Plenty more goes into a deal in commercial real estate than an offer, a counteroffer, and an agreement to meet somewhere in the middle.
He hit me with a zinger! I certainly didn’t see it coming when I was showing a building and the prospective buyer asked after a long pause, “Well, what would you pay for the building if you were the one buying it?” Thus far, the tour had been a run-of-the-mill showing. I pointed out all the amazing attributes of the building, and the investor asked me leading questions alluding to potential deficiencies. It was the same rhythmic dance we always do, filled with questions of unbelieving doubt from the buyer and answers of remarkable certainty from the broker. Neither dare make mention of the word — negotiation — even though that is exactly what was happening.
In commercial real estate, we often view the concept of a negotiation as a high-low game, analogous to the proverbial used-car salesman — and we, as highly accomplished professionals, are much too sophisticated for that. Although if we are honest, the high-low game is the script for nearly every deal in commercial real estate, even if we refuse to admit it. But this approach is an easy pitfall, and there are more productive methods, especially in today’s data-driven commercial real estate industry.
When it comes to negotiation, there is a spectrum that exists. On one end lie people who are flippant, unaware, or nervous. The other side is made up of people who are measured, savvy, and confident. As usual, most CRE professionals fall somewhere in between. Let’s equip ourselves with additional tools to achieve more directed and successful outcomes in our CRE deal negotiations.
Tool #1: Identify Your Most Important Deal Points
In “The 7 Habits of Highly Effective People,” author Stephen Covey suggests we “begin with the end in mind.” Whether you are a buyer or seller, landlord or tenant, or lender or borrower, identify where you want to be at the finish line of the negotiation. It is even better to take it a step further by writing it down. For example, if you are a seller, prioritize your deal points. What deal terms are most important to you? And, of equal importance, what deal terms are less consequential? Then, identify where you would like to be in each of your areas of priority and write it down. The act of documenting it not only prevents drifting during the process, it also serves to unify the team, because a single person is rarely involved on each side of a deal. Once the goals are set, then develop a road map to get there.
My team represented a seller of a vacant office building. In the process, our client identified that price was important — when is it not? — but of greater significance was timing. The deal needed to close by the end of the calendar year. On the other hand, the amount of refundable earnest money and other typical deal points were of lesser concern. Armed with that information, my team was equipped to structure the deal in such a way that we agreed with the buyer on some key deal points to ensure the preferred date of closing.
Tool #2: Seek to Understand the Other Side’s Most Important Deal Points
“Be sympathetic with the other person’s ideas and desires.” That bit of wisdom comes alongside many others in Dale Carnegie’s book, “How to Win Friends & Influence People,” one of the greatest works ever written on negotiation. The truth is that human beings — that includes CRE professionals, believe it or not — are naturally self-centered. We are born selfish and oftentimes, even worse, groomed to be selfish. The challenge is that the negotiation table has two sides (and sometimes more). We cannot get to where we are going without helping the other side get to where they need to be. So, how do we understand where our counterpart needs to be? This isn’t a trick question — just ask. In the same way that we identify our priority deal points, encourage the other party to explain the deal points of significance for them. Once they have weighed in, we can find ways to work within the framework of achieving the other side’s goals, addressing their concerns, and finding solutions for their problems. Doing this will clarify the value of bargaining chips. In other words, what meaningless deal point can you give up — of which the same deal point is of value to your counterpart — to obtain a concession of value?
Weighted average lease term (WALT), for example, could be critically important for an investor deploying capital into a multitenant office building. A lengthy WALT will positively impact property value for an investor intending to sell. This dynamic played out in a recent deal where we represented a landlord in negotiating a lease with a new tenant – one who was comparing the economics of this lease with options at other nearby office buildings.
A key metric for the tenant was total out-of-pocket dollars spent throughout the life of the lease, assuming the same rental period across the board for all buildings. However, the landlord’s intention was to sell this asset, and we were already preparing to market the asset for sale. A lengthy WALT and a strong rental rate were important to the landlord because both heavily affected the building valuation. To meet the landlord’s two primary objectives, the tenant agreed to a higher rental rate and an additional three years of lease term than originally proposed, but we structured the deal in a way that included reduced annual rental increases, a base-year reset midway through the lease, and additional free rent on the front end that could be paid down in cash by the landlord. For the tenant, the economics of the deal achieved their goals when total out-of-pocket dollars were spread over the life of the deal. For the landlord, the WALT more than doubled, the Year 1 net operating income was maximized, and the building sold for a value that surpassed expectations. Voilà!
Tool #3: Gather and Leverage the Data
In his book “Moneyball,” Michael Lewis quotes John Henry, renowned investment manager and owner of the Boston Red Sox, in reference to a comparison between professional baseball and the financial markets: “People in both fields operate with beliefs and biases. To the extent you can eliminate both and replace them with data, you gain a clear advantage.” Since that book was published, data analytics has become a vital part of how almost every major professional sports team makes decisions. Data is equally important in commercial real estate negotiations. Most CRE professionals realize the importance of obtaining data, but few understand how to fully use it to achieve a successful outcome.
In a negotiation where we represented a buyer of a residential-style office building in a park with dozens of similar-sized office buildings, my team cherry-picked the comparable sales in the above chart and sent them to the seller’s representative, making a case for a purchase price around $90 per square foot. The full data points have been simplified for explanation.
The seller’s representative made the case that the purchase price should be closer to $100 per square foot — submitting the comparable sales above as justification.
At this point, our team was certainly tempted to accept the invitation from the seller’s broker to play the high-low game. Instead, we evaluated the seller’s comp set to determine how we could either work toward bridging the gap or defend our original position — all while trying to achieve our client’s goals. As we dissected both data sets, we were able to see that many of the seller’s comparable sales had already been renovated, while the property being bought still needed cosmetic renovation. That was telling from a qualitative analysis, but the most convincing case came when we put both sets of sales comps on a line graph to show the trend in sale price per square foot over time.
The line graph (above) was very helpful for both the buyer and the seller to understand the current value of the property as the next data point in a trendline. Ultimately, they agreed on a purchase price that equated to $87 per square foot. Both sides had data, but it wasn’t until it was dissected and brought to life that anyone truly understood how it brought relevance to the negotiation.
Negotiation: Art or Science?
That question is often debated, but most agree the ability to negotiate is critical — both in business and everyday life. According to multiple surveys, more than half of people in business aren’t confident or comfortable in negotiations. Adding these practical tools to your belt will undoubtedly give you more confidence at the negotiation table and will result in successful outcomes for you and your clients. And repetition at the negotiating table will also bring confidence, which will lead to success. So, to that end, go negotiate.
Source: “3 Tools for Negotiations“