Mind the Gap! Transaction Cost Disequilibrium and Network Inertia in Commercial Real Estate Investment

Abstract: From a transaction cost perspective, the role of the intermediary during economic exchange is to mitigate risks by reducing uncertainty and information asymmetries between parties. The particular institutional arrangement and corresponding form of intermediation is influenced by uncertainty, complexity and the degree of relationship specific assets involved in the exchange (Klein, 2010). However, while intermediaries can reduce risk, certain forms of intermediation may actually increase uncertainty and information asymmetries for structural reasons, to wit, a structural hole is created when principals are represented by independent brokers. Moreover, the form of intermediation may not adjust in a cost economizing way as inertia within the intermediary network locks in systems of sub-optimal exchange. This paper analyses 10,687 commercial real estate transactions that occurred in London and New York City from Q1, 2001 to Q4, 2011 in order to measure asset, investor and market factors most significantly affecting transaction costs. These costs vary according to the intermediary network form and whether no broker (dyad), one broker (triad), or two brokers (tri-dyad) are involved in the deal. When intermediation is present, brokers and agents typically represent the largest non-tax transaction cost to investors of real estate in London and New York City. Among intermediated network forms, the tri-dyad imposes the highest costs to the transaction and is a defining feature of the London commercial real estate investment market. The tri-dyad form is found to be most significantly associated with informal market institutions and investor characteristics rather than attributes of the assets exchanged. Further, and unique among network forms, the tri-dyad creates a structural hole, or measurement gap, through which intermediaries mediate information flow affecting transparency, potentially increasing uncertainty, while limiting transaction cost economization.