The Long View: The brokerage industry’s conflict of interest problem

Imagine going to trial only to find out that your high-powered lawyer is also working for the person you are suing. Now, imagine buying an apartment and finding out your broker is also getting money from the seller. In New York real estate, that’s not just acceptable but perfectly common. Should it be?

The two scenarios aren’t that different. In both cases you, the client, pay someone to represent you to the best of their abilities. And in both cases the person you’re paying is also getting paid by someone whose ideal outcome may be very different from yours.

The issue has gained more urgency in recent months. Amid a slowing market, some developers have begun offering incentives for brokers. Extell Development [TRDataCustom], for example, will pay 50 percent of a commission up-front to brokers who bring in clients at three new condo projects. And at 252 East 57th Street, World Wide Group is offering brokers 4 percent commission, including 1 percent up-front.

These incentives implicitly bank on the premise that a broker can steer clients into a certain building if offered the right incentives. But if a broker gets her client into a condo that offers her an extra sweetener, did she do it because it’s genuinely the best option or because she gets greater commissions there than at a project that might be better suited for the buyer? Is she just working for the buyer, or also a little bit for the seller now, too?

These incentive schemes cause more harm than good, said Andrew Heiberger, CEO of Town Residential. “I think it puts the buyer or renter at odds with their broker because it takes away the impartiality that a broker is supposed to have,” he said. “I think (developers) are better off passing the savings on to the buyers.”

Michael Graves, a broker at Douglas Elliman, countered that these incentives are “totally fine” as long as they are publicly disclosed and buyers know about them.

Cases like Extell’s One Manhattan Square are still fairly rare, but another potential source of conflict is prevalent: brokers who officially represent both buyer and seller (or renter and landlord) in a deal.

A buyer wants to pay the lowest possible price and be able to weigh several options. The seller wants the highest possible price and make sure the buyer signs on the dotted line before looking at competitive product. If a broker represents both, that’s a conflict of interest – which is why states like Connecticut and Vermont have banned the practice, according to Robert von Ancken, who chairs Newmark Grubb Knight Frank’s Landauer Valuation & Advisory. In November, the California Supreme Court ruled that when an agent representing a seller is working for the same firm as the agent representing the buyer, they become an “associate licensee” and must properly investigate and disclose all important information related to the transaction.

New York does require brokers to disclose whom they represent. But that merely makes the conflict of interest more transparent, it doesn’t eliminate it. Should it do more?

Leonard Steinberg, president of Compass, doesn’t think so. “I think some agents who are held to the highest ethical standards are perfectly capable of representing both buyer and seller in a negotiation and transaction,” he said. “The key is the ethical standards and honesty.”

Heiberger said that conflicts of interest can arise. “I definitely see the value to being represented exclusively by a buy-side broker,” he said. But he also argued that the practice shouldn’t be forced on the industry by law. It would be better, he said, if clients press for exclusive representation themselves.

That won’t happen unless clients are aware of the conflict of interest and know there are ways around it. The residential brokerage business doesn’t address these issues.They could look to how commercial brokerages operate for guidance.

Brokerages like Savills Studley, which prides itself on only representing tenants in leasing deals, and Singer & Bassuk, which refuses to work for two sides in a finance deal, use “No Conflicts” as a marketing tool. If tenants hear Studley’s pitch and still decide to go with someone else – fine. But they are more likely to be aware of potential conflicts of interest and how they could result in a worse deal for them.

Stricter rules may not be popular with brokers, but they help make an industry more honest. Consider the appraisal business. Until 1990, appraisers were paid by property owners, von Ancken said. That created the potential for conflicts of interest: Appraisers are meant to value a property accurately, but they may feel pressure to arrive at a higher valuation if they want repeat business.

Since 1990, appraisers are hired by banks. But problems remained. In the run-up to the 2008 financial crisis, single-family-home appraisers, feeling pressure from loan originators who wanted high valuations to issue bigger loans and get bigger commissions, frequently overvalued properties. The practice contributed to the housing bubble.

The Dodd-Frank Act of 2010 introduced new rules and guidelines meant to ensure accurate appraisals. Today, few would accuse Manhattan’s appraisers of overvaluing properties. On the contrary: appraisals have consistently been far more conservative than market prices.

It took a financial meltdown for the appraisal industry to really tackle its conflict of interest problem. It shouldn’t take another one for brokers to do the same.