Real Estate Brokerage Acquisition Diligence
 
October 5, 2004
 
Jeffrey A. "Jeff" Arouh- New York

The business of providing real estate brokerage services has changed. An industry that was once almost entirely made up of “mom and pop” ventures working out of single office locations is now dominated by large companies. They may be franchisors; they may be owners; they may be investors. However you look at it, the face of the real estate brokerage industry has changed.

While new companies continue to be formed every day, at least from the outside, it looks as though the industry is getting smaller. There appears to be more “brand names” and it appears that the trend toward centralization of ownership and/or control is continuing. Big companies are swallowing small and mid-sized companies; mid-size and smaller companies are merging with one another or acquiring smaller companies in order to remain competitive; vertical and horizontal relationships going outside traditional real estate brokerage are being established.

Real estate brokerage firms are creating their own mortgage lending, relocation and title insurance related affiliates. Sometimes they are wholly owned, sometimes they are joint ventures and sometimes they are merely investments or managed enterprises.

As more real estate brokerage firms engage in transactions that impact upon the manner in which they are structured (purchases, sales, mergers, joint ventures, etc.), it becomes increasingly important for buyers and sellers of real estate brokerage firms and investors in real estate brokerage companies to be aware of the special issues and areas of concern that impact the evaluation (from a business and legal standpoint) of a potential acquisition target, a potential purchaser or seller or a potential merger or joint venture partner. Similarly, any investor in a company that may be acquired or that is funding the operations of a real estate broker or an affiliate has a tangible interest in knowing certain information about the manner in which that real estate brokerage firm operates and conducts its business.

There is always a level of diligence that must be exercised when gathering information about any potential acquisition or investment target. It goes without saying that whenever acquiring a corporation, the buyer would be interested in knowing that he or she is acquiring all of the issued and outstanding shares, that there are no outstanding rights that a third party might have to acquire shares, etc. Certainly, this would be the case if acquiring a real estate brokerage firm. However, when dealing with a real estate brokerage entity, there is additional industry-specific diligence that is warranted. This particular information is significant in evaluating the target entity, whether considering a purchase or investment. The following list is not intended to be exhaustive. However, it does address a number of the industry specific inquiries that should be made by a potential buyer, merger partner or investor.

Diligence and Compliance Audit Checklist

Legal compliance

A. Organization and professional licensing

    1. State licenses
    2. Brokerage, sales, agency, listing or similar agreements
    3. License, franchise or royalty agreements
    4. MLS, referral network or similar agreements
 

B. Federal Fair Housing Act compliance

    1. Advertising
    2. Operations
 

C. Real Estate Settlement Procedures Act compliance

    1. Referral fees
    2. Network fees
    3. Affiliated business arrangements
        a. Title insurance company arrangements
        b. Mortgage company arrangements
        c. Relocation company arrangements
    4. RESPA disclosures
 

D. State law disclosures
   
    1. Agency (buyer, seller, dual)
    2. Property condition
    3. Radon, lead paint, other hazardous substances
    4. Mold
    5. Other (will vary by state)

E. Antitrust

F. Franchising

G. Practice of law

H. Litigation

I. Employee/independent contractor status

J. Policies and procedures
   
    1. Manuals
    2. Implementation
    3. Training
 

K. Technology licenses and agreements

Many of these items require a file audit or equivalent review to ensure that the procedures that have been adopted are actually followed. This may involve testing, meeting with sales associates and individual file reviews. These should be accompanied by a report of the findings and an action plan to remedy identified areas of concern.

The foregoing list is not just for buyers. If a broker-owner has developed an exit strategy that contemplates a potential sale of his or her business, it is imperative to prepare the business for the transaction. This means ensuring that a potential buyer will not find issues or problems likely to delay or completely derail the transaction and requires doing the same kind of due diligence with respect to his or her own business that a potential buyer or investor is likely to undertake. It is highly recommended that every broker owner in this position undertakes this effort on a regular basis.

A version of this article first appeared in National Relocation & Real Estate magazine.

For more information, e-mail Jeffrey A. Arouh at jeff.arouh@hklaw.com or call toll free, 1-888-688-8500.