THE BLOG

The Most Economical, Most Sensible, and Most Overlooked Housing Market Reform

02/03/2015 04:33 pm ET | Updated Apr 05, 2015

Like Garrison Keillor's Lake Wobegon, where all the children are above average, it would seem mathematically impossible for both a homebuyer and a seller to get a better deal on opposite sides of the same transaction.

Yet this paradoxical best-case could easily be achieved by simply providing prospective buyers with the opportunity to cut out middle-people from the uniquely overstaffed real estate brokerage industry.

How overstaffed is this field? Here in Massachusetts in 2012, selling 70,000 residential properties required about 61,000 brokers and agents. Admittedly this 61,000 figure is a tad misleading because many of them also handled apartments and seasonal rentals, while others worked part-time or not at all. Even so, that doesn't seem like an onerous workload. (If a public sector union generated similar productivity, the Tea Party would have a field day.)

This featherbedding is a comparatively recent phenomenon. Our grandparents used one broker to buy stock and one to buy a house. Today, most people use none to buy stock... but two to buy a house. Surely we don't all require two commissioned salespeople following us around saying: "Look at these hardwood floors."

Homebuyers and sellers pick up the tab for this extra staffing. While the rest of the country is similar, I'll use my state as an example: even as stock transaction fees asymptotically approach zero, most Massachusetts commissions have held fast at either exactly 5 percent or exactly 6 percent. (Scroll down the link to see the price distribution chart, which forms an inverted bell curve, with almost no sales at the "average" commission of 5.5 percent.) Which of those two figures applies almost always depends on the town, making residential real estate fees perhaps the only "free" market in which prices are de facto fixed by municipality -- at specific integers, no less. (Can anyone spell "collusion"? Name any other product whose price changes exactly 20 percent when you cross a town line. Name any other product that is almost never sold within 10 percent of its average price. Finally, name any other industry drowning in supply -- one pundit writes that he feels like he is "surrounded by" brokers -- where the price doesn't fall.)

This unnatural pricing survives partly because no agent wants to alienate any other agent in order not to be shut out of future co-brokered arrangements, but also because prospective buyers have no idea what they are being charged or even that they are being charged at all, by a broker who appears to be free because his/her fee is bundled into the sales price.

Consider the absurdity the two-middleman staffing model creates. Walking into a real estate agency alone to buy a house allows the listing brokerage firm to pocket the entire commission. But if you walk in with your own broker in tow to buy the same house at the same price, the listing broker graciously cuts their own commission by half -- and gives your broker the other half. Is there any other retail establishment whose revenues automatically decline by half depending on who walks in?

Further, in many cases -- like if an unrepresented prospect walks into an open house and wants to buy it -- the listing broker assigns an agent within the same firm to "negotiate" against the other agent, who may sit at the adjacent desk. No mention is made of giving the prospect a better deal by just using one broker. (I know it's not always about me, but I recently purchased a vacant lot where there was literally no need for a second broker -- the price was the same as the other lots, it didn't need to be shown, I was paying cash, and I even knew the seller -- but the seller's broker insisted on assigning me my own agent within her firm, whom I never even met and who as far as I can tell did nothing. Yet, the realtor had said acting as my own agent was "not an option.")

Even houses sold by owners online typically offer commissions to "your" broker, using the code: "Brokers welcome." (Without that code, don't expect your broker to show you the listing.)

Yet, because real estate brokerage is a powerful cartel and because this fee passes largely unnoticed by the buyers who shoulder it, neither political party has been willing to confront the problem despite the major benefits of a more liquid market of faster sales of lower-priced homes. Fortunately no radical confrontation is needed. Instead a very simple regulation could solve the problem:

  1. A listing must disclose the hidden fee that the buyer's broker intends to collect from the seller at closing -- many thousands of dollars in most cases;
  2. Prospective buyers must have a chance to negotiate a lower fee, find discount representation, pay an advisor a flat rate -- or represent themselves and collect the entire fee at closing. (Obviously if they represent themselves, buyers would have to visit multiple agencies to look at multiple houses, not unlike buying a car or anything else.)

This proposal need not cross the Rubicon. This could be done for a limited period and re-examined later. Or it could be local-option, where municipalities can decide whether to proceed with it on their own. Such nose-in-the-tent implementations will inevitably become permanent and spread. There is no brokerage industry on record where prices rose when the industry was exposed to market forces.

Permanency is inevitable because this commission is by far the greatest amount that most people will ever spend on anything in their lifetimes without knowing it. Hence the fixed buy-side broker fee arrangement will likely crash once it is exposed to sunlight -- even briefly or even in neighboring towns. That crash would reduce transactions costs substantially, possibly to levels commonly seen in other developed countries of 2-3 percent, which in turn will increase the number of transactions, reinvigorating the housing market. Everyone benefits from more sales activity: buyers would pay a lower net price and sellers would likely sell their houses faster and possibly realize higher net proceeds.

The biggest beneficiaries might be investors who rehabilitate houses, for whom retail commissions are a major business expense. A more active, lower-fee market would also avoid some foreclosures by facilitating short sales, thus benefiting mortgage holders. Other beneficiaries include builders, lenders, home stores, and businesses trying to attract or relocate out-of-state employees.

The way to know is this a good idea is that the only arguments against it will come from the real estate brokerage lobby. Example: they might say buyers will get ripped off. But buyers will still need appraisals, they could still use a broker -- and they were already getting ripped off during the housing bubble even when they all had full-service brokers. These counter-arguments will be a tough sell, because this proposal wouldn't be a new requirement, merely a new option. Buyers will still be able to enjoy the privilege of paying retail for "full service" -- if they choose to do so. But for the first time, they will know exactly how much that privilege is costing them.

By contrast, if you were to tell new homeowners today how much they just unknowingly paid for their brokers, most would faint right onto their hardwood floors.