How to Avoid Bogus Retrading Tactics When Negotiating a Deal

The voracious appetite American and global institutional investors have for stable Class A and value-add office buildings in the top 25 US markets is not only sharply escalating asking prices, it has pushed execution risk to higher levels for buyers, sellers and commercial real estate brokers alike.

Today, the availability and complexities of financing, traditionally the primary initial obstacle in securing a commitment for an asset sought by multiple bidders, is taking a backseat to a host of other priorities and considerations for the primary participants in the deal.

Specifically, what is the potential profitability, true quality, amenitization and environmental sustainability of the property? What is the certainty of close on the agreed upon date at the contracted price? Will the buyer demand an eleventh hour price reduction or a retrade.

There is seemingly no shortage of debt or equity capital for seasoned property investors in prime downtown or suburban office sectors. But surprises, delays and other transactional roadblocks can kill a deal and taint or seriously injure an asset’s reputation and its re-marketability.

Retrading is a double edged sword in all asset sectors in acquiring commercial real estate. It is a legitimate negotiating tool and it can give the buyer more leverage if the asset otherwise meets all major investment criteria. The question then becomes whether the seller will lower the price sufficiently or repair any discovered flaws thoroughly without dragging out the close.

However, the legitimate buyer retrade request is common. Unfortunately, it’s a technique used right before a closing to muscle the seller into significantly shaving the contracted sale price. In my opinion it is one of the few cancers in the commercial real estate industry and no one has found a cure.

The most flagrant example of bogus retrading is discovering during the underwriting process deficiencies in the building that can be repaired or replaced relatively inexpensively. But rather than point them out at the time of discovery, the buyer waits until a few weeks before closing and springs an often deep discount on the seller’s broker.

The CRE brokerage community in most mid to large cities is tightly knit. With split-second fast communications, any hiccup in a deal today gets out into the marketplace instantly and impacts the perception of the property, putting the seller in a precarious position. If the buyer backs down on the deal so close to the closing without an explanation for the termination, the property can be tainted.

When it goes back on the market, it’s highly unlikely to command the same price. The seller who caves in to the buyer’s excessive demands, can suffer a costly bite into his profit margin and can potentially injure a corporate or brand reputation.

To reduce execution risk—there is no way to eradicate it—our policy is to conduct the deepest due diligence as early as possible, before we submit an offer. By identifying a potential problem with the property quickly, the seller has the option of addressing it, in good faith, before it goes to contract, and the discovery will not likely morph into a dispute or a deal killer for either side.

Instead of just reviewing the rent roll, we analyze the leases in depth to assure each one conforms with the economic criteria of Accesso’s underwriting model which spells out predicted cash flow, revenues, capital expenses, maintenance and management cost guidelines. Is there a termination option in the lease allowing a tenant to leave before expiration? Is there a parking requirement that might exceed the property’s parking capacity?

We request historical financial statements going back three years and look for trends in variable expenses such as utility costs that are in excess of the numbers presented to us. Our top-to-bottom inspection of the physical plant –roof, elevator systems, plumbing, down to landscaping is sometimes conducted by third party consulting specialists and meticulously doubled checked by our engineers before we submit a bid.

We also pay close attention to the HVAC and lighting systems and look for opportunities to upgrade them and receive energy saving rebates and discounts from utility providers that are aggressively seeking ways to conserve power in their marketplace and are financially rewarding building owners for sustainability investments.

We have found that by spending considerable time and resources in advance of submitting a bid, it makes the offer more credible. Also, by working on an expedited time frame early on, we can speed up our due diligence which contributes to a close at the agreed upon price.

But minimizing execution risk goes well beyond physical inspections. Before we write the offer, our entire asset management team and our investment team meet with the investment committee and we present our findings. These are robust and spirited discussions and all participants are encouraged to give their feedback.

We listen closely to our commercial and tenant brokers, bankers, lenders, mortgage brokers and other advisors. Because we choose to limit our relationships to a small group of outside brokerage and institutional partners around the globe who understand our philosophies, policies and preferences—and we understand theirs–we can respond quickly to any concerns or issues that may arise.

Indeed, if there are two traits a buyer can demonstrate in a commercial real estate transaction, regardless of the sector, size and complexity—they are attention to detail and agility. They do not totally eliminate execution risk but they pave the way to a much smoother deal.

Brian Rosen is chief investment officer of Accesso, a Hallandale Beach, FL-based commercial real estate investment manager, owner and operator of office properties nationwide.