Recent attempts by Extell Development to recover commissions it paid to brokers after condos at the Lucida on the Upper East Side failed to close are having a ripple effect in the industry.
Indeed, it’s not just the brokers in Extell’s crosshairs who are worried that the advance commissions they received years ago (and in many cases spent) are now in jeopardy.
During the real estate boom, when it was the norm for developers to presell units before construction was finished, it often took up to two years from contract signing to closing. As a result, many developers offered a percentage of the sales commission to agents before closing as an incentive to bring clients to their developments.
But during the downturn, doling out those commissions came back to bite some developers because many of those units that were negotiated at height-of-the-market prices didn’t close.
Bruce Ehrmann, an executive vice president with Stribling Marketing Associates, said the advances were typically offered in the larger new developments built by the bigger development companies, which had the cash to front the commissions to brokers.
Yet by the time buyers started backing out of their contracts, many advances that were paid to agents and their brokerages were already spent. Ehrmann said “there was very little concern” on behalf of brokerages to put money aside to repay those commissions in the event that the unit didn’t end up closing.
“If Lehman Brothers was flying so high that they were on the verge of collapse, and no one was concerned, why would a brokerage be concerned that the music was going to stop suddenly and they’d be short on commissions?” Ehrmann said.
Surprisingly, while presales of condominiums have stopped, advance commissions have not disappeared. Some developments continue to offer the advance commissions on units that go into contract, said Edward Mermelstein, a partner with the real estate law firm Rheem Bell & Mermelstein.
“I think the ones that are still offering them are going to continue if they feel that it is helping sales,” he said. “I know that in certain cases, some of them have even increased the upfront commission.”
Michele Kleier, head of residential brokerage Gumley Haft Kleier, said she had received notice of an advance commission deal offered by a development late last month. She said that, in theory, advance commissions could be a problem for brokerages, which actually receive the advance commission from sellers and then dole out a portion to the agent.
“That’s always a concern because then, how would you get the money back from the agent if they’ve spent it?” Kleier said. “That’s why I never thought it made much sense, though truthfully, in the markets we’ve had, up until very recently, I don’t know of anyone who failed to close.”
Some brokers said the marketing strategy had also been used in New York City prior to the boom. Louise Phillips Forbes, an executive vice president at Halstead Property, recalled that Donald Trump used advance commissions very effectively when she marketed some units in One Central Park West in the late ’90s.
“My whole experience with advance commissions has been only a positive one,” said Forbes. Forbes said she also accepted some advance commissions from sales in the Lucida that closed “where I saw them to be a successful marketing opportunity.”
In the bleak real estate market of the late ’80s, Michele Conte, a senior vice president with the Corcoran Group, said she worked with a developer who offered an advance commission deal at 1049 Fifth Avenue. “Normally, you’ll see these things popping up when the market is a buyer’s market,” she said. “In great markets, developers don’t usually have to do these things.”
But with the flood of product that came onto the market in the recent boom, some developers used advance commissions to coax agents to developments that had nothing inherently unique about them, said Gil Neary, president of DG Neary Realty. “Clearly, these developers felt they had to do something to stand out from the crowd,” he said.
So far, developers seem to be winning the advance commission fight. In March, a state Supreme Court judge ruled in Extell’s favor in a lawsuit the company filed against brokerage Sloane Square to recover advance commissions on two units worth a total of $195,745.
Then, in August, Extell sued several other brokerages to recover advance commissions.
According to the New York Times, Sloane Square reached an agreement with Extell last month. The Corcoran Group, Prudential Douglas Elliman, Sotheby’s International Realty and other brokerages have either volunteered to return advance commissions or reached settlements with Extell.
Stephen Kliegerman, executive director of development marketing at Halstead Property, said court rulings and settlements would likely reflect whatever agreement was signed between the developer and the broker at the time the advance commission was paid.
“I think every situation depends on whether there’s a written agreement or not,” Kliegerman said.
But Conte said it is not always that simple. While a written agreement may appear to make the situation an open-and-shut case, she said there are many reasons a deal might not close, like differences in the unit from what was promised in the offering plan.
“These circumstances do not necessarily constitute willful default by the purchaser,” Conte said. “Why should the brokerage firm be penalized?”