How information asymmetry twists commercial real estate markets
Information asymmetry is a term that gets used a lot in economics. It means that one party in a transaction has more information or better information than the other party—a common occurrence. The imbalance creates inefficient markets, moral hazards, and more monopolies. There are few industries that are as rife with informational asymmetry than commercial real estate. Practically every sector in commercial real estate operates with some form of information asymmetry, hiding the cost of concessions, the price of rent, level of occupancy, or tenant improvement allowances. Unlike the market for stocks and bonds, information in the world of commercial real estate isn’t easy to come by, more often shared via grapevine than publicly disbursed, creating obstacles brokers and deal makers spend far too much time dealing with. Understanding how information asymmetry impacts the real estate sector can help brokers, buyers, tenants, and landlords alike.
Real estate is notorious for information asymmetry, leading to researchers studying the subject over the years. They’ve found that this asymmetry is a major issue at every level of a transaction. When searching for a new office or a new apartment, prices are far from accurate. Odds are any publicly listed price or rent is higher than the actual price. A building owner is the only one who knows the asset’s state and the market it resides in, giving them immense power in initial negotiations. Touring a location or unit can provide better information but collecting that information takes time. Qualified prospects are often given up-to-date vacancy info, showing which specific spaces are available and the current asking prices but those are opening positions in a negotiation. When hashing out a deal, more information is revealed and offers change accordingly. Only through negotiation can you determine the actual risks of the deal and which lines the other party isn’t willing to cross, by that point, NDA’s will likely have been signed. Then there’s prospective information, which is the rarest form to share. Development and leasing professionals play plans close to the chest, keeping new deals and new tenants under wraps until they feel like sharing. Some even use shell corporations and holding companies to assemble parts of the deal, and obfuscate their actions until nearly complete. Once done, the price of completed deals do not have to be reported in non-disclosure states.
Information asymmetry is thus a structural issue, undermining the liquidity of markets. To combat those problems, many industries have laws against insider trading and other forms of contractual negotiation malpractice. Legal disclosure agreements, brokers, and agents can mitigate the issue but more often than not the information is only available to those who own it. In today’s digital age, data sharing practices have seen increased scrutiny as more operations are increasingly unwilling to give away information they could be leveraging themselves.
Commercial real estate information is defined by major players like The CoStar Group, which operates the largest database of commercial information for the office, multifamily, hotel, and retail sectors. CoStar has put in hard work building a platform at scale, but everyone in the industry has some story about issues with CoStar’s data. First, it isn’t cheap. CoStar operates Loopnet, which does offer some information without a fee, but most things worth seeing require a CoStar membership. CoStar’s commercial property data set may be the most complete, but the data isn’t always good. Dozens of researchers are placing hundreds of calls each day to build out the information, some mistakes are to be expected based on the sheer scale of CoStar’s operation. Brokers and communication departments are uploading comps and other forms of data. The pace of information being added means there will be additional mistakes. Data entry is rarely flawless and information changes rapidly that isn’t always reflected. To its credit, CoStar is committed to providing timely and accurate information and invests heavily in ensuring changes and corrections can be made. Even still, many in the industry take issue with CoStar itself, which uses its information to create a platform that some have called a monopoly, using aggressive lawsuits and acquisitions to drive out the competition while raising its own prices.
The problem is clearest in the multifamily market, where one side of the market is typically a corporation with a high-level of information and the other side is a layman. Owners are the only experts for the units they own. A tenant can only become an expert once they’ve signed the lease and moved in. Broker and apartment finder incentives align with the owner, they both want a deal done for as little effort as possible. Information asymmetry makes looking for an apartment a headache for everyone. CoStar has made headway in multifamily through its Apartments.com acquisitions, but the same problems persisted. Apartments.com does not include every complex and the information is often not up to date, leaving it to untrained renters to close the information gap. Apartment reviews help but are often only used by former renters with an ax to grind or complexes boosting their own ratings with fake reviews, skewing perceptions on both sides. What could be a powerful tool for consumers is often a marketing funnel for landlords.
“In the past, property has benefitted, and some players in the industry have benefitted, from it being an opaque market,” Income Analytics Chief Executive Matthew Richardson, told Bisnow. “But if you ask the big global investors with experience in the equity and bond market what they want now they are looking at real estate, what they say is liquidity and transparency. But the kind of asymmetry of information you have in real estate supports a world where when you buy and sell, you are just running around a prehistoric forest trying to whack anything you can with a club.”
Building owners are pulling unrented spaces off the market to artificially inflate occupancy as rents fall, it happens so often it has its own term: warehousing. Lucrative concessions including free rent and expansive TI allowances allow landlords to obfuscate rents, lowering effective rent through the concessions while maintaining the publicly posted rent. The practice has become ubiquitous. A market roiled by the pandemic has seen both practices increase, driving information asymmetry to even higher levels.
“There is a crisis in the city,” State Assemblymember Linda Rosenthal told the WSJ. “I think it is unconscionable that some landlords are keeping units off the market, and are just, you know, sitting with their arms crossed waiting for rents to go up.”
The Manhattan District Attorney landed in hot water after public statements advocating for the expansion of a federal law that requires more transparency in real estate transactions. The Corporate Transparency Act mandates corporations, LLC, and partnerships report the name, date of birth, address, and a unique ID number for each owner benefiting from a deal. It seems simple but even getting that basic information is a challenge in real estate’s opaque world.
Information asymmetry may seem like a latent issue solved by time, experience, and technology, but even the smartest professionals have crashed markets thanks to a crippling information asymmetry. The housing market crash that precipitated the 2008 financial crisis was caused in large part by information asymmetry. Homebuyers didn’t properly understand the risk of mortgages and banks didn’t understand the income and assets of purchasers.
Information asymmetry creates what Nobel Prize-winning economist Goerge Akerlof dubbed a ‘market for lemons,’ whereby quality uncertainty pervades the market. Quality commodities lose value because of information asymmetry and deals take more time because of additional vetting. The notion that a product could be a lemon and the other party is withholding information that would show as much is pervasive, twisting markets. The market becomes perceived as a market for lemons, fueling off-market deals that further increase information asymmetry. Even being listed on a secondary market plummets the value of the commodity, like commercial real estate sees often with subleases.
Overcoming information asymmetry is what sets brokers and deal makers apart, it’s why services like CoStar cost so much and are so valuable. Information asymmetry is a huge obstacle, particularly in the opaque world of commercial real estate. That’s unlikely to change soon, though technology is helping. Real estate is averse to disclosure. Pulling back the curtain is the only way to see the full picture—a picture that many built a curtain to hide.