Are Realtors Really Making Too Much?

The Freakonomics guys have been on this rant for years, and until recently, I agreed with their logic.  But the mounting evidence (in my mind) is starting to swing the other way.

The biggest piece of evidence is the existence of credible discounted brokers like Redfin.com which has been operating for a number of years now and have yet to make any impact on the 6% overall.  In the past Redfin used to have very low fixed commission fees (if I remember correctly) and now they have gone to “50% savings”, which when you look into it is really only 25% since they are just talking about one side of the transaction.  But you’d think that if they are listing both buyers and sellers they could just act like market makers and reduce both halves.

Now I understand that there is status-quo-preserving regulation and there is collusion and all sorts of conflict of interest in this game.  But if the “big fat tip” is so large, why hasn’t the open market corrected this yet?  There should be tons of competition into the discount broker space if there’s money to be had there.  It should be an exploding industry, especially. now with all the extra inventory available.  Perhaps there finally is an opportunity, and time will tell.

From a customer’s standpoint, I have to admit that it’s not about the raw information, it’s about understanding the intricacies of buying and selling a fairly complex asset (which 99% of the population is not up for doing).  And if an agent can convince me that for their extra 3% they can get me much more than that in the sale price, it doesn’t sound like such a bad deal.  Unless I’m an experienced buyer/seller of real estate, even if I understand all the numbers and regulations from a theoretical standpoint, I’m not going to be a good negotiator in practice.

My guess is that the true value of the broker (both sides combined) is about 4%.  The other 2% is the corruption in the system that we all know about.  What do you all think?

  • JK

    I think a good realtor, an actually good one, is probably worth 3-4%. When we sold our NJ house, which was _just_ before the housing crisis hit, we negotiated 4% with him and he was at a big name firm. He was very very good and we actually sold it above asking in 1 day and even before we had the ”broker open house”. Good times.

  • We operate a brokerage in Seattle that competes with Redfin. Despite the downturn, housing prices are still very high here. $500,000 homes are common, leading to a commission of $7500 each for the two agents. We provide the same full service as traditional agents and measure how many hours we spend facilitating each transaction, and I can assure you that on an hourly basis, 3% commission is absurd, no matter how good the agent is. Selling a million dollar home can easily push hourly rates to $300-$500/hr.

    The problem with real estate commissions is that the seller sets commissions for both agents. Even discount brokers encourage you to pay full price to the other agent. You wouldn’t want to be the one guy in the neighborhood with lower commissions. That will impact agent behavior and reduce chances of a sale. This mentality has increased in the downturn with some people offering agent incentives above the 3% to move their house faster. Personally, I have always advocated letting buyers determine the commission for their agent. That would open up competition on both sides of the transaction, rather than the way it is now where sellers chicken out about paying less than everyone else.

    The other big issue is that there are flat out too many agents pursuing too few deals. The average agent may close only 6-7 deals per year. They need those 6-7 deals to have big paydays to pay for their living expenses, pay for their marketing expenses, and make up for all of the transactions and customers who went bust. Given that most agents eke out a modest living on those few transactions, they cling tightly to the established 3%, claiming that it is necessary to “cover the costs of doing business”. If the bar to entry was raised and there were far fewer agents, they could secure more deals, and we wouldn’t have this incessant pressure to maintain high commission rates.

  • @Lisota, this is a very bizarre situation for me, but I’m going to argue with you and say that you must not be overpaid (at least not by much). If there are too many agents pursuing too few deals, there should be a ton of pressure to break the supposed collusion. For sale by owner is an option, so the market should clear at the right price.

    I think what you might be underestimating as an agent is how complex/difficult/daunting/emotional the prospect of buying or selling a house is for an average home owner who does maybe one of these deals their entire lives. We don’t want to mess it up and we are willing to pay a premium to have an expert hold our hand.

    I would guess that the percentages will come down if and only if the average number of transactions done by the average home buyer/seller increases.

  • @ratefurst, I see your point, though I think your argument misses a few key points.

    Commissions are largely controlled by brokers, not their agents, so a flood of agents doesn’t break the stranglehold on rates because they are locked in by practices of their brokerage. Most agents won’t pursue lower rates because it jeopardizes their livelihood. They simply can’t source enough transactions to make the numbers work. The vast amount of agents out there make a modest-to-poor living for the hours they put in. Most agents operate far, far below their true capacity to close deals and end up spending most of their time trying to source their next customer.

    I don’t think that the number of transactions per homeowner will ever really change. People buy/sell a home only a few times in their lives.

    I certainly don’t underestimate the daunting nature of the task. We see that every single day, and it does mean that true commoditization will likely never occur for the profession. People don’t trust that $500 – $1000 is “enough” to get the expetise that they need. However, the expertise shouldn’t valuable enough to pay for a brand-new car, which is what these big paydays end up being.

  • What’s the different between an agent and a broker? If you mean that broker=sell side and agent=buy side, then I still content my argument holds. If you mean that the broker is the real estate brokerage firm which hires individual agents, then again, there is incentive for individual agents to go freelance and undercut the oligopoly.

    I agree that the number of transactions per home owner is not likely to change much.

    Do you do both sell side and buy side? If not, why not? If so, what’s to stop you from simply being a match maker and facilitating the transaction with a fixed fee?

  • A broker operates a brokerage with many agents reporting to them. (Different states have slightly different titles, but the structure is the same.) It is relatively easy to go freelance in this industry and there are a number who do try to undercut the oligopoly. However, no one is able to undercut both sides of a transaction. A freelance agent may offer discounts on their fees to sellers, but they are essentially required by market dynamics to have their seller pay a full commission to the buyer’s agent. The inverse is true as well, but in a different way. Since selling commission is already set by and paid for by the sellers, buyers don’t feel they are actually paying for the service. Some firms entice with rebates, but most just “take what they are offered”, which is the amount set by the seller.

    We do both buy and sell side and try to balance our business 50%-50% between the two. What stops us from being a matchmaker on both sides of the transaction is that real estate in a big city doesn’t really operate that way. I believe that more than 95% of transactions in our market have two unrelated agents involved, one for the buyer and one for the seller. Dual-agency where you represent both parties is quite rare. No agent, no matter how successful, has buyers for their specific listings or exact listings to match their buyer’s needs. We rely on the thousands of other random agents to source the perfect buyer or seller for our clients. The largest brokerage here only has ~20% market share, so even the large players can’t be a market maker.

  • JK

    Having bought and sold many homes I can tell you that if one manages to talk a realtor/broker into a commission discount they have all still told me that they have to offer the other side the full 3% or the other agents will just not spend time on my property which will ”only” get them < 3%, so only they are taking the commission hit.

    I’m not sure what it would take to convince me that it’s worth 6% to sell my home, but it would take a lot. I sold a $1M home in NJ days before the mortgage fiasco hit and while my agent was great no way that was worth $60k. And as I said earlier I had negotiated for less.

  • ace

    @JK I am going to presume my buying behavior isn’t all that different from the average buyer. If I am looking for a house I go to the MLS site and see what is available even if I am using a realtor. Just as I can choose my flights quicker than a travel agent can, I can immediately reject houses for personal reasons that my agent may not know about. When I find a house I want to make an offer on I call my agent and if he said “I can’t make an offer for you because they are only offering me 2% commission” I would quickly find someone who would.

    So if your selling agent says he has to give the other side standard commission or they won’t work it, I think you aren’t losing much exposure.

    But I may be different…

  • @ace, I don’t think you’ll find an agent who would refuse to write an offer because they are being offered a lower commission. What you will see is far more subtle. If you’ve got a property like that on your list, maybe the agent makes suggestions that it is overpriced, in a poor location, hard to resell, etc, essentially pointing you in another direction. Most buyers are quite susceptible to nudges like that. While this is self-serving on behalf of the agent, I saw quite a bit of this sort of behavior at my previous brokerage. Can’t say that I agree with it!

    You don’t lose market exposure by offering a lower commission, but you do directly impact agent behavior and lower your chances of receiving an offer.

  • ace

    @Kevin Lisota I would be interested in your professional opinion of the “stink bid”. Several realtors have said things like if you offer too little the vendor will be insulted and refuse to deal with you if you come back with a higher offer.

    If I’m a motivated vendor and somebody stink bids me, I say no and he later comes back with a decent offer there is no way in hell I say no to it because of his prior behavior (assuming he is qualified etc).

    (Some back story for you…last year I offered $500k less than asking on a home, the vendor said no, but came back a month later and said yes and I now have my dream home at a price most realtors would have been very reluctant to submit.)

    What do you think?