Dangers of the Traditional Broker Model: Part 2

February 22, 2019

In a previous post, we explored why the mineral rights market is heavily populated by brokers, high commissions, and incomplete information. We also looked at how this can negatively impact royalty buyers and sellers.

But it gets worse for buyers and sellers. Historically there hasn’t been a central clearinghouse for minerals and other royalties (i.e. there is no central exchange where prices are listed and deals are marketed). This lack of liquidity and transparency has allowed some unscrupulous brokers to use deceptive tactics to increase their commissions even further. Although new companies are emerging to help try to address the problem, they have not gained enough market share to fix the issue.

There are three main deceptive strategies which some low-integrity brokers use to capture more value from buyers and sellers:

1) Back-to-backing a transaction (also known as a simultaneous close or “simulclose”):
The most common strategy used by low-integrity brokers seeking to improve their commissions is “back-to-backing” a deal. This means the broker lines up a seller and a buyer but never introduces the two of them. The broker knows what price the buyer is willing to pay… but they may not disclose this price to the seller. Instead, the broker may lie to the seller and claim the buyer will only pay a certain (lower) price for their asset. Imagine how you would feel if you went to sell your house and your broker didn’t tell you about the highest offer?!

The broker will set up an entity, which we will call “Dummy Corp.”, for the sole purpose of closing a deal. Once the seller and the buyer are legally committed to the transaction, they use the dummy corporation to buy the seller’s asset at the (deceptive) lower sale price.

The seller gets paid the (deceptive) lower sales price, the buyer gets the asset, and the broker pockets the difference. Because the deal was done with a dummy corporation in the middle, the buyer never knows the real price the seller got paid, and the seller never finds out how much the buyer actually paid for their property. This can lead to huge commissions for the broker.

2) Flipping:
Thankfully it’s getting harder to find sellers that are uninformed enough to be willing to “simulclose” their asset. As a result, some brokers have simply resorted to “flipping” assets. This means that the broker must seek out vastly underpriced assets, so they can “’flip” them quickly to an end-buyer. Because the broker is forced to take possession of the assets they buy, they are taking on some risk. However, many brokers do not have enough energy expertise or time to fully value an asset.

So how do these “flippers” ensure they make money? Aren’t they taking on risk?

The simple answer is: they may attempt to low-ball sellers and underpay based on very simple math. Have you ever received an offer that is simply a multiple of your monthly cash flow? Maybe a simple $/acre figure? We have. These offers usually don’t take into account the details of a land position (e.g. local well spacing, permits, etc.).

When faced with the prospect of selling to a broker that is trying to “flip” the acreage, the seller is often better off selling directly to the real end-buyer. This could allow the seller to receive a price based on a more thorough valuation.

Note: there are cases in which the “simple math” offer made by a broker looking to flip the acreage, is actually higher than what an end-buyer would offer after a lot more research. In these cases, the “flipper” often figures it out at the last minute and doesn’t show up with money when it’s time to close. We’ll talk more about how that can happen in the next section.

3) Locking up a seller without putting money down:
In situations where a low-integrity broker cannot find a buyer right away or is not confident in their ability to “flip” the acreage, they may try to lock up the seller with a bad contract. The broker may even tell the seller they are the end-buyer. They may pretend that they have every intention of buying the property. Then they ask the seller to sign a sale agreement without putting any money down.

When a broker makes an offer without putting any money down (also known as offering “escrow money” or “earnest money” — basically the same thing as making a “down payment” on a home) it is possible they do not intend to buy the asset. This is a big red flag for any potential seller. We will talk about this more in a future post about the biggest mistakes made by mineral owners and sellers.

Once the seller has signed a contract, they may be legally prevented from selling to anyone else (other than the broker) for a period of time — often somewhere in the neighborhood of 60 days. During this time, the broker goes out into the market and tries to find a real end-buyer who would be interested. The transaction would look similar to a “simulclose” without a buyer at the beginning:

If the broker cannot find an actual investor to take the deal after 60 days, they simply do not show up when it’s time to close. However, because they did not provide the seller with any escrow payment/earnest money, they do not face any financial repercussions for walking away. In order to get compensated, the seller would have to hire an attorney and sue for damages. Brokers know this is extremely expensive for the seller and therefore unlikely to happen.

In conclusion, we at Revere see the current market as full of potholes. The first step is educating buyers and sellers (the reason we’re writing this blog) and the next step is providing a fair and transparent alternative to the current system. Feel free to reach out to us info@RevereCM.com if you have questions.

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