Several major news stories involving public real estate projects gone bad have hit the front pages of our local papers over the past few years. First we had the Family Court building debacle. The Pennsylvania Courts hired an advisor to find a site for a new Family Court Building and negotiate the terms for the acquisition, development or lease, only to find out that along the way he had become the co-developer of the site he recommended to them. Now, this week, we find that the Montgomery County Commissioners purchased a $26M building which turns out to need $22M of unexpected repairs to fix latent defects. The official designated by the Commissioners to handle the transaction on their behalf (a licensed broker) just happened to be an investor in the defective building they ended up purchasing. In each case the advisor claimed they disclosed the conflict to their client and it’s even theoretically possible that neither did anything illegal, unethical or wrong. The problem is that by the existence of the conflict itself, each put themselves in a position to have their integrity and motives questioned if things went south. Further, their clients (and the public) were left to wonder, in retrospect, about the objectiveness of the advice and recommendations they received from their conflicted advisor.
Hiring a conflicted advisor makes no sense. In both the Family Court deal and the Montgomery County deal, had the client hired an advisor with no economic interest in the subject property, there would have been no story, no finger pointing and no blame. The client (and the public) might not be happy with the deal that was struck; however, they would not have questioned the motives or integrity of either the advisor OR the public officials who hired the advisor. When things go bad, it just looks bad when it’s clear that your advisor’s direct economic interests were always completely adverse to your own. While the Pennsylvania Courts claimed they did not know about their advisor’s conflict until after the fact, that issue was in factual dispute and created considerable backlash for the officials who made the hiring decision once the deal fell apart.
With the benefit of hindsight, the Pennsylvania Courts would not have hired their advisor nor would the Montgomery County Commissioners have hired their’s. Even if their advisors in fact acted against their personal economic interests and truly negotiated the best deals for their clients in these two cases, the world has plenty of reason to doubt that now; the appearance of impropriety taints everything if and when problems arise. Sometimes people make bad deals. However, when a company turns out to have made a bad deal that enriches its advisor, it just looks really bad.
In some industries like law, there is zero tolerance for conflicts of interest. Clients want to know that they have the undivided loyalties of their advisors so they do not need to question the objectivity of the advice and counsel they are receiving (and for which they are paying a lot of money). Pharmaceutical companies who hire law firms to defend them in products liability suits don’t allow their attorneys to sue drug companies; same with automobile and insurance companies. You’re either on their side or on the other side. For some reason, however, the real estate industry has continued to allow these conflicts to exist and people just don’t seem to learn from their mistakes. While the typical broker conflicts are often less blatant than in the Family Court and Montgomery County transactions they are no less problematic. Brokers have been allowed to represent buyers and sellers and landlords and tenants in the same market and even in the same transaction and many clients don’t seem to appreciate the significance of the conflict or realize there are alternatives.
The recent news stories expose certain truths: (1) conflicts of interest in real estate are not simply theoretical problems which can be dismissed; (2) things often go bad when a broker is conflicted and (3) when things go bad, it’s not just the broker who gets called into question; it’s also the decision maker who hired the conflicted broker or who failed to identify the conflict in the first place. People generally act in ways that best advance their own economic interests. That’s human nature. When a deal ends up benefiting the broker to the detriment of the client, people will wonder why the decision was made to hire that advisor in the first place. As these stories of deals gone bad continue to hit our front pages, decision makers will not be able to plead ignorance much longer.
For more information contact Glenn Blumenfeld