Guest authored over on the Moderne Ventures blog a few years ago. Super relevant today as new developments in the form of class-action lawsuits by Big Tobacco conquering law firms and the Department of Justice, seeks to reign in artificially inflated commissions around the sale of residential real estate. 

Picking up that thread below under the idea of taking the recent DOJ <> NAR anti-trust settlement one step further to achieve meaningful transparency and drive competition across the industry for the betterment of the consumer.

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Buy-side real estate agency is primarily a phenomenon of the U.S. real estate industry that causes total sales commissions paid upon the sale of a property to run almost twice as much as European, Australian, and other global residential real estate markets. This is perpetuated by obfuscating buy-side commissions in ways that confuse consumers regarding how real estate agents are paid and who is paying them. This fact has drawn the attention of both the DOJ in the form of (another) anti-trust lawsuit and 3 class-action lawsuits against the National Association of Realtors and a group of the largest real estate brokerages and brands in the country. 

First, the DOJ recently found the non-practice of making buy-side agency commissions readily apparent to consumers is to their detriment and required the NAR, through settlement, to impose new rules around how buy-side commissions are displayed and explained to consumers. Among other things, real estate agents can not say things like: ‘The seller pays my commissions, my services are free to you!’, which is bullshit. Every dollar you add to transaction fees is a dollar that the seller loses or the buyer pays. 

The DOJ also found it problematic that agents can filter and sort listings by buy-side commissions without disclosing such to consumers. Dense agents readily come out and say things like: ‘I’m not going to waste my time showing a property if I’m not paid what I’m worth!’ … which is exactly the type of behavior that’s deemed anti-competitive and indicates likely steering consumers to listings that pay an agent more rather than which listing is best suited to their clients’ interest. I also hear arguments like: ‘No other industry has to disclose how much profit they make!’ or something along those lines. Again, they’re missing the point. It’s not about disclosing profits; it’s about anti-competitive practices that cost consumers critical insights that can cause them substantial material harm. 

The DOJ’s lawsuit also has a proposed settlement in place with the NAR that will:

The NAR is in line with this settlement while stating they are in no way admitting liability, wrongdoing, or truth of any of the allegations. There will allegedly be no fines or further punishment with proposed changes being put into practice by Q1 2021. 

There are many opinions out there regarding the efficacy of the settlement on creating a more transparent and competitive environment. Many in the industry see this as a ‘win’ as the settlement conditions aren’t very intrusive and more along the lines of Do The Right Thing. I’ve also read where some folks believe this settlement should also effectively put the three class-action suits that allege anti-trust practices to rest. I don’t think it’s quite that simple, the opposite, in fact.

The DOJ case and settlement is a move in the right direction and more of a forecast of things likely to come rather than a tangible end solution. While MLS and NAR membership numbers may diminish, it doesn’t go far enough down the intended path of creating a tangible competitive playing field for all. There are some influential folks with power and a new presidential administration who agree with this and the DOJ very likely isn’t done with the NAR on the issue of how buy-side commissions are marketed and ultimately paid.  

Second, the three class-action suits ostensibly have an end game in mind: Divorcing real estate commissions, meaning that a home seller should negotiate listing commissions with a listing agent while a home buyer should negotiate buy-side commissions directly with a buyer’s agent. While this seems like an awfully commonsensical thing to do, the implications for the real estate sales industry would facilitate more transformative change than any technology-based innovation. 

Point of note… This article’s purpose isn’t to discuss the validity of these lawsuits, rather the implications of the desired end game.  

So, what are the implications of divorcing real estate commissions?

Downward Pricing Pressure on Buy-side Commissions

A buyer’s agent’s work has shifted dramatically since the last DOJ <> NAR antitrust settlement in 2008 that ended up establishing the Internet Data Exchange (IDX) policy. IDX enabled the ubiquity of real-time property listings data available to the public. Before this settlement, listings and their metadata resided behind protected firewalls, only available to those consumers who established a relationship with a licensed real estate professional who was a paying member of the NAR and the local associations that control the local MLS’s. The likes of Zillow rose to become the consumer brand for residential real estate by creating derivative products from listing and general property metadata. See: Zestimate.  

As a result of the IDX policy and subsequent innovations around property data and search, consumers could now access and interpret housing data on par with a real estate professional. The buyer’s agent value proposition went from providing access to and interpreting raw housing data to ‘professional negotiator’ and logistical support around closing a transaction. While these services certainly have value, they don’t line up with the typical expense of 2.5% to 3% of the property’s sales price. 

Before anyone gets up in arms about me calling anything a ‘typical fee’ for buy-side commissions, because that may imply anti-competitiveness, the fact is the bunching of buy-side commission rates is simply too typical to ignore. MRED is the ~6th largest MLS in the country by member count. As of late last week, the buy-side offer of cooperating commissions for active single family listings breaks down like this:

14% have a commission under 2.5%
11% have a commission above 2.5%
75% have a commission of exactly 2.5%

Not a good look

Industry practitioners will talk to the expense of running a business that requires much fruitless work to be done before one gets paid, the profit eating commission split arrangements, the notoriously low profit margins, and other inefficiencies of their chosen models to defend the bloated yet preserved pricing model around buy-side commissions. If necessity is the mother of innovation, it hasn’t been necessary to innovate around antiquated agency practices. Divorcing buy and sell-side commissions would immediately usher in that necessity. 

It’s one thing to make buy-side commissions apparent to consumers as the DOJ has settled on; it’s another to put the onus of selling independent buy-side services to every consumer without the cover of ‘that’s already been negotiated through the seller.’ Since buy-side commissions couldn’t be negotiated through the seller, they now have to be negotiated directly with the buyer. The difference sounds small and nuanced, but the delivery and end result are significant. Please make no mistake about it, consumers will be weaponized to negotiate and shop buyer services far more aggressively than ever before, and the cost for buy-side services will drop precipitously below 2.5% – 3% of the sales price of a property. Maybe it’s not a percentage at all.  

Traditional independent contractor broker business models that tolerate agent count over agent production will face a reckoning. They operate on notoriously thin margins; cutting into profits even a little bit will be untenable. While many traditional brokerage models also have ancillary business units to monetize, the capture rate on those cross-business opportunities is woefully low due to a lack of top-down control or misaligned incentives. 

Proliferation of Alternative Business Models and Transaction Services 

Other more nimble and cooperative brokerage models that understand how to leverage comparative advantages to sell their services at a lower price than competitors and realize stronger sales margins will face more opportunity. The oft bastardized ‘discount brokerage’ and ‘low fee’ models become far more practical and common. Hiring licensed agents as full-time employees looks a lot more attractive in this world as a way to cut headcount while exerting operational control over processes like requiring every customer to be introduced to affiliated businesses, with the proper disclosures, of course.

iBuyers like Zillow Offer and OpenDoor are already lowering service fees (their equivalent of agent commissions) by hiring licensed agents as full-time employees to better control the consumer experience and drive business to more profitable ancillary business units, i.e., mortgage, title, and insurance. Other alternative transaction service providers, i.e., Homeward, Knock, EasyKnock, etc., are executing similar strategies of monetizing their affiliated business unit chain in lieu of charging substantial fees for transaction services. 

Collectively, these ‘Verified Buyers’ and the services they provide address many of the issues consumers loathe when buying and selling and home. They offer safety, certainty, and convenience at levels well above the traditional transaction route. Consumers will not only pay for these tangible benefits but will come to expect them when choosing which brokerage/agent to work with. If an agent wants to compete and charge a premium for their services, the services (plural) offered better be premium. 

This phenomenon is already well underway. Some new entrants have made such central to their value proposition like Orchard and FlyHomes. It’s also becoming more common for incumbent well-run brokerages to begin to offer alternative transaction services like 8z in Colorado and MetroBrokers in Atlanta.

Divorced real estate commissions will further drive the need to differentiate to compete and win business. It is better to be able to speak to and offer choice, positioning yourself as a total marketplace expert, rather than losing to a competitor who can and will.

Disruption of Real Estate Referral Networks 

The business of real estate sales referrals makes up a large sub-industry fueled by the inflated buy-side commission. Almost all of your major residential real estate brands have internal referral networks. Agents are incentivized to refer their out of service area buyers with other agents in the same network that work the destination service area. These sub-networks charge on the order of ~10% of the total buy-side commission for facilitating the exchange of information, while the referring and receiving agents split the rest. At a 2.5% – 3% buy-side commission rate, there are enough $ to go around to make this worth everyone’s effort. 

Forcing buy-side agents to negotiate buy-side commissions stands to carve out the margin that makes these sorts of business arrangements possible. That goes for proptech driven lead generation and referral networks, too. If you’re in the business of monetizing buyer leads, I would spend a couple of strategy sessions considering these implications on your business.

Industry Contraction 

Quality supply rises to serve the smarter demand, and there will be much attrition in agent count as a result.  I don’t think I need to draw out how this leads to far less than ~1.4M agents much further than this. 

Real estate associations, which also run on notoriously thin margins, generate revenues from recurring agent/member dues. Conjoin the DOJ’s settlement provision that non-member licensed real estate professionals must be given access to all listings with divorced commissions, and agents will be looking to cut costs everywhere they can. If any properly licensed real estate professional can access homes on the MLS, that hurts the value of being a part of a NAR sanctioned association and MLS. Maybe membership isn’t what it used to be. Fewer agents, fewer dues, more contraction among associations and MLS’s. Maybe those who procure listings also administer where they’re syndicated to. Distributed > Centralized property databases for reasons that are outside the scope of this post.

Shift Happens

Divorcing real estate commissions will cause a tectonic shift across the real estate industries, creating more transparent competition and driving down commissions while catalyzing new business models and transaction choices as legacy trade groups lose influence and control. All to the benefit of the consumer.