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.
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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.
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.
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!
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!
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.
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.
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.)
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.)