Ethics in Commercial Real Estate

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Holding a license as a real estate professional carries with it an important duty and responsibility to protect and promote the clients best interest. However, there are times when agents with the best of intentions can have situations that challenge this code of ethics.

This can be especially true of in cases of large commercial real estate or investment transactions. The commercial real estate climate has been heating up in recent years, leading some newer investors to enter the market. In many cases, the only real estate experience these investors have are in the residential market, and an investment in the commercial market holds a completely different set of challenges and requires a much more extensive knowledge base in order to operate and maintain the investment.

As a licensed real estate agent, you have a duty to act professionally and ethically, and not to practice areas of real estate that are outside of your expertise. An agent attempting to act outside of their area of expertise can cost their client thousands or even millions of dollars. Newer real estate investors who may not be very experienced may contact a residential realtor for assistance with purchasing an investment property, not understanding that the agent may not have the expertise necessary to assist them with this type of purchase. A professional real estate agent would recognize their lack of knowledge of investment real estate and refer this deal out to an experienced commercial real estate broker who can provide the expertise necessary to properly represent the client.

Commercial real estate transactions can be much more complicated than residential real estate deals, and can also have much larger consequences if the appropriate due diligence is not completed. A commercial real estate expert is required to understanding items including the following:

  • Investment property proforma
  • Types of leases (Net, NN, NNN, Gross, Modified Gross, and Full Service)
  • Operating Expense pass thru’ s (CAM, Net, Dollar Stop)
  • Expense Reconciliations
  • Capitalization Rates, Internal Rate of Return, and Cash on Cash Returns
  • Expense Prorations
  • Income Taxes and their effect on an investor’s return
  • Due Diligence – Extensive due diligence is required when purchasing a commercial property to make sure that the property meets their clients’ needs. Required investigations include zoning and permitted use, physical condition and limitations and making sure there are no environmental issues.

One of the most important areas of due diligence is physical due diligence, which includes inspection of the roof and structure, HVAC (heating and cooling system which can include cooling towers, boilers and other complex systems), plumbing, electric, sprinkler system, etc.  An agent must be adept at assisting their clients with evaluating the sufficiency of the existing systems in place at a property including things such as power supply. If these existing systems are not sufficient, can they be updated to accommodate the client’s needs? For example, a manufacturing client may need significantly more power than is already supplied to the building and the power company may not be able to provide the additional power for 18 months which would probably be an issue for the client. This is just one example of the type of due diligence that a good commercial agent must investigate so the client does not purchase a building that does not meet their needs.

Another area of required due diligence is environmental.  Environmental issues can cost millions to clean up.  A good commercial agent will make sure the client is aware of the appropriate environmental investigations that they may want to do in order to protect their interests and make sure the property is not contaminated. Environmental contamination is often times not visible and requires the services of an environmental expert.  Brad Kitchen was working with a client purchase commercial property that exhibited no potential environmental issues. However, an environmental investigation concluded that a neighboring property had contaminated that had leached under the property being purchased and contaminated the ground and groundwater.  Had he not recommended his client do the environmental investigation, this issue may not have been revealed and he may not have been able to resell the property without an expensive contamination removal.

It is easy to see that a commercial real estate transaction is completely different than a residential transaction, and carries with it a greater risk to the client if not handled properly.  A good residential real estate agent will establish a relationship with a good commercial real estate broker who they can refer commercial real estate prospects to make sure they receive the expertise necessary for a successful transaction.

 

About the Authors:

Brad Kitchen, SIOR
Robert LeVeck III
Alterra Real Estate Advisors
Columbus, Ohio