Risk and Compensation; A different way of looking at Ag Real Estate Transactions

How is risk tied to compensation in the agricultural real estate and investment world? The simple answer is the greater level of risk taken, the greater the level of compensation or reward that can be achieved. Therefore, you see so many agricultural real estate professionals (REP) being compensated on a straight contingency fee much like other residential and commercial realtors. The REP takes all the risk in marketing and generating information on a transaction up to when the transaction goes under contract and even up until the real estate transaction closes. In this scenario, the incentive for compensation is based largely on getting the transaction under contract and closing as quickly as possible. However, this scenario incentivizes the REP to put minimal time and effort into the diligence of a property until the REP has some certainty that they will be compensated for the effort.

As a result, this limits the upfront research and due diligence on a potential transaction until it enters the contract phase and this is applicable whether the REP is representing the buyer, the seller or will be providing the ongoing farm management. The work (and some of the risk) is then shifted to the potential buyer of the transaction or shared between the seller, REP, and the buyer. Most of the time, the due diligence is completed in a rush which often leads to mistakes with the ever-looming risk that if some of the diligence is not satisfactory to the buyer, the buyer can still terminate the transaction. The buyer could also elect to extend the transaction, with the seller’s approval, which then provides additional time to resolve the issues. If the due diligence is started earlier (or better yet completed prior to any marketing) in the transaction, it could potentially eliminate the need for an extension or termination, thus providing adequate disclosures, and reducing costs for both the buyer and seller.

An alternative to the agricultural REP assuming 100% of the risk for their compensation, is a scenario where a strong relationship is developed between the counterparty (seller or the buyer) and the REP. In this scenario, trust is developed to a point where the counterparty engages the REP to act as a trusted advisor. The REP is then compensated by a retainer for some or all the real estate advisory activities that are performed. It is important to separate the due diligence from the transaction work so as not to be influenced by the ultimate sale, contingency fees or commissions. This eliminates the incentive to mislead, tell partial truths, etc. Success favors the prepared.

Under this compensation arrangement, the REP and the counterparty work together to prepare a property to go to the market. Most, if not all the due diligence can be prepared by the REP before the property is ever exposed to the market thus eliminating the need for a prolonged due diligence period and the uncertainty of what a buyer may find during this period. By taking the time upfront to do the diligence that is due, it ultimately takes less time to contract and close a transaction. It also helps to eliminate the need for escrow extensions, reduces costs, and crucially, reduces risk that a transaction would not close due to issues which could have been resolved before the property went to market.

Another fee structure is hourly rates, where the risk is owned entirely by the client…

So, a REP and their clients should be considering how and who takes the compensation risk in every transaction. The contingency fee shifts all the risk onto the shoulders of the REP, the hourly fee shifts all the risk onto the client, and the retainer plus contingency arrangement spreads the risk between the REP and the client.

At Scythe and Spade, we like to develop long-lasting relationships with our clients that are built on experience, trust, and accountability. This enables us to partner with our clients under several alternative compensation approaches which share the risks and rewards, reveal and resolve issues up front, and ultimately speed up the entire process while achieving the clients selling or purchasing objectives.