Sellers of commercial real estate in today’s hypercompetitive market are focused on a number of objectives, including maximizing sales prices and ensuring that a selected buyer will close a transaction. On the other hand, prospective buyers are looking for any competitive advantage that will result in a successful acquisition.
Traditionally, the intermediary between these two parties is the investment sales broker, who uses experience, knowledge, and, perhaps most important, relationships to execute a transaction on behalf of the seller. The seller takes the quality of these relationships into consideration when selecting a broker to market an asset.
In our recent study “Price Signals and Uncertainty in Commercial Real Estate Transactions,” forthcoming in the Journal of Real Estate Finance and Economics, we look at the value of these relationships in terms of a broker’s ability to influence a buyer’s bid price through broker-communicated pricing guidance, which is known as the “broker whisper price.”
We also evaluated the surety-of-close concept—the likelihood that a buyer will purchase an asset once selected in the auction process. More specifically, we studied the pricing premium sellers of commercial real estate require to select a buyer who presents an elevated risk to the seller in terms of his or her ability to close a transaction at the price agreed upon.
The Broker Whisper
Broker-communicated pricing guidance is typical in the commercial real estate auction process because the broker’s intent is to maximize sales proceeds for the seller. Brokers frequently distribute general guidance to all buyers concerning the seller’s price expectations.
A more targeted approach to issuing pricing guidance, though, is through the use of the broker whisper price—jargon for information communicated by the broker concerning a seller’s minimum acceptable sales price. It is typically communicated toward the end of the marketing effort when most of the final bids have been logged. This information is often communicated to one prospective buyer with whom the broker has a strong relationship.
Theoretically, a broker whisper suggests that if the prospective buyer who receives the pricing information is able to meet the pricing level, then the transaction will be awarded to this specific buyer. The tool is valuable to a seller because it is thought to maximize sales proceeds if executed properly, but it is also valuable to a buyer because it represents an opportunity to make a deal in a highly competitive market.
Though broker pricing guidance is commonplace in the market, no one has yet been able to demonstrate the effectiveness of this tool, in large part because of data limitations. Because broker advice and influence are directly evident in the sales price of an asset, our research is based on an experiment using a sample of Certified Commercial Investment Member (CCIM) designees and candidates.
The experiment, sponsored by the CCIM Institute, was administered via an internet portal where participants were asked to act as buyers and make a hypothetical best and final-round bid for a high-quality, grocery-anchored shopping center that would be viewed as highly attractive to buyers. The experiment outlined key attributes of the real estate, such as grocer quality (high), center occupancy (97 percent), health of in-line tenants (very good), near-term tenant lease expirations (low), and the relationship of contractual rental rates to market rental rates (parity). Participants were also provided first-year underwritten net operating income, as well as the capitalization rate at which recent, similar transactions had occurred.
Each participant was provided the same asset-level information and comparable sales data but received different broker pricing information. For instance, one group of participants received broker pricing information that was said to be communicated to all buyers (i.e., general pricing guidance), whereas another group received pricing information from a close broker relationship (i.e., the broker whisper price). A final group served as the control group, receiving no additional pricing information. Variation in the broker-communicated pricing guidance via the internet portal sought to test two key questions:
- Is general broker pricing guidance that is communicated to all prospective buyers effective in influencing buyer pricing behavior?
- Is a broker whisper price from a reliable source to a specific buyer more effective than broadly communicated guidance in influencing buyer pricing behavior?
- In short, if a buyer feels as though he or she is receiving confidential pricing information through a close broker relationship, does this elicit a higher price than information conveyed by the broker to the entire prospective buyer pool, if all other things are equal?
Our findings suggest that broker pricing guidance communicated to an entire buyer pool is effective in influencing prices—both raising and lowering them—when compared with the control group that received no broker-originated pricing information. The most interesting finding, however, is that the broker whisper price had an even stronger effect than general pricing guidance in moving a prospective buyer to accept a price higher than those of recent comparable sales. We believe that the broker/buyer relationship is one of trust, and brokers with a relationship this close are more effective in maximizing the sale price.
However, this result is not to the detriment of the buyer. Market value is believed to be a range rather than an estimated point, and a trusted broker relationship gives the buyer an opportunity to beat the estimated highest price and acquire a real estate asset without contest. Relationships that result in the receipt of the broker-whisper call are deemed highly valuable to the buyer’s employer, and as a result these acquisition professionals are highly sought.
Surety of Closing the Transaction
Most sellers are risk averse when it comes to a buyer’s ability to close a transaction. Sellers are highly focused on selecting a buyer who will be able to execute all facets of the transaction and who ultimately will buy the asset at about the terms agreed to when selected as the buyer. It is not uncommon for a second-place bidder to be selected as the buyer during an auction process if the seller believes that party presents less execution risk than the lead bidder. The seller trades a level of additional sales proceeds for greater certainty that a buyer will do what he or she has agreed to do.
Institutional investors typically represent the lowest execution risk because they often can purchase the asset without a loan and are thorough in their diligence process, thereby constituting a lower likelihood that meaningful problems will emerge during due diligence that would affect the agreed-to purchase price. Moreover, institutional investors typically have multiple sources of capital interested in the asset should their first source decline the investment. Private buyers can present a higher level of risk because they tend to be loan dependent; they also may lack the ability to carry out the sophisticated due diligence necessary to thoroughly evaluate deals early in the auction process. In addition, their sources of equity capital may be more constrained than those of an institutional peer.
A failed auction process can significantly complicate the seller’s position because the broker is then required to resurrect the marketing process, which typically involves going back to the next-highest bidders to determine if they are still interested in buying the asset. It is not uncommon for these bidders to then lower their price for any number of reasons, including the belief that they may now have leverage over the seller. Sellers also have reason to worry that a failed auction process will result in a stigma in the market for the asset: other buyers might wonder if there is something wrong with the real estate and reflect that doubt in a lower revised bid.
Quantifying the Risk Premium
It would stand to reason, however, that a pricing threshold exists at which a less-qualified bidder is meaningfully above second place in terms of price—a point at which it would make sense for the seller to take a chance on this higher-risk buyer given the potentially significant price differential. The amount of this price differential—the risk premium—had never been studied before and is the second component of our research.
Our paper is one of the first pieces of research that attempts to quantify this risk premium. Similar to the lack of data about broker whisper prices, the paucity of research about risk premiums is directly related to the limited data available to evaluate the issue empirically. The list of bidders and their offers on any marketed asset is generally closely held by the seller and the broker. To address this, we again employed an experiment as a first step in quantifying this premium.
The same population of CCIM designees and candidates were asked to take the role of a disposition officer charged with selling assets within a firm. They were told that there were two lead bidders for an asset the firm was selling, one of which was a $50 million bid from an “institutional investor with prior transaction experience with your firm and multiple sources of capital for the investment.” They were told the other bidder was a “private investor with no prior transaction experience with your firm, but decent references. There is some uncertainty on available capital for the investment despite assurances.”
They then were asked how much more they would require from the private investor above the $50 million institutional offer to accept the execution risk of selecting the private investor. The findings suggest that this population of real estate professionals would require a roughly 10 percent premium, or $5 million, to take the risk associated with the private investor.
To the best of our knowledge, this is the first academic finding directly supporting certainty of closing the deal as a defined premium in the market. The data reveal that certainty of closing is a considerable risk factor that carries with it an economically relevant risk premium.
This study uses behavioral experiments to test for the effects of broker influence and the premium associated with surety of close using a rich and meaningful sample of CCIM designees and candidates. The results clearly demonstrate that brokers have the ability to influence asset pricing by providing general guidance to the market, but specifically through the broker whisper price. Furthermore, surety of close remains a significant issue to sellers, and we find that prospective buyers with uncertain closing capabilities will pay a roughly 10 percent price premium.
Matthew L. Cypher is the Atara Kaufman Professor of Real Estate in the Steers Center for Global Real Estate at Georgetown University’s McDonough School of Business; S. McKay Price is the Collins-Goodman Chair in Real Estate Finance at Lehigh University; Spenser Robinson is director of real estate at Central Michigan University; and Michael J. Seiler is the K. Dane Brooksher Endowed Chair Professor of Real Estate at the College of William and Mary.