Real estate fees inflated by $30 billion
Article criticizes industry’s commission structure
The commission structure in the real estate industry is “an anomaly” that may inflate compensation for services rendered by tens of billions of dollars each year, according to an article published by the AEI-Brookings Joint Center for Regulatory Studies, which offers analysis and recommendations on regulatory programs.
The draft paper, “A Critical Assessment of the Standard, Traditional Residential Real Estate Broker Commission Rate Structure,” (this is a large pdf file, so allow a few minutes to download) suggests that consumers would benefit most from fee-for-service real estate companies that base compensation on flat fees, hourly fees and other specific payments for services rather than relying on a commission rate that is based on a percentage of the sale price of a home.
“Residential real estate brokers and salespersons have long quoted their fees as a straight percentage of a home’s sale price. This traditional formula, however, ill serves the interests of both home buyers and sellers, and is a primary reason why such fees may be inflated by, on average, more than 100 percent or $30 billion annually,” states the paper, authored by government lawyer Mark S. Nadel.
Not affiliated with the Federal Trade Commission or Justice Department and studying the real estate industry as an independent scholar, Nadel said he has also written about copyright, organ donation, affirmative action, and compensation for travel agents, among other topics.
Traditional real estate industry commission practices have come under fire from discount real estate companies and consumer groups, and government agencies have taken action against perceived anti-competitive behavior in the industry in an effort to preserve the option of low-cost and menu-based real estate services for consumers.
In a typical real estate transaction, the agent who enters into a contract with the seller receives a commission that often ranges from about 5-7 percent of the sale price. This agent typically shares about half of the commission with an agent who brings a buyer to the transaction.
Nadel said that experienced real estate brokers may actually stand to gain income over traditional commission rates by charging a fixed rate or hourly rate for services. “Some brokers are, I have no doubt, worth $500 or more per hour — comparable to the best lawyers, the best accountants,” he said.
Nadel said he agrees with Julie Garton-Good, a real estate educator, author and broker, who has said that agents often give away what is most valuable while charging for relatively routine tasks.
“That’s backwards and should be flipped around,” Nadel said. “Most other groups charge for expertise and their advice. I’d like to consult with somebody who has expertise.”
There are some very big obstacles standing in the way of changes to the structure of real estate compensation, Nadel said. “The National Association of Realtors and traditional brokers understandably want to protect the revenues they are making.”
There is intense competition in the real estate industry, Nadel said, “but it’s not on price.” Citing the example of the airline industry, Nadel said that consumers and new companies are the beneficiaries of price competition while traditional airline companies and their employees have “suffered tremendously.” Traditional real estate brokers, he said, don’t want that to happen in their industry.
“The main point of my article … is that the percentage basis is not defensible in my view. It is both too low and too high,” he said. A percentage-based commission provides an incentive for agents to sell homes quickly because compensation is based solely on the sale price rather than on the time, effort and marketing dollars that agents pumped into the properties, he said.
While the multiple listing service is a valuable tool used to list information about for-sale properties, Nadel said he believes that the MLS should be operated more like a public utility. “If MLSs continue to be operated to favor brokers over consumers, then a new entity, like Google, may displace the current NAR affiliates with a more inclusive MLS,” he states in the draft article.
Consumers are largely unaware of the compensation practices in the real estate industry, Nadel said. “I believe a large portion of buyers still think that their buyer-broker is paid by the seller, not by them … the money is coming from somewhere.” And consumer education about industry compensation practices may be the primary driver for changing the commission-based system, he said. “That will create tremendous market pressure.”
A consumer who earns $30,000 a year in salary might question why the real estate broker who assisted with a home purchase is worth the $15,000 commission collected in the deal, for example, he said.
While some real estate agents working for traditional brokerage companies have in some cases discouraged clients from working with discounters such as limited-service and fee-for-service real estate companies, Nadel contends that the concept of a “full-service” real estate company is ambiguous — especially when the so-called full-service companies work to discourage consumers from considering all available properties rather than those properties that would generate the most compensation, he said.
“Nobody is enforcing this rule that says your fiduciary duty is to the buyer,” Nadel said. “Right now there are new entrants that are using the fee-for-service (model), but there are a couple of problems that they are facing. One is that if I list with a broker who is charging me less and offering less than the 3 percent (commission), you have a lot of traditional buyer’s agents who will not show that property.”
In his article, Nadel compares the real estate industry’s commission practices to those of the funeral industry as exposed in the 1963 book “The American Way of Death,” which found that families arranging for funerals “were regularly asked to pay a single price for a bundle of services, many of which they did not need or want.”
The traditional rate structure in the real estate industry has “serious drawbacks and a lack of economic justification,” Nadel charges in the article. “Consumers would be substantially better off if residential brokers used fee structures similar to those used by professionals in other advisory/consulting service fields, such as law and accounting.”
In making a case for an a la carte rate structure for the real estate industry, Nadel states in the article that the local MLS “appears to be the a la carte offering most desired by sellers,” and “some believe that fixed-price access to MLSs is inevitable” while the National Association of Realtors trade group “and its supporters … are adamant in refusing to permit the MLS to be treated as a public entity, which would facilitate price competition.”
Some newspapers maintain searchable online databases with information about for-sale properties, and these online sites along with others such as craigslist.org or Google could function as quasi-MLSs, Nadel said. Even if a national, aggregated list of for-sale properties is created, “agents will still be valued for their early knowledge about homes about to be listed, particularly agents who monitor local news about divorces, retirements and relocations, and are even willing to contact owners of homes that may be ideal for a buyer even though they are not for sale,” the article states.
Steve Cook, a spokesman for the National Association of Realtors, said in a statement, “MLSs should not be treated as public entities because they are not public entities. They are private databases, and are no more a public Web site than Inman News Service. Most are owned by nonprofit boards of Realtors, which spend millions on their operations. They are legal, comply with antitrust law, and are a vital force for competition in the real estate industry today.”
He added, “MLSs are a powerful force for competition. They level the playing field so that the smallest brokerage in town can compete with biggest multistate firm. The MLS makes it possible for a listing placed by the newest rookie Realtor to reach just as many prospective buyers as a seasoned professional. Buyers and sellers can work with the professional of their choice, confident that they have access to the largest pool of properties for sale in the marketplace.”
As for Nadel’s recommendations about changes to the real estate compensation structure, Cook said, “We don’t comment on different business models or commission structures used by our members.”
The article states that there are many agents who are willing to provide real estate services for flat fees of less than $5,000 per transaction, agent costs per transaction do not appear to be directly proportional to the varying level of house prices and commission compensation, and brokers in other countries charge “much lower fees for providing similar services.”
More price competition in the real estate industry “could very possibly reduce total revenues for brokers precipitously, by $30 billion or more annually,” the article states. “This gives traditional brokers a strong interest in resisting this result.”
To stimulate more price competition in the industry, the article suggests that consumers be armed with six pieces of information:
- Buyers should receive an estimate of the dollar amount of the fee that their broker expects to receive in a home-sale transaction;
- Buyers should be told whether their broker’s agent may refuse to inform them about homes that become available and that meet their criteria if those homes are not represented by traditional brokers;
- Buyers should be advised that fees paid directly to a buyer’s broker can be treated as part of the sale price for mortgage purposes;
- Sellers should be informed that many buyers have no broker, that others have brokers who have agreed to receive less than the customary buyer’s broker co-op fee, and that both groups of buyers expect to be able to translate this savings into a price discount;
- Sellers should be told whether their broker will attempt to limit the dissemination of their listing by competing brokers;
- And buyers and sellers should learn all of this information before they hire a broker, according to the article.