The Real Estate Commission Puzzle

by on April 12, 2013 at 7:30 am in Economics, Law | Permalink

Some seven years ago I wrote that the system of real estate commissions is horribly inefficient:

Consider, house prices are much higher in California than in Idaho but commissions are stable at around six percent. Thus, even though the realtor’s job, brokering a deal, is the same in California as in Idaho, a realtor in California will make much more per-house. As a result, there are far too many realtors in California and many of them will spend an entire year selling only a handful of houses. [At the height of the real estate boom in CA there were 437,000 real estate agents and only 680,000 home sales a year!, AT added 2013] Indeed, many realtor’s spend most of their time prospecting for clients rather than actually selling houses – this is a huge waste of resources. The same relationship holds over time as over space. That is, when house prices go up we don’t see a fall in commission rates. Instead, we see more entry. Since the same number of houses are being bought and sold, the extra realtors don’t make the buyer or seller better off and sadly the realtors aren’t better off either – instead the excess return is siphoned off in wasteful prospecting for clients. Unfortunately, no one really understands why commissions are stable.

When I wrote this in 2005 many commentators argued that fees would drop with the entry of online brokers. That has not happened. Indeed, as a recent piece in Bloomberg titled Why Redfin, Zillow, and Trulia Haven’t Killed Off Real Estate Brokers notes, the puzzle has in some ways gotten more difficult to understand. Today, lots of people use the internet to find homes by themselves, so brokers are doing less work, yet fees have by and large not fallen and most sales continue to use agents. Add to all this the Levitt and Syverson result that brokers sell houses too quickly and get lower prices than would be optimal for the seller and the puzzle deepens even further. As I wrote earlier the obvious answers don’t seem correct:

The answer is not monopoly. It’s very easy to enter the market for realtors. So why don’t commissions fall? One can certainly point to some restrictive practices by the NAR but I don’t think that is the whole or even the major part of the story. A clue to the puzzle is that we also see stable commission rates in law (contingency fees) and in services (tipping). Why is the appropriate tip 15% at an expensive restaurant and at a cheap restaurant? Does the tuxedoed waiter really have a harder job than the diner waitress? Maybe (indeed, I have argued along these lines elsewhere) but the commonality across these very different markets tells me something else is going on. Is it signaling? Would you distrust a realtor offering lower commissions? Again, maybe, but it’s hard to believe that with so much money at stake there aren’t enough people willing to take a risk on a discount realtor for long enough for reputations to be established. I think part of the problem in the realtor market is that other realtors can easily discriminate against discount brokers by pushing their clients one way or the other – that says the antitrust actions will probably not be very effective [and may help to explain why Zillow and Trulia which don’t compete with agents have been very successful while Redfin which offers more value but does compete with agents is still a very small player, AT 2013]. But this doesn’t explain stable commissions in law or waiting.

Hat tip: Newmark’s Door.

Gary Leff April 12, 2013 at 7:51 am

Not an answer but there is definitely price discrimination. You can work with a realtor that will give you a kickback — the same realtors work full price, and through services that rebate a substantial portion of their commission, either in cash or frequent flyer miles.

And of course at the closing table it’s pretty easy to squeeze not just the buyer or seller but also the brokers — you’re close to a deal, they are close to a payout, and a few thousand dollars can be extracted back from commission to close.

Most homeowners and home buyers have little to no experience in these transactions, each does one so seldom. Most real estate agents are inexperienced, as you note they don’t do very many transactions on average. Prices are set by brokerage firms.

Commissions get bid up (usually offering more to the buyer’s rep) in a down market, when competition for eyeballs of real buyers is fierce. Perhaps changes over the past 5 years would have reduced commissions, but market conditions drove them up in a countervailing way. 4% to buyer’s agents sort of PUT OFF the natural transition to lower commissions.

And that suggests as the market recovers we might finally see the shift to lower commissions, beginning gradually with a shift towards rebated commissions

Cliff April 12, 2013 at 8:55 am

I have bought 5 houses, and if you tried to negotiate for some of the commission AT THE CLOSING TABLE people would be screaming and throwing stuff. There are no brokers there and everyone would be absolutely furious with you. I would say there would be a substantial risk of the deal falling through just to punish you for your bad behavior. And at that point you have significant skin in the game and your agent also would probably not work with you again if you pulled that.

babar April 12, 2013 at 8:58 am

the docs from the bank have already been printed and signed off by lawyers, brokers, bankers, sellers, etc and who knows how many people behind them in their offices….

ChrisA April 12, 2013 at 8:44 pm

When I went to the final negotiation on the purchase of one of my houses, there was one remaining issue that we couldn’t close (about the costs of some repairs I wanted done to the house taken out of the purchase price). The sellers agent kept pushing us to close, I turned to the other party and said “Why don’t we take the cost out of his commission” almost as a joke. To my surprise the agent agreed straight away. It was probably about half his commission.

PD Shaw April 12, 2013 at 10:28 am

I know a broker who once had a practice of rebating a portion of the commission at closing. Unfortunately, he found that when the customer received the check, they often seemed confused about what it was for. He switched to a 5% commission, for which he had to give the biggest share to another broker when a fee-split occurred.

I think that home buyers are not necessarily very sophisticated, and the fees are somewhat hidden.

Ed April 12, 2013 at 7:53 am

I’ve been in fancier establishment where the prices have gone up and have been told by the waitstaff to tip at a lower pecentage. Obviously I was regular at these places. At some point the calculation was made that it was better to keep my custom than to drive me away with higher prices plus higher tips. But this doesn’t happen that often.

Paul April 12, 2013 at 7:53 am

I’m a Raltor in Maryland. I have to run out this morning to show houses, but very quickly:

Trulia and Zillow don’t actually make house hunting that much easier for buyers, and they add little value to sellers (who typically pay the commissions). They don’t have up to date information, and the zillow valuation tool has accuracy issues (in man areas, accurate market analysis requires some knowledge of the specific market).

A good Realtor still adds value by saving buyers time (we do the searching, ad we see everything in real time), acting as advocates and consultants, and providing negotiating expertise, as well as handling the contract to settlement process (something many discount real estate firms forgo)

On the selling side, market, marketing, and staging expertise still have a value difficult to replace, what ou see on HGTV notwithstanding.

Good Realtors are embracing technology, but many of the examples you give add little value other than to Realtors (we are how Zillow and Trulia make money).

derek April 12, 2013 at 11:58 am

As a buyer this is not my experience. For me, a realtor was helpful only in dealing with the other realtor, which is unsurprising given the subtle collusion noted in Alex’s post. I found the house I wanted to look at on Zillow and suggested it to my realtor, whose suggestions did not include the house that I purchased. Since there was no cost to me in using a buyer’s agent, I was happy to do so, but if it became normal to negotiate for a commission rebate from the seller’s agent, I would definitely avoid using a buyer’s agent again.

mpowell April 12, 2013 at 12:31 pm


Trulia and Zillow don’t actually make house hunting that much easier for buyers, and they add little value to sellers (who typically pay the commissions). They don’t have up to date information, and the zillow valuation tool has accuracy issues (in man areas, accurate market analysis requires some knowledge of the specific market).

This is total bullshit. Online listings have enormous value. My parents bought a house in 1984 and they saw 7 houses because they had to visit each one. When I bought a house recently, we probably looked at photos from 100 different homes in neighborhoods we were interested in around our price point. There are probably many buyers who don’t know how to take advantage of this information, but for even a minimally intelligent buyer there is a huge advantage to be had.

At the same time, if you are paying the full 3% on both sides of the transaction you are leaving money on the table. Some realtors won’t agree to a kickback. But other agents who are just as good will. It’s just a question of negotiation. I doubt anyone knows the actual industry rate of kickbacks. Maybe Keller-Williams (and they’re not going to tell you). It may be substantial.

Paul April 13, 2013 at 6:41 am

The technology available to Realtors is not the same as 1984, when the multiple list was actually a list in Brokers’ offices (and in most places, there was no such thing as buyer agency).

Today, we email clients information on potentially hundreds of homes based on thir criteria, and we can add our insight on those homes, en we go see the much smaller list. And we can actually represent the buyers best interest.

The information I send is up to the minute. Trulia and Zillow are often as much as a monthbehind, so many of the homes you see listed are no longer available, so Realtors can save people valuable time.

That is not to say there aren’t great web resources for buyers. Many MLS run public websites (homesdatabase.com, for example) that are updated along with the MLS.

Buyers usually don’t pay any commission, so I’m not sure why anyone would forgo buyer representation. Buyers are not the customers of Trulia or Zillow, advertisers are.

Geoff Graham April 12, 2013 at 7:53 am

Brokers rely heavily on other brokers for business. Many sales have a cooperating broker involved, and the fee is split 50/50. If a listing broker is willing to take less (say 5% rather than 6%), buyer’s agents will quietly shun the listing, refusing to show it to prospective purchasers. They absolutely do this where sellers offer a 50/50 split of a lower than normal fee, and they even do it in cases where the buyer’s agent is guaranteed 3/5 of a 5% fee or for FSBOs where the homeowner is “protecting” buyer’s agents if they bring a buyer. I think this dynamic makes their commission stickier.

Master of None April 12, 2013 at 9:23 am

I think if this were “true”, we would see more prisoners’ dilemma-type outcomes where a third-party broker would swoop in and pick up the twenty dollar bill. I’m conflating economic concepts here, but you get the point.

Reuben Moore April 12, 2013 at 9:34 am

Given the ability to find practically ALL listed and non-listed for sale properties on the internet, agents can’t really “quietly shun” anything. In almost all cases today, it is the buyer’s, themselves, who find the properties that they want to see.

If the offered commission is less than the buyers agent’s contracted price with the buyer, then the buyer’s agent has a choice: Either accept the lower commission, or charge the buyer the difference.

Rahul April 12, 2013 at 8:02 am

Cost of living? Realtors in CA have to live in expensive CA too.

I don’t see any rational parity point: Should inter-state $-per-sale be about same? Or $-per-year earned? Do any of those metrics make more sense than a constant percentage? Why?

Mike April 12, 2013 at 9:02 am

Bingo.

dead serious April 12, 2013 at 4:38 pm

How about lower-priced homes vs higher-priced homes in the same county, or town? Where I live there are million dollar homes and $300k homes practically side by side.

Why should an agent make $60k on one house and $18k on another? The effort expended has to be almost exactly the same with both sales. Hell, it might even be more on the lower-priced home as there might have to be more hand-holding.

alexh April 12, 2013 at 8:34 pm

A constant percentage is more than just “metric” of final agent compensation, it’s looks like there _rule_ that seems to be broadly honored nationwide. On the face of it, it looks just as if there were a nationwide price control authority setting and enforcing it (maybe it does it in it’s downtime after setting medicare reimbursement rates?). But there isn’t such an authority. So the question is not how to justify this particular rule, but why we see something that looks so much like a clear fixed rule (_any_ rule) in the first place.

You don’t need to take a stand on whether this is a good rule overall. whether it is good for agents, whether it is good for buys or sellers, to see that there is an important economic puzzle here. The market for agent services looks like it should be competitive (there’s no obvious monopoly or government coercion), and yet fairly compelling economic reasoning should then suggest we should see something quite different than what we do actually witness. (E.g. from the previous post, why aren’t rates systemically lower on the high-priced side of a town; why don’t agents just cross town to that location and compete down prices?)

Many people think the market is not competitive, and then they hear the silly and cravenly self-serving arguments some real-estate industry members serve up to justify the status quo, so they suspect the worse – i.e. we don’t just have an honestly competitive industry, but rather one that systematically conspires to loot the public. But the existence of many foolish “defenses” doesn’t prove anything negative (and anyway, how can the industry _maintain_ noncompetitive practices when so much is at stake?). It would be interesting, and furthermore a boon to the industry’s reputation, if we could find a sound economic reason why agent pricing ends up as it is without assuming an improbable collusion. But on the other hand, a relatively firm quoted price of 6.0%? Not 6.3 or 5.1? Not something that varies a bit with market demand? If there’s an explanation for this consistent with fair dealing and normal competitive practices, it’s probably a fairly subtle one.

Rahul April 13, 2013 at 3:03 am

Reading the comments it does seem like the effective rates may well be 5.1% in some cases. 6% is the quoted rate but if the agent is splitting his share back the actual commission might turn out lower?

Rahul April 13, 2013 at 2:59 am

@dead serious

Price discrimination? Perhaps the million dollar home owner can more likely afford to pay $60k than the $300k home owner?

byomtov April 13, 2013 at 9:56 am

This sounds sensible to me. If housing prices are a rough index of cost of living then the fixed percentage commission allows for this variation.

James April 12, 2013 at 8:22 am

I can explain a bit of the tipping puzzle between expensive and cheaper restaurants. My wife has worked part time at a diner for years, and the main benefit is less variability in income, faster table turnaround times and less people to split your tip with. She worked for a very short time at a fancy place. I remember her selling a $50 bottle of wine, but the tips had to be shared with runners, buspeople, bartenders. And people who order $50 bottles of wine don’t just leave after 45 minutes.

That is anecdotal to be sure. So if there is systematic data it would be more interesting.

Master of None April 12, 2013 at 9:26 am

FWIW, once it gets in to the upper echelons of fanciness, I typically tip less as a percentage of the bill (if less than $50/person, usually 18-20%). In part, this is because alcohol (wine) usually ends up being a larger portion of the bill, and, yes, because the nominal amounts get to be a little crazy.

But there are often offsetting factors… server is a friend-of-a-friend (+5%), server brings free drinks/dessert/appetizer (+40% of the value of the free stuff)

Slocum April 12, 2013 at 8:36 am

I’m not sure you can do very much about this as a seller (except FSBO), but as a buyer, it’s possible to contract with a ‘buyers agent’ for a flat fee who will then rebate the half of the commission that is split between the ‘listing agent’ and the ‘buyers agent’. Alternately, with a bit of googling, you’ll find people discussing negotiating discounts with listing agents in exchange for allowing them to handle both ends of the deal.

Bob Dobalina April 12, 2013 at 9:44 am

Not in every state. Outlawed in CT for example.

Anthony April 12, 2013 at 5:27 pm

There are also agencies who will sell for a flat-fee commission of about $1000 (though you’re doing most of the work yourself, other than getting listed on MLS), but provide a buyer’s agent payout of whatever you set (typically 3%), which shows up on the private part of the MLS listing.

david April 12, 2013 at 8:46 am

Its not a puzzle. As prices go up, more relators enter. So the comission per sale is higher, but the average realtor gets fewer sales. So the average realtor’s income is not necessarily higher.

Hasdrubal April 12, 2013 at 3:59 pm

But then, why don’t some of the realtors bid down the comission in order to make more sales?

GW April 13, 2013 at 6:43 am

It’s the same with medical doctors, as their supply increases, so do fees, suggesting that doctors (hospitals, etc.) set their fees by beginning from their expectation for their total income and working backwards to the charge per service, rather than beginning with a competitive market price for each service.

JWatts April 12, 2013 at 8:48 am

I contacted the listing realtor for the last house I bought and offered a flat commission fee, which was roughly 3% of my offering price. I think this happens a lot more than the statistics might indicate.

Shane M April 12, 2013 at 9:53 am

JWatts, can you elaborate? Were you buying and offering 3% or selling and offering 3%? (ex: If you’re buying you call the listing agent and say I know you’ll make $18,000 on this deal, but I’ll offer to buy right now at $X if you take only $9000?) thanks

JWatts April 12, 2013 at 5:23 pm

I was buying a semi-distressed property. And it was pretty similar to your example. In this case, I offered 300K with a flat 10K commission and settled on 335 of which the seller got $325 and the broker got $10K.

Rahul April 12, 2013 at 9:08 am

Bureau of Labor Statistics says the employment outlook isn’t bad:

“Employment of real estate brokers and sales agents is expected to grow 11 percent from 2010 to 2020, about as fast as the average for all occupations.”

http://www.bls.gov/ooh/sales/real-estate-brokers-and-sales-agents.htm

John Faben April 12, 2013 at 6:14 pm

How can employment grow at 11% over 10 years on average over all professions? Surely the demographics don’t work.

Rahul April 13, 2013 at 3:06 am

I don’t know. Some of the stuff BLS writes doesn’t make much sense to me.

e.g. “Employment of travel agents is projected to increase by 10 percent from 2010 to 2020, about as fast as the average for all occupations”

Travel agents? Really? I thought that was a dying breed.

Reuben Moore April 12, 2013 at 9:44 am

> “I think part of the problem in the realtor market is that other realtors can easily discriminate against discount brokers by pushing their clients one way or the other….”

In the internet age, I would sure like for you to explain how exactly that happens?

Bill April 12, 2013 at 9:48 am

As a Brit who owns property in Florida (I know – tell me about it!) I’m disgusted by the lack of movement on commissions. In the UK, you only have selling agents – no buying agents – and commissions have been falling for years, particularly since the onset of the recession. It’s quite easy to get one (yes one) percent commission. US realtors will no doubt argue that they provide more service than in the UK. Maybe, but five percent more service? Hmmm….The main difference, as far as I can see, is that realtors in the UK work on a more salary-based system. Low salaries plus small commissions. Also, in my experience, UK realtors tend to be much younger than in the US. Unless you own the business, or have a fantastic client base, it’s only the young who can afford to live on this kind of low salaries + commission basis.

I believe that Foxton’s, a UK realtor, tried to break into the New York market a few years ago and offered 3 percent commission. They didn’t make any money and eventually pulled out (the specific reasons I’m not sure about, but I believe it was because US realtors just refused to deal with them).

Basically, it’s a cartel, right? Is there anything else to say?

JWatts April 12, 2013 at 5:28 pm

Basically, it’s a cartel, right? Is there anything else to say?

It’s not even close to a cartel. I know plenty of people who have negotiated lower brokerage fees.

mulp April 12, 2013 at 8:12 pm

“US realtors will no doubt argue that they provide more service than in the UK. Maybe, but five percent more service? Hmmm…”

Sweet deal if you can charge 6 times as much while doing only 5% more work…

But that is the difference between the two sides of the pond.

Nigel April 12, 2013 at 9:51 am

I’ve always been puzzled by the extraordinary level of commissions in the US. Between one and two percent seems usual in the UK.

What extra benefit do US realtors provide ?

Glenn Mercer April 12, 2013 at 10:03 am

Um…. they tend to wear brightly colored blazers?

(More seriously, having lived in various countries over the years, I see huge variation in these commissions, but less variation in how they change. Is there a risk-aversion problem here? That is, if Customer A buys a house for $100,000 and pays a discount commission (the absolute level varying by country), and if A is not happy over time with the house, does A suffer years of regret and remorse (not to mention relentless criticism from friends and family) because he or she or others assert “Well, you got what you paid for!” Is there something about the large amount of money spent, and the long and hard-to-reverse typical ownership period, that induces people to “pay up?” And then add in that in the USA at least the cost focus is almost always on the monthly payment on the mortgage, which tends to wash away the impact of the commission? And then add in that for most people house purchases are so infrequent that there is little opportunity to learn about low commissions? (That is, if I buy only brand-name toothpaste I can experiment with generic toothpaste easily and quickly, with a few tubes of the other stuff over a month or two: how do I “sample” the discount commission market for houses.)

I guess I am wondering if the stickiness is due not to one large factor (e.g. the cartel) but to 5 or 10 smaller ones which add up to a web of resistance to change.

John Kozyn April 13, 2013 at 11:28 pm

Still scrolling down, but so far this is the most intelligent post I have seen…

bepah April 12, 2013 at 9:57 am

All of the data sources mentioned in this blog have no data to back them up. A critical thinker will not stipulate that there is any practical use for the references and the author wants us to accept his proposition that he makes. I choose not to do so. Since his ‘data’ implies that commissions should be down but facts are that they are not (again, no data to support this claim) his model must not be correct. I suggest that rather that writing an opinion piece, he relook at what drives the behavior.

Andrew' April 12, 2013 at 10:00 am

Sold a house “By Owner” and asked an agent if they’d split the commission with me (especially considering the buyer found me from a drive-by) and they said “no” and I said “have a nice life.” I eventually sold By Owner to a By Buyer and we split it ourselves. My guess is there is a critical mass, and as long as half the people are using an agent, and if their agent only deals with other agents there is a bifurcation point.

As for closings, I think I’ve said before that at the subsequent closing where I bought a house by buyer from a distressed by owner, we asked the lawyer to at least witness a contract that we were owed the escrow refund and the lawyer said “I can’t help you.” So, they just do their thing, dog.

j r April 12, 2013 at 10:08 am

Did you specifically ask him to split the commission or did you just push for an asking price that was 3 percent higher? What was the agent’s sticking point: the price difference or the principle?

derek April 12, 2013 at 12:04 pm

This seems like a sub-optimal negotiation strategy to me. If you had simply initially listed the home price as 3% higher, then for a agent-buyer, you would charge the normal price, while for a By-buyer, you could entice them with a 3% discount. This avoids the awkward situation with the buying agent and allows you to incentivize any By-buyers.

Andrew' April 12, 2013 at 4:02 pm

I’ll write that down for next time. On the other hand, I’m too old for anything to be awkward anymore.

j r April 12, 2013 at 10:06 am

How much of this is a simply an information asymmetry?

For most people, this is the biggest purchase/investment/financial transaction that they will ever make and they do it maybe a couple of times in their entire lives. That gives real estate agents a tremendous information advantage over buyers and sellers.

Also, most people don’t think of themselves as paying for an agent when they buy, since the fee is baked into the price. Then when they sell, they may feel some obligation or desire to go back to their buying agent either to handle the sale or refer someone.

Rahul April 12, 2013 at 10:17 am

Does it ever happen that after being matched the buyer and seller bypass the realtors entirely (unethically, of course)?

Or is there a contractual arrangement that makes this difficult? Unlike other commission based transactions the buyer / seller reputational incentive is minimal since there’s very low probability of repeat business.

PD Shaw April 12, 2013 at 10:23 am

When you retain a broker, you sign an agency agreement that you would be violating if you tried to cheat that broker of his commission. Lawsuit probable.

Da55id April 14, 2013 at 1:02 pm

This theory sounds correct. Therefore it can be tested by creating a fsbo negotiation simulator wherein the simulator presents multiple negotiation, legal and closing scenarios to provide the user with a simulated lifetime of typical, unusual and consequential situations. This could be a business in itself.

Urso April 12, 2013 at 10:18 am

Seems to me that, for sellers’ agents at least, the rate should be structured as a modest flat fee + 10% of the selling price *above* some agreed-upon floor. So if the parties think it is a roughly $300K house, and it sells for $330K, the agent cashes in. If it sells for $300K, the agent breaks even. This gives agents more skin in the game.

Obviously wouldn’t work for buyers’ agents.

Paul April 13, 2013 at 6:46 am

I’m licensed in a state where that is illegal.

Prefer to Remain Anonymous in this Case April 12, 2013 at 10:27 am

I can report from the front lines that some buyers are distrustful of discount brokers.

My wife, in other respects a highly intelligent person, believes that full-price realtors have a magic inventory of desirable properties at affordable prices, that discount realtors associated with Redfin do not have access to.

Matt April 12, 2013 at 10:29 am

Online brokers haven’t replaced agents because the main functions of an agent are to:

1. Navigate the legal mumbo-jumbo that no normal person has time to bother with
2. Give advice. This is actually difficult to do while avoiding just telling people what to do.

You are basically paying for someone who knows what they are doing, which is usually a good idea. That doesn’t mean that it is never possible to go without an agent and come out ahead for it.

The fees haven’t changed because they are basically arbitrary. What should an agent be paid for a sale? 3% seems as good as any other number, and in truth most agents only get half of that.

For the tips example, tips are constant because ideally waitstaff being more highly paid at more expensive restaurants translates to better service.

Rahul April 13, 2013 at 3:13 am

About your #1: In a typical US home deal is a lawyer involved or not at all?

byomtov April 13, 2013 at 9:53 am

Quite often there is no lawyer involved until the actual closing documents are signed – a tedious procedure during which a lawyer hands the buyer an endless stream of papers, including one in which the signer asserts that he is in fact the person signing.

Rob Kinyon April 12, 2013 at 10:33 am

I wonder if the inelasticity of relator commissions has to do with the fact that most buyers/sellers only interact with the real estate market once or twice in their lifetimes. Doesn’t the law of supply and demand pricing have an assumption of a certain amount of repeat business by the same individuals?

Andrew M April 13, 2013 at 8:50 am

Yes, but although each individual only makes a handful of transactions in their lifetime, buyers and sellers do talk to each other in great detail about all these things. “Which realtor did you use? Was he or she any good?” Not to mention all the advice from parents and well-meaning extended family members when you announce that you’re thinking of buying your first home.

Mike H April 12, 2013 at 10:50 am

This sounds similar to the current problem of legal job market where you have a paradoxical situation of 1) Ever-increasing attorney’s fees among big-law firms and corporations paying them $1000 per billing hour 2) Tens of thousands of recently-graduated JDs out of job or working in retail 3) More and more Americans go to court without a lawyer because they can’t afford (or just don’t want to pay) one and instead rely on their own online “legal research”.

On the other hand, competition from online real estate websites tend to hurt small market realtors the most as they lose commissions in rental and cheap houses, while mid and high end realtors take advantage of the reduced competition from the bottom and therefore are at liberty to set higher commissions.

I think this is yet another example where internet actually increases the barriers to entry in highly specialized markets, although there might be some forces at work here we are not aware of.

Mark Thorson April 12, 2013 at 10:51 am

As executor of my parents’ estate, in the not-too-distant future I’ll have to sell their property consisting of three houses on two acres in one of the most desirable parts of Silicon Valley. I’m wondering what alternatives to traditional real estate agents I should consider. I have been considering making up a sandwich board and handing out flyers outside of Google and Facebook.

Anthony April 12, 2013 at 5:34 pm

As I mentioned above, there are sellers’ agents who will charge you a fee of about $1000, put your property on the MLS (so buyers’ agents don’t steer customers away from your property), and pay the buyer’s agent commission (at whatever percentage you set, but make it 3% or buyers’ agents will refuse to buy your property).

http://www.congressrealty.com/ says they’ll charge $299 in California.

Mark Thorson April 12, 2013 at 6:36 pm

Thanks! I’ll save that link.

Rahul April 13, 2013 at 3:15 am

Buy google AdWords? Wacky but just might work. I think they allow you now to restrict ad placement geographically.

Mark Thorson April 13, 2013 at 11:25 am

That’s an interesting idea! Wacky is good in advertising because it means it’s new and different — that gets attention. Less wacky than the sandwich board idea, but much less work too. Gorilla suit + sandwich board has the disadvantage of being uncomfortable, especially in the summer.

Doug S. April 24, 2013 at 6:32 pm

Craigslist?

Ben Doty April 12, 2013 at 11:16 am

I bought a CA home in 2010 with Redfin and they refunded half of the buyer broker’s share of the commission, so half of half of 6% or 1.5%. The effective commission was %4.5. I don’t know what the market is like now, but a lot of “regular” brokers were advertising the same deal at the time.

Master of None April 12, 2013 at 11:17 am

Brokers serve an important role: it is their job to sell the house. Most people selling a house have a full-time job. They can’t drop everything for 3 hours 4 times a week to go give someone a tour of the place.

So, here is my model: Necessary service + occupational licensing = price fixing

This model also works with investment bankers and IPO fees (see research showing that 95% of all IPOs pay a 5% fee to their bankers)… you would think this would be competed away, and yet…

babar April 12, 2013 at 11:31 am

i don’t imagine that occupational licensing has much to do with it. it’s very easy to get a realtor’s license, at least in the states where i’ve lived. it does make sure that people don’t do it themselves, though.

RC April 12, 2013 at 12:12 pm

There’s a big difference between a realtor’s license and a broker’s license. While the former is relatively easy to get, the latter is not. People can’t “do it themselves”, because they still have to work through a broker.

James April 12, 2013 at 6:57 pm

I think it depends on the state. For example in Wisconsin, you pretty much have to take a class and pass an exam and you can become a real estate broker (i.e. not sales). I actually considered it when I was considering investing in some property there. Of course then you have to disclose you are a broker on any offers, etc.

jimbino April 12, 2013 at 11:51 am

I’ve bought and sold several houses without resorting to an agent. I now have a home to sell in Brazil, and my usual lawyer says he’ll handle the deal for 8%. I told him, no, there’s no way I’ll pay 8%. I can’t wait to show him that the fee is as low as 1% in Britain and low even in Germany.

The biggest obstacle is establishing a selling price. It’s worth hiring a couple of appraisers and skipping the RE brokers.

Bill April 12, 2013 at 12:21 pm

One or two people have suggested that commissions remain high because people rarely buy and sell homes. I’m not sure I agree. In the Sunshine State, for sure, real estate turnover is – or certainly was! – quite high.

Anyway, the important point, surely, is that the market doesn’t seem to be functioning properly. As much as realtors will tell you otherwise, the service they offer is simply not worth 6% of the sale price. A buyer’s agent, i would agree, has to work hard – taking clients to see properties etc. But what does a seller’s agent do – apart from take a few photos and list the property? Anybody who’s lived in an area for a few years usually has a pretty good idea of where a condominium, for example, will sell.

Btw, someone mentioned that people don’t com[plain about the commission because it’s “in the price”. Not so. You list your property, sell it, then get gouged.

Someone else talked about tipping in restaurants: now tipping realtors, instead of paying them commissions? That’s an interesting idea!!!

Nicholas Weininger April 12, 2013 at 12:32 pm

Having now bought two properties with the same agent in a very expensive market, I find that a good buyer’s agent can earn his/her outsized commission in these ways:

1. Sound judgment as to what kind of house you, the buyer, are likely to really want. A good agent will recon a bunch of likely-looking-on-paper houses ahead of time and then tell you which ones you should actually go see, in priority order. Even with Internet virtual tours this in-person scouting remains a valuable service, not least because the virtual tours are skewed to present the house in a literal and figurative better light. If you are buying in an expensive market your time is probably worth a lot, so the value of the advance scouting goes up proportionately.

2. Related to (1), the ability to use their connections to other agents to get you in for private showings when the house would not ordinarily be open. Another great time and convenience saver and it also lets you take a closer look at a house than others might and thus make a better offer, which brings us to…

3. Sound judgment as to what houses will actually sell for, how often comparable ones will come on the market, and how to craft an offer to win a bidding war. In low-inventory, high-demand coastal markets, this can save you months of searching and tons of stress and wasted effort from losing bidding wars; it can also save you from overpaying in order to win that house you “just have to have”.

I suspect that expensive-market real estate agents are sort of like drug dealers in Sudhir Venkatesh’s book, where a very few of them earn the vast majority of the commissions and the rest scrape by and hope. I get probably half a dozen flyers from agents in the mail every single day, and would never even consider looking at any of them; the good agents get their business mostly through word-of-mouth referrals.

Mike April 12, 2013 at 4:15 pm

All this rings true to me. We started out buying last year using Redfin in an overheated market (Seattle: lots of buyers, little inventory recently; lots of bidding wars). We met more than one agent who admitted they directed their sellers away from Redfin buyers because they were “value buyers”, which is bullshit and strikes me as unethical. At any rate, the market got so heated we needed a lot of help putting together appealing offers and trying to win bidding wars, and we weren’t getting it from Redfin’s model. When we switched to a traditional agent, we got a lot more help with that stuff. She also did preview houses and do a reasonably good job figuring out which ones we should see, so we spent less time visiting houses with her. Finally, we ended up snatching house that was going temporarily off the market, that we heard about because their agent knew our agent.

Frankly, the whole thing infuriated me, but given the state of the Seattle market, I felt like we had to use a traditional agent in order to get the house we wanted. If I were buying again in a more relaxed market, I’d try again with Redfin. If I could do much to break the agents’ stranglehold on the market, I would. They offer useful services, but there should be price competition and a better opportunity to decide if those services are worth it for you.

On the selling side, the agent’s experience with cleaning up and staging the house almost certainly paid for itself. She just had a good sense for what was worth doing.

Anthony April 12, 2013 at 5:42 pm

My experience with realtors in the Bay Area is that the majority of them are not competent to do their jobs. Realtors are told that the point of sitting an open house is to prospect for buyers; in my experience, this means they don’t bother to find out basic facts about the house they’re selling beyond the asking price.

Foobarista April 12, 2013 at 1:07 pm

Part of the reason there’s so many people with RE licenses in CA is RE investors are strongly incented to get a RE license by the tax code; you can write off a bunch of investment activity if you have a RE license.

Also, you need a RE license to sell commercial real-estate and businesses. My wife has an RE license and has never sold a house, although she’s sold several buildings and dozens of businesses.

One element of commissioned sales is if you think about it in terms of deals, “winners” subsidize “losers”. In business selling and presumably in house selling, most deals fail, and the agent gets nothing. Since almost no buyer or seller will pay agents a salary to handle the transaction, commissions have to be high enough to support an agent doing lots of work “for free”.

Also, as for the 6% (actually 10%+ in businesses, although amounts involved are typically smaller than residential RE), there’s lots of splits and taxes involved. The agent is lucky if they net 30-40% of their side of the commission after splits and taxes.

Bernard Guerrero April 12, 2013 at 1:56 pm

Dutch Disease? The amount of work it takes to be a broker in CA may be identical to that required to be one in ID, but the amount of money it takes to attract one to the business surely must be higher given the relative cost of living. And the knowledge required to work in either market is not easily transferable.

Guy April 12, 2013 at 2:09 pm

Real Estate Brokers are similar to Investment Bankers and Lawyers. Everyone loves to hate them until they need a good one.

Every house and every real estate transaction are, by definition, unique. Every case worth litigating has subtle nuances that have to be balanced out, and every company has a capital structure and different attributes that require a lot of analysis and good judgement.

There is a LOT of friction in a real estate transaction and there is also a LOT of things that can, and do, go wrong. A good agent absolutely adds value to the process by more than their fee. A good agent/broker’s job is to manage the entire transaction process on behalf of their client, which in many cases involves dealing with a dozen conflicts between appraisals, inspections, underwriters & escrows. If a deal blows up you simply don’t get paid for all of your advice, judgement and skill, even if it isn’t your fault and you did everything “right”.

The sheer numbers of licensed agents is meaningless. The barrier to entry is such a low hurdle that anyone can do it, motivated by the potential of big commissions on just a single house, particularly in California. The truth of the matter is about 80% of those licensed are “trying it out”, a bit less than 20% really struggle and muddle through, while a select few agents/brokers in the field are competent enough to build up a deal flow sufficient to make decent money. (About 1%!)

Disclosure time: I’m a homebuilding and land development executive with over 15 years experience in the field, mainly in project finance and business planning. My current company, whom I’ve worked for for over 10 years, built over 3,000 homes in California during the previous boom-bust cycle.

During the housing bust we took foreclosures, renovated them to a “better than new condition” and sold them on the MLS. (Flip is a four-letter word)

On every transaction on the MLS we pay a full commission to the selling agent, and it is well worth it.

ChrisA April 12, 2013 at 8:57 pm

The puzzle here is not that people need a Real Estate Broker, I would guess than 95% of people would say they do, but why do they get a fixed percentage, and why is the percentage so high. The amount of work must be broadly fixed per house, not as a percentage of costs. And why, in this new electronic age, has not the cost come down somewhat?

Dave April 12, 2013 at 3:03 pm

I’d say that the large price is a big part of it – a home is the biggest purchase (and hence the biggest risk) most people take in their lives. The fear associated with that kind of risk tends to stimulate the limbic response to cower and trust the experts. And with their shiny business cards and gleaming smiles, a seemingly experienced realtor can assuage some of that fear.

But I’d build on that notion, which you mention in your piece, and say that increasing the anxiety is that most people only buy 1 or 2, maybe 3 or 4 houses in their lives. They don’t have a lot of practice. Using your tipping analogy, it’s possible that the first several times you needed to participate in the tipping ritual in a restaurant, you miscalculated or weren’t really sure what you were doing, or if you needed to lessen the tip because your steak was cold, or the waiter looked the other way when you were ordering, or, or, or. . . Over time, perhaps even after a handful of meals, you got the hang of it and probably no longer give much thought to “screwing up” the tip. But a handful of times is almost twice as many times as most people get to “screw up” their home buying for life. And so the risk is increased, and the cowering reflex intensifies.

I recently sold my apartment using only a discount broker. I also paid a broker acquaintance $100 an hour to consult with over the course of the sale (total: $300), and that mainly comprised of soothing and hand holding while the negotiations were the most intense.

In the end, I got above asking in a tough market, and fully 10% (~$50,000) more than most of the brokers I interviewed suggested was possible. I also saved the 3% in broker’s fees (~$16,000), so I made out like a king. My consulting broker told me unequivocally that no broker would have gotten me a price that high, and I would have lost the 3% to boot.

I was very pleased with myself (obvi), but I have to say it took some balls to do it and not simply place myself into the warm, certain embrace of an all-knowing broker who would have cost me over a year’s living expenses for the honor.

Incidentally, in the process, I was *floored* by the unscrupulous behavior of some of the buyers’ broker I encountered. One actually forwarded me emails between him and his client discussing their negotiation strategy and telling me what his maximum bid would be. I feel really badly for that guy, but it goes to show that brokers panic just as much as buyers/sellers when the waters get hot.

Anyway, I can see how most people would buckle under the fear and just pass the responsibility over to some authority – any authority – who could promise them calm and certainty. We don’t have a multi trillion dollar government behemoth for no reason! All you need to do is tickle the brainstem, and people will do whatever you want them to. Brokers seem to have figured this out, and as appalling and immoral as their quasi-monopoly is, I’m no longer surprised that it has held its ground over the years. Maybe if there’s a second crash and real estate comes with less daunting price tags, people might be willing to step out on their own a bit more. But of course, there will be fewer brokers to service them at that point. . .D

Gary Lucido April 12, 2013 at 4:05 pm

I’m a full service, discount broker in Chicago and I’m indeed perplexed by this whole issue, which is why I opened my brokerage. I’m still mystified. In the current hot market some agents are earning $2500/ hour for listing a 1.5 MM condo that sells in 2 weeks. Why aren’t the sellers shopping around? I think it’s partly the endowment effect (see behavioral economics) – risk aversion to losing on something you own. These sellers really believe that a full price realtor will sell their home faster and at a higher price. Of course they are dead wrong.

There’s also this relationship thing going on, where buyers and sellers are terrified of jeopardizing a personal relationship to save several thousand dollars. So they go with cousin Vinny or their old college roommate.

How else do you explain irrational behavior?

BTW, when I was creating my business plan I did read a research paper that postulated that low barriers to entry in real estate led to higher commissions. Just as Alex said above, realtors just spend more time prospecting and more money advertising – and consumers fall for it.

Reuben Moore April 12, 2013 at 6:12 pm

Today, there is no “subtle collusion” by traditional agents to “punish” other agents for discounting or working with discounters. Given the fact that most all for sale properties can be found by buyers on the internet, agents can no longer steer their clients away from ANY property that even vaguely interests the buyer. No matter what, the buyer is going to want to see that property.

However, traditional agents do dislike discounters because the discounters often shift transactional responsibilities from their side to the other (that is, to the traditional agent). And since the traditional agent’s clients know about the properties in advance, the traditional agent is forced to cooperate with the discounter. And often, do a chunk of their job.

Agent commissions, even when cooperating with a discounter, are protected in the agency contract. So from an agent perspective, this is not about pricing. It’s about duty shifting.

Tom of the Missouri April 12, 2013 at 6:14 pm

I am a real estate investor in St. Louis and not a broker. I usually use a discount broker to list properties or if it is a hot neighborhood simply put a sign in the yard (You would be suprised how quickly the word spreads among brokers and everyone else.) Most discount brokers who I pay $300 insist on giving the brokers their half, i.e, their 3%. It is a considerable savings. I often have a flood of brokers contact me and tell me how I am asking too much and how I am losing out not giving the listing to a full service (read 6% broker). I have a 100% record of selling for more than the brokers recommended and for halving or eliminating my commissions. The brokers and agents don’t like it but most of them put up with me. I am sure that some of them avoid me but so far it hasn’t hurt.

As to Tylers assertion that increasing regulations don’t affect commissions. I disagree. Like all government or semi-government regulators, our state real estate commission (i.e., the regulators) gradually over the years continues to add to their regulations and licensing requirements. I used to be a broker because a broker’s license was required to manage property for others. I was just doing it as a favor for friends (most were bankers or other sophisticated investors) but I eventually quit for fear of running afoul of their ever increasing regulations. I once asked my state auditors who they were protecting in my management business? I told them my tenants and property owners would all volunteer not to be protected by them if we could opt out, but they said it was not allowed. I gave them my license and quit. My company was small and mostly under the radar and once appealed an issue to the state real estate commission. I lost. I was told that they could not make exceptions for me and that little guys like me were such a hassle to regulate. I was surprised to find that the commission board was of course made up of owners of large real estate firms in the state. They were certainly in my opinion in the business of making things easier on themselves and harder for small firms and individuals. I am sure it has gotten much worse since I have left. There has also been a continuining increase in the amount of time and expense required in taking classes to get ones license either as an agent or as a broker. All of this of course enables to big firms to control the business and thus maintain the 6% holy grail. It is certainly anything but an unregulated free market and on many fronts they keep it that way.

Bryan Caplan April 12, 2013 at 11:22 pm

Alex, I’m shocked that you failed to mention the fact that your original post inspired me to write my *Pandaemonium* scenario, “Today 6%, Tomorrow the World!” I could run it again at Capla-Con 2013…

Brian Holtz April 12, 2013 at 11:58 pm

As knowledgeable and patient buyers in Silicon Valley, my wife and I eschewed a buyer’s agent for our 2000 and 2006 purchases. For our first purchase, the selling agent was of course salivating for our offer, even after we negotiated a kickback of 1% of the price. She then effectively sold out her seller, and even bragged to us afterwards that she got him to accept our offer even as another competing offer was walking up the sidewalk. If we had been outbid by a represented buyer, she would have lost tens of thousands of dollars. Most sellers probably have no clue about this conflict of interest.

I can’t understand why anybody would use a buyer’s agent, unless they were 1) under enormous time pressure, or 2) were not competent to match their housing utility function against the online inventory.

Gary Lucido April 13, 2013 at 12:50 am

Brian,

That’s why we offer people like you an hourly model where you pay us $100/ hour to do the stuff that doesn’t make sense for you to do and then we rebate 100% of our commission to you. So instead of you getting just 1% of the price back you could get up to 3% back depending upon what the co-op is.

ag April 13, 2013 at 1:43 am

I have been casually looking, and am about to seriously pursue, an investment property in Houston. I have noted a couple of rather frustrating things in the course of researching local sub-markets:

1. Finding accurate and current information on recent sales is almost impossible, without either visiting (in person) the tax office, or hiring a realtor. MLS listing services such as HAR in Houston, and even Zillow/Trulia, do not provide accurate information on recent sales. For someone who is trying, on their own, to determine if a listing price is reasonable, this obfuscation makes the task frustrating at best. Without a realtor account at HAR.com for instance, I can only see a “range” of prices that a house has sold for (i.e. “This house sold for between 100,000 to 115,000″). Of course a membership that gives access to sales data costs money, and in this particular case is limited to licensed real estate agents/brokers.
2. Houston is a large, very diverse market. Trying to find a real estate agent that knows the area I am interested in, and has experience dealing with things like foreclosures and rehab properties is very difficult. With more experience in buying/selling homes, I am sure this would not be an issue. But combined with the first problem, it puts me at a severe information disadvantage when it comes to evaluating home prices.

I spent a good two hours on Redfin today after reading about it here for the first time. I was not impressed, particularly since they “partner” out their service for homes less than $200k, which is more than the median price of home sales in Houston.

The first company that is able to provide accurate, real-time data on home sales, trends, rents, etc. and to do so with a realtor-beating fee will make a killing.

Rory Sutherland April 13, 2013 at 9:34 pm

I don’t think the on-the-ground realtors will disappear any time soon. One of the essential ingredients of trust is being rooted in one place. In other words you have to be at risk of reputational damage in order to be fully trustworthy. Someone who is highly mobile is less trustworthy by definition since they can simply up sticks and move elsewhere without much loss, and escape the reputational consequences of their deceit.

The seller of a home is, by definition, moving elsewhere. Hence you need someone else who is committed locally – who has a long lease on an office somewhere, and a reputation which has taken them time and effort to build – to be the person who will be around to be embarrassed/sued if your new home turns out to have some major flaw.

The other game-theoretic explanation is that, once you offer less commission to the selling agent, he is going to be less eager to sell your home than any of the other properties on his books. Ditto with a buying agent – cut his commission and you will end up being shown around his crummiest homes. So you offer the norm, or I suppose even more than the norm if you are in a hurry to sell.

The same applies with tipping. The point of a tip is not to reflect the value of the service, but to reflect/signal your generosity relative to the other diners. Without an arbitrary norm, the signal has no value – if everyone performed their own calculations, it is no longer clear from the size of a tip whether I was a happy or sad customer – a generous customer to be welcomed back or a mean one to be treated resentfully.

But the actual norms seem to be arbitrary. Not only in real estate commissions but in tips. As a Brit, I now know to be more generous in the UK than the US – 10-12% is acceptable in Britain. However when I go to most overseas countries, taxi drivers seem to find London-style tips pretty generous.

Gary Lucido April 13, 2013 at 11:39 pm

I don’t think you want to negotiate down a realtor who doesn’t normally negotiate for the reasons you state. What is difficult to understand though is why consumers don’t shop around for discount realtors who don’t suffer from these problems. And discount does not have to mean lower service levels.

Bill April 14, 2013 at 11:51 am

Questions on tipping; Why should I tip someone standing behind a bar who simply pours me a beer and takes my money? Why should I tip a taxi driver, particularly a New York or London taxi driver, who is hardly on the breadline? And why DON’T I tip a bus driver, who may well be earning less than the taxi driver? Where do my tips go? To the waitress or to the person who cleans the toilets? Should I tip the same if I get great service but lousy food, or lousy service but great food? What if I find the background music SO annoying that I hate the experience of eating there? Why should I subsidise a restaurateur who pays his staff sub-minimum wage? What if the I’m served by the owner of a restaurant? Why should I tip him? The answer is I tip because I want a quiet life, because I don’t want some New York waitress screaming at me in front of a hundred other diners. Yes, I’m a moral coward, folks! Just like (most of) you!!

Bill

Mike April 14, 2013 at 5:24 pm

While I agree that it is surprising that commission rates have remained at roughly 6 percent for so long, it is not obvious that competition and free entry should drive these rates to zero. To the contrary, we should expect competition to drive the commission rates for sellers’ agents up to 100% coupled with a lump-sum transfer to the sellers of the expected equilibrium price that the (now highly motivated) seller would obtain. In other words, sellers would essentially auction off the right to sell the house (and keep all the subsequent residual claims) to the sellers’ agents. Analogously, it ought to drive the commission for the buyers’ agents down to -100% coupled with a lump-sum transfer to the agent for the expected equilibrium price at which the (now highly motivated) buyer would be able to buy the house. This would yield zero expected profits for the marginal agent who is considering entering and would maximize the value of their services to the home buyers and sellers.

Ray Schmitz April 30, 2013 at 6:23 pm

There are a few different parts to what is going on here:

Buyers do not pay their own way, with most buyer agents being paid whatever the seller and the seller’s agent agreed.

Add to this that the local MLS might regulate the split between fees paid to the seller’s agent and those paid to the buyer’s agent. For instance, a 6% fee might have to be split exactly 50-50 between the agents on each side of the transaction. This *is* a monopoly

Market concentration is actually much greater than the number of agents would suggest, with most markets having 3-7 dominant brokerages controlling mostr of the listing inventory. (On the buy side the market concentration is lower.) This makes it much more likely that collusion (perhaps implicit) will help keep the commissions stable, where they are set, which is when a seller signs an exclusive agreement.

Possible solutions:
1) Get rid of the 2-tier license system so agents can more easily be truly independent. (I think Colorodo did that.)
2) Have competing MLS systems (as in Atlanta).

It would be telling to look at these markets for evidence, but I suspect neither alone is sufficient to change the system. However, neither may be what is truly necessary either.

If buyers understood that economically they are the third-party payers funding agents’ compensation on both sides they could negotiate a commission rebate, at least in the 40 states where permitted (in 2013).

I was always taught as a Realtor not to discuss commissions with the buyer which suggests much of the trade agrees with me on the prior point.

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