What CRE Can Learn from the Shockwaves Sent through RRE

With chaos in Residential Real Estate (RRE) over commissions, what is the message for Commercial Real Estate (CRE)? Is the sky falling? Will CRE commissions next be attacked in lawsuits? Although there are no guarantees and legal winds are difficult to predict, those in CRE should keep calm — but perhaps do more than just carry on in the same way.

Recent lawsuits filed against the National Association of REALTORS® and large real estate brokerages, including the staggering $1.78 billion jury award in Missouri to a class of home sellers, have sent shockwaves through the RRE industry. That award was appealed, and, in mid-March, the NAR agreed to a $418-million settlement resolving the claims. The settlement, which includes significant rule changes, needs to be approved by a federal court, which most in the know believe is likely.

While the primary focus to date is on residential real estate commissions, these cases leave many in the CRE industry wondering if similar attacks on the payment of CRE commissions are on the horizon.

At the heart of these cases has been the NAR’s “Participation Rule,” which the NAR abandoned as part of the settlement. It required a seller’s broker to make a blanket offer of compensation to the buyer’s broker, who is paid by the property seller, to list a property on a realtor-affiliated Multiple Listing Service. The NAR also agreed to eliminate the requirement that brokers subscribe to the MLS. Total commissions paid by the seller were typically 5–6% and split 50/50 between the seller and buyer broker. Cases allege, and the Missouri jury agreed, that this model forces home sellers to pay costs that buyers should (and ordinarily would) pay for their own brokers in a competitive market. Sellers are effectively forced to pay for the services of the buyer’s broker (who does nothing for seller) to list their home on the MLS — a critical service to provide visibility for the listed home.

Many in CRE are now wondering if their commission structures may face similar attacks. Arizona law does not require any particular commission rate in either RRE or CRE transactions. The law only requires that listing agreements, including commissions, are stated in writing, written in clear and unambiguous language, set forth all material terms of the compensation, have a definite duration or expiration date showing inception and expiration dates, and be signed by all parties.

In CRE transactions, broker commissions are also traditionally paid by the seller or landlord with a 50/50 split to the buyer or tenant’s broker. There is no standard commission percentage, although typically in deals of less than $1 million, estimated rates are 4–8%. Moreover, CRE deals are often highly negotiated between sophisticated parties, so this traditional structure is increasingly modified and subject to negotiation.

Numerous factors influence CRE commissions, including property type, size, location, market demand, length of lease, transaction complexity, and level of broker work needed. Larger deals may incur lower commission percentages due to economies of scale, while smaller deals may have higher percentages to adequately compensate brokers for their work. In CRE, alternative fee arrangements are also used, such as flat fees, splits other than 50/50 between seller and buyer broker, and buyers paying their own broker commissions.

The problems in RRE are real and not empty in CRE because many deals still use the traditional seller-paid 50/50 commission split. With this in mind, the CRE industry would be wise to take a closer look at how broker commissions are handled and consider either departing from continuing more of the same when appropriate or, better, documenting why the traditional approach makes sense for a deal.

Key takeaways from the RRE suits include a wakeup call for more transparency and client protection in CRE transactions. CRE brokers should consider immediate modifications to their processes. Certainly, contracts should clearly outline all terms of broker compensation. But transparency and protection should start earlier than the final contract. Some considerations include:

• Having robust communications early in negotiations about how commissions will be paid.
• Using alternative commission arrangements.
• If the seller/landlord is paying commissions, clearly explaining upfront what the buyer’s broker is doing for them and why seller should pay commissions in that deal.
• Requiring buyer to pay for its broker.
• Memorializing all agreements about commissions and scope of work in a separate document incorporated into the final contract.
• Including provisions in the final contract to resolve disputes through mediation, arbitration or other out-of-court means to avoid long and costly lawsuits.

While it is unlikely at this time that CRE will see massive, forced changes spilling over from the residential lawsuits, the RRE suits have caused greater scrutiny of all commission structures. Thus, CRE participants would be wise to review current commission structures and processes and consider implementing changes to increase transparency and client protection where appropriate.

Fennemore attorney Andrea Marconi serves as chair of business litigation at Fennemore. Her areas of practice include business and complex litigation, real estate, banking law and health care.