AEI-Brookings Joint Center Policy Matters 05-26

The Unreality of Realty Broker Fees. Mark S. Nadel. September 2005.

Whether or not a housing price bubble is poised, ready to burst, one price that is floating untethered to reality is the commission received by real estate brokers who represent buyers.

Under today’s standard framework, the seller’s broker passes half of its typical 6%-of-sales-price commission to the buyer’s broker: an amount completely unrelated to the quality or quantity of service desired or actually received by the buyer.  (Although commissions now average 5.1%, 6% is still typical for traditional brokers.)

Brokers presenting a successful $500,000 bid to sellers’ brokers due 6% commissions generally receive half the $30,000 fee.  It does not matter whether the buyers have independently narrowed their choices to one home and seek only a few hours of an agent’s assistance or whether they have required many months of exhausting house visits.  It does not matter whether buyers have relied upon an agent’s decades of experience and wisdom or whether they found themselves in the hands of a novice agent.

Few homebuyers complain about their broker’s fees or shop for a fair price, however, because most have accepted the pervasive myth that the seller, and not the buyer, pays for the buyer’s agent.  The fallacy of that belief, however, is easy to illustrate with a simple example.

Sellers who agree to pay a 6% commission to their real estate broker and to accept a bid of $500,000 for their home are, therefore, actually willing to settle for net proceeds of $470,000.  Since the sellers’ broker has agreed to accept a net $15,000 commission for his or her own services, the sellers would accept a $485,000 bid from a buyer if there was no buyer’s agent to compensate.  If, however, the buyer has an agent, and the sellers’ agent has promised half the $30,000 commission to that agent, then, to enable the sellers to clear $470,000, the seller must demand $15,000 more from the buyer.  Thus, the commission to the buyer’s agent ultimately comes out of the buyer’s pocket.

Meanwhile, the percent-of-sales-price fee structure also creates two serious conflicts of interest.  First, unbeknownst to most buyers, traditional agents often fail to show even possibly ideal homes to buyers if there is no associated offer to pay buyer agents the going rate, e.g., three percent, as in the property’s multiple listing service entry.  These may include homes represented by discount brokers, properties for-sale-by-owner, and new homes offered by developers.  Second, while a buyer wants to offer the lowest acceptable sales price, the buyer’s agent gains most by coaxing the buyer to the highest practical bid.

Buyers should not tolerate this harmful, defective structure, which emerged when buyer agents were legally sub-agents of sellers and thus required to serve the seller’s interests.  Today, about two-thirds of buyers using agents already use “buyer” agents (those who commit to serve the buyer’s interests), but buyers should also remove the residual conflict still caused by the way buyer agents are paid.

Now that electronic databases and the Internet have made it easier for buyers to personally handle many of the tasks involved in identifying the home they want, buyers should be able to purchase the quantity and quality of services they desire.  The obvious alternative is the hourly-fee-for-service option used by lawyers, accountants, and other professionals.  This approach is described in Real Estate a la Carte: Selecting the Services You Need, Paying What They’re Worth (2001) by Julie Garton-Good, a broker twice named by the National Association of Realtors (NAR) to its annual “Most Influential” list.  Such a la carte services have long been offered by many online broker websites and the 1200 members of the National Association of Real Estate Consultants.

In fact, such agents may well be worth rates of $500 an hour or more if they have exhaustive knowledge of the community and exceptional skill at helping buyers recognize their real long-term interests, avoid purchases based on infatuations, and identify homes that meet their unique needs.  Buyers’ agents could even offer to recommend local doctors, other service providers, and retailers to those buyers needing to start fresh in their new communities.

Yet the current structure hinders the efficient allocation of these experts.  The most capable agents have incentives to serve buyers of the top priced tiers of properties, even where there is little need for their skills, because the implicit fees associated with multi-million dollar homes can run as high as $1,000 per hour or more.  This makes it difficult for buyers seeking mid-level priced homes, even those willing to pay $600 per hour for agents who can help them find a home with neighbors compatible with their idiosyncratic lifestyle and schools ideally suited to the very special needs of their children.  It is as if one’s legal fees were based on one’s wealth rather than on the complexity of the matter, making it difficult for even upper-middle class clients to attract top lawyers to handle their difficult cases.

A percentage-of-sales-price commission does save buyers from the need to pay anything if no purchase is made, but this benefit is really an insurance policy against a failed effort.  Buyers who are willing to pay their agents for services rendered whether or not they actually buy should not be forced to also pay a hidden, possibly exorbitant, price for insurance.

Understandably, the NAR, the largest trade association with half the two million residential real estate agent as members, has been fighting mightily and effectively to preserve its existing rate structure.  After all, the 60 billion dollars in annual commissions that the mechanism now yields to those agents (probably at least 20 billion more than a vigorously competitive system) gives them an enormous incentive to remain one of the heaviest contributors to political candidates’ campaigns, and those investments have not gone for naught.  Twelve states already prohibit buyer agents from engaging in price competition by rebating to their customer the difference between the commission they receive from the seller’s agent and the lower fee they attempt to offer the buyer.  Both the United States Justice Department and Federal Trade Commission are working vigorously to try to protect consumers against such laws and regulations, but so far state politics appears to be trumping consumer interests.

Home buyers should be clearly informed that they ultimately pay their buyer agents and they should be allowed to employ an agent who provides and only charges them for the quantity and quality of service they desire.  Permitting sellers to continue to set a fixed fee for buyer agents should be treated as price fixing.  Local media should expose legislators favoring realtors over consumers by supporting laws denying homeowners rebates due to competition, so that home buyers can evict such lawmakers from their cozy state houses.

Mr. Nadel is an attorney in Washington, D.C. who writes on public policy issues.