The sketchy gray areas of NYC’s commercial real estate game

The not-quite-black, not-quite-white areas of the industry, from scamming building sellers to deceitfully flipping contracts

May.May 01, 2014 07:00 AM

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The real estate industry was never known for choirboy-like behavior.

Many people can share a tale of backstabbing or dirty dealing. Most times, these acts fall into an ethical gray area.

Many of them are well documented on the residential side. For example, The Real Deal and others have written about pocket listings — when a broker fails to follow rules set forth by the Real Estate Board of New York and doesn’t let other brokers know about a listing they have, in an effort to swipe the entire sales commission for themselves.

Some residential brokers also intentionally fail to indicate that an apartment has a signed contract, to reel in potential buyers for other properties in a bait-and-switch move.

But in the more opaque world of commercial real estate, sketchy behavior remains further under the radar, brokers said. In the past, cash commissions were sometimes used to sidestep taxes, but now a whole different host of ethical infractions are coming out of the woodwork, as more money is put into play. Brokers, lawyers and analysts said cutting corners is increasing in this environment of escalating property values — especially as more newbies enter the market.

Plus, they said, the industry is gradually consolidating, meaning that firms are taking on more duties in-house: brokering, lending and developing. That means that the risks of self-dealing are higher.

Not surprisingly, real estate professionals said these self-dealers are just a few bad apples in the bunch.

“A true professional with a high intellect can differentiate themselves,” said Stephen Siegel, chairman of global brokerage at CBRE Group.

In the following story, TRD explores these not-quite-black, not-quite-white areas that have some in the industry concerned.

Inaccurate comps

Comparable deals, or comps, are real estate’s lifeblood. But the rules for setting comps can be loose, and, sources said, listing brokers readily exploit them, especially for retail, where market data is not as accurately tracked as the data for office space.

On paper, a store may appear to be renting space for, say, a steep $1,000 per square foot. But that may not factor in the several months of free rent and complimentary space build-out that the landlord threw in, lowering the net effective rent significantly.

A listing broker representing a nearby space risks stepping into a gray area when he cites that comp to prospective tenants, knowing it’s inflated.

In general, the industry would be better served if comps were readily disclosed through an independent clearinghouse, brokers said.

“There is no PropertyShark for leases once they are signed. There is no ACRIS,” said Adelaide Polsinelli, an investment sales broker with Eastern Consolidated, referring to the popular website and the city property records database, both used for sales comps on the residential side of real estate.

“There’s really no place to verify the accuracy of any claims,” she said.

Promises of purchase

They’re the real estate equivalent of stock options: signed agreements to purchase a building down the road.

But so-called “letters of intent,” or LOIs — often the first step in that purchase process — can tie the hands of a property owner, and are viewed by many sellers as sneaky, if not downright hazardous.

At their worst, sources said, they can allow duplicitous buyers to occasionally pull off scams like this: Buyers lock in the sellers with an LOI. Then, the buyers get a third party to make a fake offer — “maybe a wife, their mother, [or] a friend,” said one veteran broker.

The original buyer then claims to have heard through brokers that the seller violated the terms of the LOI by talking to the third party.

The seller is hamstrung if that straw buyer gets the seller to sign another contract, though either way, the seller has breached the initial contract.

A spokesman for the New York State Department of State, which regulates real estate brokers, said the agency does not monitor these types of scams because they involve private individuals. The Attorney General’s office, meanwhile, said it had no way of tallying these cases, adding that they would generally be resolved in civil court.

Once that breach of contract happens, the original buyer sues, tying up the property in litigation, giving him more time to evaluate the market and decide whether the property is worth purchasing. That move, which comes with the risk that the scam could be exposed, also locks in the sales price.

If property values keep climbing, the seller could be cheated out of significant dollars.

On the other hand, if the market tumbles, the buyer can walk away scot-free.

More generally, though, these types of maneuvers are shortcuts used by buyers who don’t have their loans in place or are otherwise not serious about a deal, said Thomas Hong, the principal of BSJ Holdings, a New Jersey–based holding company for real estate and apparel businesses. In 2012, when Hong was trying to sell a five-story Soho building at 72-76 Greene Street, several buyers came to him with LOIs. He demurred.

“At the end of the day, the LOIs that I’ve gotten, they were pretty much trying to tie in the deal without putting real money behind it. There was always something underhanded behind it,” he said. “They’re not worth the paper they’re written on.”

In the end, he ended up going with a firm that just wanted to execute a contract: L3 Capital, a Chicago-based retail investment firm, which bought the building for $41 million.

LOIs, which according to brokers are used mostly on deals between $15 million and $50 million, aren’t necessarily all bad, said Isaac Kohannim, a vice president with commercial brokerage Capin and Associates, which focuses on Northern Manhattan and the Bronx.

Many sellers depend on them as a way to vet the prospective buyer, said Kohannim, noting that about 60 percent of his transactions include LOIs.

“The main intention is to find out what your terms are as a buyer,” he said. “They are useful.”

Others said as long as the language in the letter is clearly non-binding, the seller will not get trapped.

Conflicts of interest

As real estate companies expand into different aspects of the business, conflicts of interest can arise.

That’s what outdoor sports retailer Eastern Mountain Sports, or EMS, claimed happened at 530 Broadway, which is owned by Thor Equities, and is now mired in litigation. The case is illustrative of the potential conflicts that are increasingly prevalent throughout the commercial sector in New York.

In this case, EMS signed a 15-year deal in 2008 with a starting rent at about $280,000 a month, according to court papers. But sales in the store were weak, and the company later decided that it wanted out.

In 2013, EMS enlisted Thor High Street Advisors, Thor Equities’ retail brokerage arm, to find a tenant to take over its lease, court records show.

Thor High Street found Brandy Melville, a fashion chain, to pay roughly $310,000 a month, with the landlord keeping the difference. But Thor High Street’s parent company, Thor Equities, rejected that deal.

Around the same time, news broke that investor Jeff Sutton had signed a contract to buy the building (along with some adjacent buildings) for $327 million, with plans to shake up the tenancy.

Although the affiliation between the brokerage and landlord was clearly disclosed — and the two firms share a name to boot — EMS sued Thor Equities in November for $10 million, claiming a conflict of interest.

“Both the broker and the landlord assured EMS’s representatives that such affiliation made the broker uniquely attuned to the landlord’s requirements for an acceptable assignee or sublessee,” the complaint stated. But it added Thor High Street “would abandon its fiduciary duties to EMS in favor of the landlord, its affiliate.”

Thor Equities denied that EMS got anything other than fair treatment, and has moved to have the case dismissed.

As of early last month, the case was still winding its way through New York State Supreme Court.

Financial shortfalls

Brokers, who are often the ones accused of duplicitous behavior, said sometimes the clients are the ones acting shady.

Mostly, it’s over a basic buyer claim: That the buyer has the money to buy a property. While many buyers in big deals bring in outside investors, some are not truthful about how much cash they can contribute, or have access to upfront.

Drilling clients with questions can help weed out buyers who are bluffing about their finances, said Brian Ezratty, an investment sales broker with Eastern Consolidated, who has completed $10 billion worth of transactions in a two-decade career.

“You ask what he owns; he may say, ‘I’ve done a couple deals,’ ” Ezratty said. “And I say, ‘Okay, which buildings are they? I know all of the addresses in the city.’ Then, they start backtracking.”

The tall tales run the gamut: Some buyers say they have relationships with bankers who can provide debt financing; others claim all their equity is tucked inside special funds, said Doug Harmon, a top broker with Eastdil Secured, “but then they don’t have the money for a deposit.”

Harmon said he asks for the names of banks and hedge funds to vouch for some clients’ claims.

“It’s the new guys, fast on the scene, loud and brash,” he said. “Those are the guys with red flags.”

Not ‘best and final’

In a hot market, a handshake isn’t always worth a lot, as buyers and sellers frequently go back on their word, brokers said.

TRD has reported about this on the residential side, where sellers frequently agree to a “best and final” offer and then back out to accept a higher bid.

The same backsliding is now happening on the commercial side. In today’s heated market, building owners and landlords are also often willing to make a few extra dollars, even if it means going back on a promise, brokers said.

“Some people honor handshakes and others don’t,” said Eastdil Secured’s Harmon, who explained that sellers often send out multiple contracts simultaneously.

Usually, drafting numerous contracts isn’t illegal. But for people who believe that a handshake is tantamount to a deal, learning that a seller went with a rival buyer can sting.

And the courts may not help.

Nesenoff cited a recent case of an aggrieved would-be buyer of a Brooklyn industrial building who lost a lawsuit that targeted a seller who broke his word.

“A handshake for buying and selling real estate property is not enforceable,” he said.

But by some measures, breaking deals may be less of a problem now than in the past. During the last boom, when banks were more generous, and a borrower could finance 90 percent of any deal, promises were being broken repeatedly, Harmon said.

“When you add that kind of rocket fuel,” he said, referring to the easy credit, “everything gets more competitive.”

Today, though, banks scrutinize deals much more closely, which slows down the process and adds transparency, which in turn makes buyers and sellers act more ethically, Harmon said.

Underhanded flipping

Sometimes buyers aren’t as innocent as they purport to be. In fact, some brokers actually disguise themselves as regular buyers and then attempt to flip contracts.

Most of these underhanded brokers are up-and-comers who don’t have track records, and can therefore get away with fooling sellers, sources said.

Here’s how it works: The broker pretends to be an interested buyer and signs a contract to purchase a building. But just before the 90-day contract period is up, he turns around and finds someone else to pay more, justifying the higher price with the promise of added air rights, a potentially higher-paying tenant or another sweetener.

Then a double closing is scheduled, and the property changes hands twice, in quick succession, with the first buyer pocketing the profit.

Sellers, who were essentially cheated out of extra cash, are, not surprisingly, miffed. Sources noted that weakly worded contracts are partly to blame.

And while a lightning-quick resale usually isn’t illegal, there could be illegality if the broker didn’t identify himself as such in the fine print, sources said.

Some brokers, however, say there is another side to the story, and that contract flipping can be an above-board practice if the broker is up front about his intentions. Sources described a slightly different scenario, in which the broker lines up a first buyer, but then quickly finds a second, higher-paying buyer to flip the contract to.

They say when a broker steps in with a transparent plan to flip a contract, it essentially guarantees that the sale will go through, because if one buyer backs out, another is waiting in the wings.

And, brokers noted, many sellers don’t care if contracts are flipped, as long as they are happy with the sales price they get.

Either way, sellers should investigate buyers’ backgrounds and demand that the 10 percent contract deposit go directly into their account — and not a third-party escrow account. That can help sellers if the original buyer fails to find a new purchaser, and attempts to back out of the deal, sources said.

Owners of single assets, who are less experienced at selling and who have properties listed around $5 million, are often the targets for these types of flips, sources said.

“But buyers who do this a lot have developed a very bad reputation in the industry,” said one longtime commercial broker. “It’s a lesson learned, working with them.”

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