Sometimes it means a salary bump or a higher commission. The perks can also include bonuses, travel, new business opportunities, a private office, access to research, or no-cost administrative help.

Mounting Case Law Precedent
For brokers engaged in conflicted practices, the chickens are finally coming home to roost as case law precedent begins to mount. Last month, Fidelity Investments’ corporate real estate arm was sued over a $23 million building appraisal. The building’s owner claims the appraiser’s valuation was biased due to its national relationship with Fidelity.

A recent California Supreme Court case could weigh against Fidelity. In Horiike v. Coldwell Banker, two agents for Coldwell Banker represented both the buyer and the seller in the purchase of a Malibu mansion. After the $12.25 million purchase deal was inked, the buyer sued the seller’s agent for misrepresenting the property’s square footage by thousands of feet. For brokers engaged in conflicted practices, the chickens are finally coming home to roost as case law precedent begins to mount.

In December 2016, the court ruled that in sanctioning the practice of consensual dual agency, “the Legislature undoubtedly understood that the dual agent‘s loyalty must extend to both parties, and that it cannot bear any fiduciary duty to one party that requires it to breach its duty to the other party.” The court further held that, if agents representing both buyer and seller work at the same firm, they become “associate licensees” and must disclose all relevant information concerning the transaction.

Even though this was a residential purchase, the precedent applies to commercial transactions as well. In other words, a commercial real estate broker conflict of interest can trigger significant legal and financial liability.

The new FASB leasing rules are echoing the changes that are taking place in the legal landscape. And they make it clear that it is time for CFOs to act. But what can CFOs do to protect themselves from conflicts of interest?

The solution is simple and effective: Corporate officers can reduce or eliminate their financial risk from transactions by securing a “No Conflict Assurance Statement” from their agents or by seeking counsel from exclusive tenant representation firms. And, make no mistake about it; there will be substantial consequences for shortsighted, misinformed, or unprepared CFOs who put their trust in the wrong broker.

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