I’ve been an advocate of trashing ‘The Traditional 6% Real Estate Commission Model’ for almost 10 years. When I owned a brokerage I offered alternative commission models to clients and was nearly hung, tarred and feathered (definitely blackballed) at the bequest of numerous other Realtors and NAR’s local chapter.
In spirit of my experiences, any time a chance arises to take a swipe at NAR’s antiquated ways and membership, I’ll oblige.
Part 1 Freakonomics
A New York Times best seller (and blog) written by Steven Levitt and Stephen Dunbar pointed out that a real estate professionals traditional compensation methodology is (way) out of sync with buyers and sellers economic interests and incentives.
Levitt writes that incentives are tricky when it comes to real estate commissions. The traditional 6% is typically split between sellers and buyers agents and split again between the agent and their agency, so the agent may only end up with 1.5% of the sales price, not 6%. At a $300,000 sales price, this would yield $4500 to the (buyers and/or sellers) agent. Drilling down quickly here, the basis of the argument is:
What is the agents incentive to sell the house for more than $300,000? What if they were a little more patient, put in a little more effort and could have secured a $310,000 sales price?
That would put $9400 net more in the sellers pocket, a good chunk of change. How much more would the agent receive?
$150.00
The same happens in reverse. You list the home at $300,000 but a buyers agent brings an offer of $290,000. You stand to eat ~$10,000 while the agent only stands to lose $150.00, but puts money in their pocket much quicker.
Long and short of it: The home seller and listing agents incentives are no where close to aligned.
*Pow* A black eye to the real estate commission model from a highly respected economist.
Part 2 Mark Nadel
Mark penned the following blistering expose for the FTC:
A Critical Assessment of the Traditional Residential Real Estate Broker Commission Rate Structure
To which I compartmentalized a bit here:
The Traditional Real Estate Commission Model. A Critical Assessment
Critical Assessment of The Traditional Real Estate Commission Model II
*Ugh* Gut punch from the Ivory Tower
Part 3
B. Douglas Bernheim and Jonathan Meer from the Department of Economics at Stanford University released the following case study last month:
HOW MUCH VALUE DO REAL ESTATE BROKERS ADD? A CASE STUDY
From the Introduction section of their study:
Historically, sales commissions for residential real estate brokers have averaged between five and six percent of sales prices. In 2004, commissions paid to brokers in the U.S. totaled roughly $61 billion (Hagerty, 2005). Do brokers provide commensurate value?
Sellers potentially benefit from brokers’ services in a variety of ways:
First, brokers provide promotional services. They help prepare a house for sales, circulate flyer’s, place advertisements, hold open houses, and recommend the house to individual buyers.
Second, they often assist with negotiations.1
Third, they screen prospective buyers, facilitating and potentially accelerating the process of matching buyers and sellers (Salant, 1991).
Fourth, they provide access to the Multiple Listing Service (MLS), which lists all homes available for sale.
Fifth, they provide market information and recommendations pertaining to the appropriate asking price.2
Sixth, they of-ten assist with paperwork and legal documentation.
How much is this bundle of services worth? Because the component services are some-times unbundled, we can judge their value by examining market prices.
Discount brokers provide access to the MLS for as little as $300 (Darlin, 2003).
Market information and forecasts of selling prices are available through professional appraisals, which cost a few hundred dollars. 3
In Illinois, where sellers are required to retain real estate attorneys to prepare and review sales contracts, legal fees average roughly $700.4
Thus, the total market value of the fourth, fifth, and sixth benefits listed in the previous paragraph is roughly $1400 – enough to justify a 6% commission on only the first $23,000 of proceeds from the sale of a home.
To justify brokers’ commissions, the value of the first three benefits must be substantial.
Berheim and Meer test pool consists of homes sold on Stanford Universities campus over a 26 year period. It’s an interesting microcosm to study since it allows the authors to hone in the first three perceived benefits of a real estate agent:
Several features of this data make it particularly useful for our purposes. First, since the eligible buyer population is limited, the MLS plays no role in the campus housing market. Instead, the Faculty Staff Housing (FSH) Office maintains a free listing service for eligible buyers and sellers. Consequently, there is no risk of confounding the value of broker services with the value of access to multiple listing services. In addition, access to free listings has historically enhanced the willingness of homeowners to sell their homes without brokers. Indeed, during the 1980s, brokered transactions were rare. Second, our data sample spans a major regime shift. Brokered transactions became increasingly common during the 1990s, and have accounted for roughly half of all sales in recent years.
The value of real estate brokers for Stanford campus transactions is likely confined to promotional services, negotiations (the first and second roles listed above), and the interpretation of market data (an aspect of the fifth role). Given the small numbers of available houses and active eligible buyers as well as the physical proximity of all the homes, the costs of comprehensive search, and hence the value of pre-screening by brokers (the third role) is small for both buyers and sellers.
As we have mentioned, the value of MLS listings (the fourth role) is zero. The FSH Office also makes comprehensive market information (home characteristics, listing prices, listing dates, selling prices, and closing dates) for all transactions available to all buyers and sellers. Because market participants are generally familiar with the campus neighborhoods, and because the number of comparable transactions is limited, sellers can acquire and review virtually all pertinent market information at low cost. Thus, the value of brokers as providers (rather than interpreters) of market information (another aspect of the fifth role) is likely negligible. Finally, the FSH Office assists with paperwork, largely eliminating the value of the sixth role. Therefore, an analysis of the Stanford campus housing transactions permits us to hone in on the value of brokers as promoters, negotiators, and interpreters of market data.
Berheim and Meer use a series of coefficients and variables to create complex but proven statistical models, as well as reference Levitts (and others) data to substantiate their work. It’s not an easy read but the results are predictable, even though they don’t come right out and say it.
The 6% Realtor commission model is economically and practically retarded.
The study draws two primary conclusions that better articulate my less than novel statement:
First, using a real estate broker does not significantly affect either the average initial asking price or the average selling price of a home. This dispels the theory that brokers have negotiation power, thus diminishing their second perceived value above.
Second, using a broker does lead to a quicker sale. An added value, unless you consider Levitt’s work stating that agents are incentiveized to move a home quicker simply to turn inventory over. Holding out for a higher price, even $10,000 higher, is economically insignificant for an agent. We’re all driven by motive, ‘altruistic business practice’ is an oxymoron.
Even more interesting, an agents ability to sell a home quicker apparently is only prevalent during the first 60 days on market, after which homes represented by agents sell slower in months three and four, slightly higher in month 5, with no difference in month six. It would seem to make sense to fire your Realtor if they haven’t sold your home in 60 days…or at least not sign an agency agreement that binds you for longer than that.
Dialing back to a paragraph from the study’s Introduction:
Thus, the total market value of the fourth, fifth, and sixth benefits listed in the previous paragraph is roughly $1400 – enough to justify a 6% commission on only the first $23,000 of proceeds from the sale of a home.
To justify brokers’ commissions, the value of the first three benefits must be substantial.
Refresher:
First, brokers provide promotional services. They help prepare a house for sales, circulate flyer’s, place advertisements, hold open houses, and recommend the house to individual buyers.
Second, they often assist with negotiations.1
Third, they screen prospective buyers, facilitating and potentially accelerating the process of matching buyers and sellers (Salant, 1991).
The second benefit appears to be negligible according to this case study. The third is effectively the job of a mortgage professional or disintermediated by the advent of better information online which allows prospective buyers and sellers to quickly disseminate through and find each other, sans agent.
All of ‘this’ would lead someone like me (and many many more people) to summarize that a Realtor will sell your home fast and cheap for 6% of the sales price.
Granted, Berheim and Meer ’s case study isn’t the final word and may be off on more than one account, there are many debatable points and the same holds for Levitt and Nadel’s work. But when you start to add up the cumulative work from hundreds of hours of comprehensive study and research by highly intelligent people and institutions, you don’t have to posses a masters degree in Business Economics from an Ivy League school to understand that the traditional real estate commission model is (has been) broken.
Maybe one day the NAR will use it’s collective wisdom (and money from it’s million person army) to offer their membership some worthy advice and strategy instead of trying to protect some antiquated legacy.
Disclaimer: I believe real estate professionals provide a valuable service and aren’t the scourge of the earth. I also happen to like attorneys and claim members of both groups as friends.
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