Note to Realtors: You May Want to Skip This One

In the interest of not piling on, I was initially reluctant to mention this working paper, posted on the AEI-Brookings Joint Center for Regulatory Studies website, about the flaws in the commission structure used by Realtors. Especially since its author, an attorney for the federal government named Mark S. Nadel, cites our book as well as a more recent article we wrote about Realtors. But Nadel lays out the case so cogently that I think it’s a valuable addition to the ongoing about Realtor commissions. From Nadel’s executive summary:

While real estate brokers have long set their fee as a straight percentage of a home’s sale price, this formula is an anomaly and a primary reason why such fees may be inflated by more than $30 billion annually. Although competitive pressures ordinarily produce a fee structure reflecting costs, real estate broker commissions are strangely unrelated to either the quantity or quality of the service rendered or even to the value provided. Rather, this fee has been based solely on the price of the home. (It is as if tax preparers set their fee as a flat percentage of a client’s gross income, irrespective of how difficult the return was to prepare or how much their efforts saved the taxpayer). Oddly, not only is there no evidence that it is any more costly to sell higher-priced homes than median-priced properties, but it is possible that the opposite may be true! Furthermore, the straight percentage fee formula creates little incentive for real estate agents to provide home buyers or sellers with additional value.


jobrien283

The analysis of Realtors is close to being right on. As a former one myself, I can tell you that the strength of the NAR is the only thing that holds the industry together.
There are some misconceptions in the 2 roles a Realtor plays, though. The "lister", who will end up receiving 1/2 the commission does next to nothing (but has an exclusive contract). He never shows the house or takes any active role in the selling of it other than placing ads.
The buyer's agent is a completely different story. Typically they will just work with one buyer, showing them all available listings (thanks to the Multiple Listing Service). Many buyer's agents work very hard, setting up showings, driving buyers around, helping them write an offer, obtain financing, inspections, and closing. Arguably all this work still does not merit 3% of a purchase price (1/2 of 6%), but it is worth considerably more than what the lister brings to the table.
The rub for buyer's agents is this: the only way to get buyers is to have listings. Buyers call listers for information on a home their interested in. Whether or not they buy that home, they will often end up working with that lister to see (and buy) another house.
Therefore, the suggestion that sellers pay for listing the home and holding it open wouldn't bode well in the market. Maybe a better way would be for a seller to pay $750 for the listing agent's services, plus 2.5% to a buyer's agent. This eliminates the useless lister, but still entices an agent who has a buyer to show (and sell) your house.

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Stockum

While there is much to be criticized in the structure of real estate commissions, there also is much to be criticized in sloppy economic reasoning. Let me quote from the "Freaks:"

"real estate broker commissions are strangely unrelated to either the quantity or quality of the service rendered or even to the value provided."

Brokers, both buyer and seller brokers, take actions to facilitate transactions, and get paid only when a transaction is completed. That's the "quantity" part that you say is unrelated to commissions. If my house gets sold (not a hypothetical, mine has been on the market for almost a year), I am clearly getting "value." C'mon guys, your readers deserve better. Are ALL industries with fixed-rate commission structures for sales people similarly flawed? I don't claim to have all the answers, but I would hope that the Freaks could shed A LITTLE light!

rok pants

It's the same dilemma faced when ordering an expensive bottle of wine with dinner. The service is the same but since I ordered a $150 bottle of wine my tip will have to be much bigger than when I order a $30 bottle of wine.

MSN

In reply to Stockum:
Section II of the article identifies five justifications for using percentage-based fees. Section II.A. includes a discussion of why fixed-rate commissions make sense where the commission represents a portion of the "incremental value" produced by the salesperson. It also suggests that real estate agents would be motivated to create incremental value if they were offered a significant, e.g., 30% share of any increased price they obtained above some benchmark.

In reply to rok pants:
The relevance of the tipping example is addressed in section II.D, where the scholarly literature suggests that tips are based more on generosity.
(See footnote 60.)

oddTodd

To Stockum: The "quantity" refered to is the hours necessary to sell the house, which is independent of the purchase price. In fact, in the next sentence the author states it is easier (i.e., takes fewer hours of work) to sell a more expensive house than a less expensive house.

If you read the report, you'd also see that most of the author's problems with the industry are with the collusion and deception, not with the fixed-percentage fee. Buyers' brokers don't show For Sale By Owner homes. Sellers' brokers don't do much of anything. That's his complaint.

MSN

To oddTodd

Thanks, but the author (me) is very troubled by
1) basing the fee on a percentage-of-sale-price of the home, as well as
2) letting the seller's broker (or seller) determine how much the buyer's broker should earn for serving the buyer, irrespective if the quantity or quality of service the buyer receives.

If you want to view the agent working with the buyer as actually working for the seller to help sell the home, then it is fine to let the seller pay him/her. But in that case you should inform the buyer that the agent working WITH him/her is actually working to serve the best interests of the seller. In that case, the buyer might want to find an agent willing to be loyal to him/her, who would then need to be paid.

ALSO to all:

The article identifies many services of value that listing brokers can provide to sellers, other than simply placing a listing in the MLS, that may be worth substantial fees, including

1. helping to "stage" the home to look its best, including renting new furniture, etc.
2. actively tracking down potential buyers due to special skills or information, such as research on what neighborhoods have previously been "feeders" to the seller's neighborhood or home,
3. superior negotiation skills
4. the ability to anticipate problems and solve them before they kill a deal.

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rarelyright

In the broker-sold mutual fund world there are breakpoints (i.e. volume discounts) on sales. The same thing should apply to real estate imho. I lay this out in a post here...

http://herefortheduration.blogspot.com/2006/02/why-arent-there-breakpoints-on-real.html

The analogy is not perfect, because mutual funds pay a small trailer in perpetuity, whereas the real estate commission is one time. Nevertheless, some form of volume discount should apply to real estate commissions as well.

Another question I have is why should realtor income be so highly affected by real estate prices? Iow, when real estate prices soared by 100% during the most recent boom did it make sense for realtors to make 100% more on a commission? I don't think so, but that's exactly what happened. Granted there are other factors like increased competition as more realtors moved into the profession. But, hey, that was a nice COLA.

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MSN

To rarelyright:

So called "tapered commissions" have long existed in the real estate industry. See footnote 15 of the article.

The main thesis of the article (section II) is that there is no good justification for basing broker fees on the sale price of homes.

rarelyright

Thanks MSN, I wasn't responding to your paper so much as just jumping into the conversation.

I guess I assumed that tapered commissions existed, especially at the high end. But, i wonder why they're so rare in practice? In broker sold mutual funds breakpoints are absolutely mandatory with potential penalties applied if they are not offered and applied by the broker.

The first home I bought cost around 150K and I sold it for 300K+ about three years later. Both times the commission was 6%. I'll take a peek at your essay.

kazshak

I completely agree with the exec sum from Mark Nadel. When my wife and I sold our home in New Jersey, we sat down and made a clear list of the services that the listing agent would provide, and placed a "convenience" value on each item - in other words, what would we be willing to pay someone to do these things so that we did not have to be troubled. The resulting answer was about 1.5% of the selling value of our home. We negotiated with a number of agents and found several willing to accept the price, and we selected the one we liked best. On the selling side, we decided to proide 2.5% of the selling price. Our thought process was that the selling agent is bringing a buyer that we would not have access to through any other means. Therefore, we are willing to pay a relatively substantial price for that service. Is 2.5% the right amount? I don't know - we made this choice based on the standard being 3% and wanting to be slightly "cheaper" but indistinguishable by the agent. The process went very smoothly, and we never felt under-served.

After moving, my wife chose to start her own Flat Fee Real Estate firm in Nashville, TN - she calls it iList Realty (www.ilistrealty.net). She exercises the same principles - sellers should only pay for the services that they need. She is just getting started, but is excited about the potential. The local real estate community does not like the approach, and she has recieved two phone calls from agents telling her she is doing the wrong thing. I view this as fear created by a change in the industry that is being driven by better informed buyers and sellers and the vast availability of information on the internet. It's exciting, and I think enforces the fact that the old commission structures of the Real Estate Industry are changing at a very fast pace.

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realtyfreak

The one thing ALL of you are missing, consumers are absolutely unwilling to pay ANY out of pocket expenses when it comes to using the services (good or bad) of a real estate agent.

I hope I live to see the day when a buyer pays directly for the services (whatever they may be at whatever the going rate is) of a buyers agent.

Consumers have been drinking the Realtor "cool-aid" for so long they actually believe this service is free. It's not, it cost 2.5% to 3%.

What is just as whacked, is that FSBO's (For Sale By Owner) almost never discount their asking price by the 5% to 6% cost that is built in to the 80% to 90% of the properties sold through a MLS (where they get the data to price the property). I am not sure if they are greedy or stupid.

MSN

To realtyfreak:

The article acknowledges that most home buyers, because they believe that their broker is free to them, are not interested in paying a buyer broker. One of the 6 proposals in the article, therefore, is that consumer media need to educate buyers to ask their broker how much they expect to receive (from the listing broker) for working with the buyer.

An increasing, albeit still small, number of buyers are recognizing the size of this fee and the article gives examples of many buyer brokers who offer buyers substantial, e.g. 50-75%, rebates of the commissions the brokers receive from listing brokers. Some rebate a fixed percentage, some rebate the difference between the commission they receive and a flat fee or hourly rate they set with the buyer.

With respect to FSBOs, buyers should only demand and receive a discount of HALF the 5%, 6%, or other commission that would have been paid if the home was sold by a traditional broker. The buyer deserves to keep the half of the commission that would have gone to the buyer broker, whose work they handled themselves. On the other hand, the seller deserves to keep the half of the commission that would have gone to the listing broker, since the seller has handled those tasks him/herself.

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amit

This is what happend when you create a system which has some fundamental conflict of interest. I used to work in the travel industry, in my case a car rental firm.

The way it works in the travel industry is the travel agent gets a commission when they made a booking with us. A fixed percentage of the final purchase.

The more expensive the booking is, the more money they make. So it's not in the agent's interest to always look for the best price.

They will juggle how much you're willing to pay vs. the possibility of you not making the purchase.

Sometimes they will make an expensive booking knowing a cheaper alternative exists, and if the customer doesn't go for it, they will call back to change to the cheaper booking.

The best situation for a travel agent is of course when the end user is not the party paying for it, ie. business travllers who have expenses covered. In those cases normal market forces don't apply and agents can make more money with less work since there is no incentive to shop around.

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Ken D.

I think this "who should get the discount" is theory that is very difficult to apply in practice to specfic house sales. The reason is that even in relatively stable markets, there is enough uncertainty that any given sale can vary by several percentage points for extraneous reasons. The buyers bid what they are willing to pay, taking into account their direct broker payments, if any. The sellers only agree if the price acceptable, taking account of their costs. In a non-broker sale, what each side "saved" from the non-existent commission is usually unknowable.

ace6off

kazshak, I will be interested to see how your wife's deal works out. I live right outside of Nashville and of about 20 homes sold in our development in 2 years, only 3-4 used a realtor. Most just post a FSBO and move rather quickly. I'm sure that some would pay a reasonable price for assistance, but not the current 6%.

realtyfreak

MSN:

Given that real estate advertising is a major source of newspaper's dwindling ad revenue, I am not going to hold my breath for the major consumer advocacy coverage that would be needed to deprogram the majority of consumers from NAR brain washing.

Rebates are a fine marketing gimmick but they don't address why the seller is paying for the representation of their adversaries agent in the first place nor do rebates help tie the interest's of the buyer and those of the buyer's agent together.

Also strange to me (maybe because I am not an economist) is how anyone can truly judge the value of agents services without the benefit of an efficient and fair market from witch to judge from. Look at attorneys who practice in the same type of law, the rates they charge for the same service can very greatly depending on experience, reputation, personality, firm, etc. Would we see that same variance of rates if only one party paid the fee's of both sides attorney?

FSBOs can of course discount at whatever percentage they want. Who deserves or demands what percentage of the missing Realtor fee is irrelevant. My point was that most FSBO's miss a good opportunity to sell their house before any of the similar competition while pocketing the same amount of money by trying to hold on to the value of the missing agents commission. If I was selling a used car but I charged the same amount as a used car dealer selling the same make and model (since I was doing the dealers tasks myself) I would most likely have a hard time selling it.

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jdshipley

Do I have the gist of this correct? A listing agent wants listings because listings attract buyers who may purchase the listed property but may also purchase another property.

What's more valuable?
a) The services provided to the property seller; or,
b) The marketing clout and access to buyers gained by the listing agent?

Perhaps, just for discussion, one listing means the Realtor (sorry for the lack of a registered trademark!) attracts three buyers who are not obligated to another Realtor. The listing Realtor earns @ one-half of the commission for the listing and @ one-half or the commission on the sale for each of the three buyers. (Let's keep this simple and not discuss the split between some Realtors and their brokers.) This assumes they're darn good at lead conversion.

So, that would mean the property seller is essentially paying to create a marketing presence for the listing agent that is, potentially, of greater value than the listing commission.

If, as some argue here, the real time & labor is the buyer agent's then this suggests that a (small?) flat fee for listing plus iteimized costs of advertising and other promotions (open houses, etc) would be a competitive advantage with the real payoff in commissions gained as a buyer agent from spinoff sales inquiring on each listing.

An agent confident in their lead capture and conversion processes should offer listing services free of charge in order to capture the buyer leads that each listing seems to generate. Would that drop the gross commisison (just to the buyer agent) to 2.5% to 3%.

Of course, some listing agents and agencies do offer a la carte listing fees. Some buyer agents do accept fees from the buyer, foregoing any portion of the commission. What is the gross cost of sale/purchase in these cases? More or less than 6%? Oh, wait, this business model is what the Fed's say that some MLS services and realty associations are trying to crush out.

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kazshak

ace6off:
Thanks for the response. I agree that most homes today will "sell themselves." And buyers are much better informed because they have resources such as the internet at their disposal - so they know what they want and move quickly when they find it.

That's exactly why my wife chose to offer a flat fee listing service. Sellers pay as little as $499 and their property will appear in the MLS and on realtor.com and all over the internet, thus making it much more visible to buyers. To the extent that the seller wants more service, my wife is willing to offer all of the services of a traditional real estate agent for only 1.5% - generally half the price of traditional agents. So far it's working well and her clients have been very pleased. If you have a moment you should check out her website, www.ilistrealty.net, and feel free to contact her to discuss it.

normfisher

The biggest problem with fees in the real estate industry stems from the fact that there are just too many marginal agents who take 2-5 transactions a year. The top 25% of agents are probably well prepared to handle all of the business that's available. Until consumers are prepared to give old Uncle Charlie a pass and deal with a real professional, fees will remain high.

jobrien283

The analysis of Realtors is close to being right on. As a former one myself, I can tell you that the strength of the NAR is the only thing that holds the industry together.
There are some misconceptions in the 2 roles a Realtor plays, though. The "lister", who will end up receiving 1/2 the commission does next to nothing (but has an exclusive contract). He never shows the house or takes any active role in the selling of it other than placing ads.
The buyer's agent is a completely different story. Typically they will just work with one buyer, showing them all available listings (thanks to the Multiple Listing Service). Many buyer's agents work very hard, setting up showings, driving buyers around, helping them write an offer, obtain financing, inspections, and closing. Arguably all this work still does not merit 3% of a purchase price (1/2 of 6%), but it is worth considerably more than what the lister brings to the table.
The rub for buyer's agents is this: the only way to get buyers is to have listings. Buyers call listers for information on a home their interested in. Whether or not they buy that home, they will often end up working with that lister to see (and buy) another house.
Therefore, the suggestion that sellers pay for listing the home and holding it open wouldn't bode well in the market. Maybe a better way would be for a seller to pay $750 for the listing agent's services, plus 2.5% to a buyer's agent. This eliminates the useless lister, but still entices an agent who has a buyer to show (and sell) your house.

Read more...