Do any of you guys know anything about economics? Because I have a question I can’t answer and I’m hoping you can help me.
In many real estate markets (including the one where I’m currently shopping), the agent’s commission is equal to a fixed percentage of the sale price. (Typically it’s 6%, though this is split evenly between the buyer’s and seller’s agents, each of whom gives a cut to their respective agencies, so either agent’s take-home is more on the order of 2%).
This means that if you sell a million-dollar house, you earn TEN TIMES the commission of your identical twin who sold a hundred-thousand-dollar house, though I doubt very much that you did ten times the work or bore ten times the expense.
Now, plenty of hundred-thousand-dollar houses are being sold, which means that plenty of agents are settling for the relatively dinky commissions. Question: Why are those agents not attempting to steal some of the high-end business by offering to accept a smaller percentage? After all, 1% of a million is still a lot more than 2% of a hundred thousand.
You might say that the agencies collude to restrain them — but what stops a rogue agency from busting the cartel?
All too many times in my life, I’ve noticed some apparently anomalous behavior which I’ve challenged myself and/or others to explain with the tools of game theory, axiomatic bargaining theory, and the theory of markets — only to discover that the true explanation is “It’s required by law”. (Of course one can always step a little further back and try using economics to explain the advent of the law.) But I don’t think that’s the case here. (I’m prepared to be wrong about this, though.)
So what’s going on? I see something that looks a lot like a competitive labor market where different workers receive substantially different wages for doing pretty much the same thing. Economic theory says that under very general circumstances, that can’t happen. Why is this market different from all other markets?
My knowledge of real estate practices is (very) rusty, but I believe the cartel behavior is enforceable because a buyer’s agent needs the cooperation of the sellers’ agents in order to get access to listings. Or is it the other way around: a rogue agency would still need the cooperation of buyers’ agents in order to bring them potential customers?
It’s the wrong time of night for me to sort this out, but I believe that’s the basis of it: the same cartel controls access to the market from both sides.
You can negotiate the commission if you are selling a million-pound house. At that level, nobody pays full price. Come on, Steve!!!
Secondly selling a million-pound house is more expensive. You can’t just turn up late, show them round for 15 minutes or even just hand them the keys and ask them to drop them off at the agency. You have to turn up early, talk through your prepared talking points about the virtues of the house, show them round several times, and be prepared to answer many questions. That all takes a lot more time.
Well generally not all million dollar homes are in a neighborhood with 100.000 dollar homes, so I am guessing cost of living factors into it as well?
Then there is of course frequency of selling of type of homes, million dollar or ten million dollar homes are not sold every day whilst their cheaper counterparts i.e. mid-range, change hands more often?
The cost-benefit calculus a real estate agent makes is = frequency * commission * house prices – cost of living.
So a little bit less frequency and a higher cost of living should explain part of the difference.
When it comes to different real estate agents in the same area selling different priced homes it might be either specialization or the result of a tournament pay structure. I find the latter to be not improbable: the best agents get the perks of selling expensive homes.
That there is a 6% collusion isn’t far fetched. See US v Foley, 598 F.2d 1323 (4th Cir. 1978).
And while this doesn’t really answer your question, it might be a bit informative: “You Don’t Have to Pay 6% Broker’s Fee.”
http://www.nytimes.com/2011/01/30/realestate/30cov.html?pagewanted=all
I would not have thought the barriers to entry for real estate were large enough to maintain a cartel. There are quite a lot of agents out there, and if I were selling or buying a $1M house, then I would be attracted by a rate of 5% instead of 6%. I would have thought that it would be easy enough to set up shop offering discounts for larger houses.
It may be that sellers of million dollar houses can negotioate commission, but why not jump the gun and offer lower rates up front? This will surely bring you more business than being secretly willing to negotiate if asked.
Perhaps the peception from the seller is that anyone offering a lower price must be offering a lower standard, but that does not ring true to me – especially as it is real estate agents we are talking about.
I think the real estate business is quite competitive. If the agents are not making excess prifits, then the wealthy must be subsidising the less wealthy.
Presumably there is a minimum fee for very low priced property.
So it is a mystery to me at the moment.
To provide some international colour and an argument SB7’s point, I can inform you that in London there is no buyer’s fee (at least not explicitly) but the same %-age is still charged no matter what the value of the house is.
SB7: In London there is no buyer’s fee but the same %-age is still charged to the seller no matter what the value of the property is. (My previous post seems to have gotten lost for some reason so apologies if you see this twice)
Don’t really know, but this guy thinks he does:
http://blog.franklyrealty.com/2011/02/6-realtor-commissions.html
On the other hand, he sounds like he is selling something, so I doubt his objectivity.
Wait! What’s that I hear? Is that Steven Landsburg arguing in favor of the labor theory of value? Don’t tennis rackets and shoes sell at vastly different prices even though the cost to produce the racket endorsed by Federer and the shoe endorsed by LeBron sell for much, much, more?
Now, my answer: There is far more negotiation at the top end. There is also a lot more spent by the agent in marketing the home. First, advertising the home in more exclusive media sources is more costly; and second, the market is thinner so they sit on the home longer.
Lastly, I do believe that agents to uphold the cartel for reputation reasons. Agents change agencies all the time and don’t want to be known as a renegade or non-cooperator.
Maybe it is ten times harder to sell a really expensive house. Finding people who can afford it is tough. Once you find people who can afford it, they might be very particular and demanding. I’m hesitant to offer a signaling explanation because it can often be an easy cop-out. I don’t know much about the market for houses 5 times more expensive than I could dream of but in Rochester, I expect to see a Hunt Realty sign in front of really expensive houses. If I see some other agency’s sign in front of a mansion, a red flag goes up “Hmmm what’s up with that”
It is a relatively simple answer. The seller can negotiate for a lower rate but the response by the selling agent will be to strongly counsel against it because if they agree on a lower commission, buyer agents won’t show the house. They’ll avoid showing it at all costs to send a message about what happens if they threaten the status quo.
One way around that (roughly economically equivalent) is that the selling agent agrees to rebate a portion of the fee to the seller and that amount would be higher if s/he gets the buyer also. In essence, the buyer’s agent will receive a bigger share than the listing agent.
It is a fragile model and won’t last for much longer but agents have ways to keep it propped up for a while.
the 6% fee is negotiable. but to address your question, such agents exist, i’m working with one now. they are probably reviled by other agents, though, and this may hurt when it comes to making deals. someone i know got several bids on a property they’d put on the market, and their agent told them ‘lets ignore this bid — the agent is hard to work with.’
I agree with an earlier commenter — this is partly reinforced by the fact that two agents are involved in every deal, and one of them can refuse to work with the other. In a similar situation, a friend of mine was shopping for a house without an agent, thinking to cut a deal with the selling agent to pay 3% less, and the selling agents wouldn’t work with him. They were either going to take the full 6% or not sell him the house. (In his market, there were plenty of buyers.)
That said, there are totally discount selling agents in my area, very publicly advertising that they take less commission. Real estate agents, like travel agents, were historically a “gateway” profession, and the monopoly on that gateway (in North America, the MLS) is being chipped away. Their commissions are getting lower because of pressure from the the growing FSBO market enabled by the internet, not other agents.
Steve, I’m in coastal California, where there have been a lot of pricey houses for a long time. Talking to people who buy and sell, I have heard a number of stories where the agents (sometimes on both sides of the transactions) cut their fee in order to “make the deal happen.” So both buyers and sellers learn to be strategic: state a rigid asking price or offering price so that the agent will cut it to 5% total or even 4% total. I have no data on this, but anecdotes from buyers and sellers over the years.
I think Martin-1 has the best answer. It takes longer and longer to sell a house the more expensive it is.
But I think that’s only part of the story. It seems to me that the rest is accounted for by experience. A novice real estate agent doesn’t have the reputation (or perhaps on-the-job skills) built up enough to be able to handle a big sale like that. Simultaneously, the more experienced agents are less likely to reduce the size of their commissions, under the belief that they have more mojo than the under-cutters. And houses are sufficiently large investments for most people, that owners/buyers are less inclined to “take a chance” with a less-experienced, under-cutting agent.
In my experience, it’s relatively easy to negotiate a reduction up to 0.5% with the selling agent when you are the seller. And if the market is slow, the selling agent is often willing to kick in a bit to make a deal happen happen. I’ve also negotiated down a buying agent commission – again when the market was soft. In both cases, agents prefer to frame the discount creatively/discretely, e.g. as a rebate, suggesting that they are hiding from the cartel. I think they are concerned that other agents will boycott the listings of rogue agents – potentially damaging half of their business.
With public access to the MLS, it’s now possible (at least for local buyers) to cut out the buyer agent. The selling agent is then very willing to share their windfall with the buyer.
A similar situation exists in the farm real estate market. Whether selling 40 acres or 4,000, commissions tend to stay fairly consistent. Pensions and investment groups that make multiple large purchases every year have the power to force lower commissions on the buy side, but often don’t use that power fully. Even if they do, the sell-side broker often still realizes a “full” commission (4-6%), and that no doubt gets baked into the purchase price anyway.
I think it’s a cultural issue to some degree – transactions in the $10M+ range were not all that common years ago, and the market has been slow to adapt. The average broker that I’ve dealt with is 50’s and older. Hard to teach an old dog new tricks and all that. Also, farmland brokers create barriers to entry through accreditation…which requires a sponsor from one of a relatively small number of farmland brokerage firms. It’s a tight knit group.
It’s frustrating to see a commission of $250k+ paid to brokers (often multiple in a given transaction) that have put in very little work. Even more frustrating, after a transaction takes place, it’s not uncommon to receive a letter from a broker (who wasn’t even involved in the transaction) demanding their cut. They’ll assert a claim because they once had the listing, they once showed the farm for the seller, or they mentioned in passing sometime in the past (even years prior). They send such letters because, even though they know the claim is erroneous, there’s a chance they could get paid with only a threat. It works more often that you’d expect.
FYI, in New York state *by law* commissions must be negotiated. I am enough of a public choice cynic to see this as a way to deter advertising lower rates rather than as a way to prevent price fixing.
Related question: why do mutual funds charge the same percentage management fee, regardless if you have $10,000 in the account, or $100,000? In that case, it CLEARLY is exactly the same set of services in both cases.
In Canada, some funds have a class with lower fees for higher investments, but not many. And, I think the ones I’ve seen are all money market funds.
In the UK, estate agents fees are commonly about 1.5-2%. Is the service offered in the USA that much different? Maybe they include all sorts of other expenses that are charged at a percentage (legal fees?).
Blah blah commission blah.
Why is Landsburg in the real estate market? Is he dumping Rochester?
I don’t see how this is different from any other market. Does a high-end restaurant really provide 5x the value of a low end restaurant? What about the waiters? Is a waiter at the low-end restaurant really worth only 1/5 the value of the waiter at the high-end establishment (keeping in mind the waiter is compensated primarily by tips)? And, the crux of the question: is price the true measure of the the product?
“Is he dumping Rochester?”
Ho! Good question! After the attack by his dimwit dean, could you blame him?
Professor, you must be speaking without the benefit of recent personal experience. The larger the sale, the more willing brokers are to cut fees–normally, significant reductions are offered before one has to ask. Brokers are, in general, poor negotiators, and more focused on actual dollar compensation than percentages. Only exceptional brokers with long-standing control of their markets retain some semblance of discipline.
The “Multiple Listing Service” (MLS) was always the prime enforcement tool for price-fixing realtor fees.
In 1955, a group of California residential MLS brokers conspired to set a 6% fee as the ‘standard’ charged a seller on all home sales. That 6% fee became very popular with brokers nationwide for decades, though it had already been ruled a violation of federal antitrust laws. But MLS brokers simply ignored court decisions.
To enforce the price fixing… the residential brokers used the MLS that they fully controlled, requiring brokers who published listing information on the MLS to include the total fee agreed to by the seller (a mandatory 6%) — with 3% to the listing broker & 3% to the buyer’s broker.
Thus, a seller’s broker submitting a listing to the MLS was policed by all other brokers and agents for conformance to the 6%/50:50 rule. If a seller’s agent did not comply, all the other (fee-fixing) MLS brokers/agents would either refuse to deal with the rebel broker… or refuse to share fees (50:50) on the sale of their listings.
Most real-estate brokers/agents are essentially a unionized work force … thru national & local real estate “trade associations” ( like the ‘National Association of Realtors’). Those powerful union “Arbitration Boards” also enforced the ‘6%/50:50’ rule against any rebel brokers… typically forcing them out of business. Union membership was an MLS requirement, with biased binding-arbitration mandated for any disputes among members or with the union bosses. The unions assessed heavy fines against any rebel brokers — enforced by automatic, local government court judgements.
Also, there were/are various state laws that prohibit real estate agents from providing credits/rebates or discounts on the standard 6% commission fee. Currently, 10 states have such rules.
This 6% price-fixing cartel began to unravel in the mid-80’s with aggressive Federal anti-trust & commerce actions — but it’s still strong nationwide.
There IS a rogue agency! Redfin gives buyers “rebates” of a portion of the commission that the seller pays to the buyer’s agent (in this case, Redfin), which effectively means that the seller pays a smaller percentage to the buyer’s agent (because Redfin buyers can afford to spend more on the house because of their anticipation of the rebate). I understand they also act as seller’s agents, but my personal, recent experience has been with engaging them as a buyer’s agent. Unfortunately, they only operate in select markets right now but hopefully they will expand soon!
I’m with nobody.really – the most surprising thing in this entry is that you’re shopping.
That said, the costs of doing business as a $1M/house agent are significantly higher. You’re expected to dress at a level to match your clientele, and to drive an appropriately pricey vehicle. Your hair/nails/make-up will be seen as indicators of your likely success and nobody’s going to want you representing them on a $1mm deal if you look like a loser. You also have to maintain appropriately more upscale office locations, furnishings, and so on. I doubt that it’s exactly 10x as expensive to be a high-end realtor as a low-end realtor, but it’s probably a 5x or more multiple.
I would further guess that there are far fewer $1mm houses available to be sold per unit time, so your chances to make that larger commission are fewer and the competition to be selected as the agent involved in the deal is much fiercer. If you do in fact land such a rare deal the incentive to discount it must be lower. I think this is common to most/all luxury goods and services – discounting is much rarer.
The Realtors(don’t know how to do the trademark symbol), control access to the listing services.
Perhaps part of the problem is that everyone is talking about agents but a quick reading of the comments shows *no* discussion of the entire process including brokers.
Agents *cannot* sell a house. The sale is done through a broker–who has to meet overhead on the office, etc.
So…If the agent is on a 50/50 split, then the math is as follows.
You ask your selling agent to reduce the commission to 5%. She goes to the other side and they say that’s fine, do whatever you want, but we want our 3%. So then your selling agent goes to the broker and says “let’s reduce the commission to 5% and we will take the 2%. The broker says “fine, but we still need the 1.5% for the office, so you can do this but you will get 0.5% commission on the sale.
Now the numbers. On a $100,000 house, the agent would normally get $1,500 on a 50/50 split of a 6% commission. If she takes the 5% commission as outlined above, the agent would then only get $500.
So what looks like a 17% cut in the commission rate quickly turns into a 67% cut in pay.
Last time I went house-hunting several people told me “but the buyer doesn’t pay the commission, only the seller does!”
I actually did the reverse of what jimmy described: I found a house (definitely more of the 100k variety) and called an off-the-run agency basically at random who agreed to do the paperwork for a flat fee. Supporting the ‘covert’ theory that has been advanced here, they did this by collecting the full commission and then cutting me a check. The seller’s agent clearly suspected something and got a little snotty but played along.
Phil – totally agree that the stickiness of investment fees as a fixed % of AUM is even more puzzling, e.g. given the economies of scale in the biz.
Maybe they don’t adjust the percentage commission down but lower their commission by offering to sell your home at a lower price.
“You’re expected to dress at a level to match your clientele, and to drive an appropriately pricey vehicle.”
These “expectations” are not exogenous to the question posed. When the price is fixed, providers have to compete on quality measures since they can’t compete on prices.
I think this is a major case of a more general phenomena where prices are set as a percentage of something in a way that doesn’t seem fully relevant. Another example is building contractors, who are often paid based on a percentage of the cost of materials. So if the cost of lumber rises, so magically does the cost of the contractor. Another example is tipping in restaurants.
@Ken B
“[I]nNew York state *by law* commissions must be negotiated.”
That true everywhere: Anti price-fixing laws require that real estate commissions be negotiable (even if the result is the same ~6%).
On note related note and (hopefully relevant) note, I just discovered that the Supreme Court issued its decision in Freeman v. Quicken Loans, Inc. re whether Section 8(b) of the Real Estate Settlement Procedures Act prohibits a settlement-service provider from charging a borrower an “unearned fee”, i.e., a fee for which the provider in fact provides no service to the borrower. The court held 9-0 (and contra to the CFPB’s position) that such unearned fees are not prohibited by the statute; rather, the prohibition against fee splitting is violated only where a provider actually, uh, splits a portion of its fee (with third parties).
That’s relevant here because real estate brokerages have been similarly sued under RESPA when, among other things, they’ve charged a flat fee along with a percentage-based commission.
As I understand it, antitrust lawsuits opened the MLS, which was formerly only available to members of the local real estate board. Since then I thought that peer pressure was the primary force holding commissions up. “Nice real estate business you have there. It’d be a shame if anything happened to it…”
Especially in small towns agents can’t afford to rock the boat unless and until they are big enough to go it alone. Once they are that big, there’s no benefit to cutting prices to win more business.
I have heard of listing offices reducing their agreed commission rate if the seller accepts an offer from a buyer who was brought in by the same agent or the same office. In effect, the selling agent reduces the buyer-side commission in exchange for keeping the entire commission in-house.
First of all who would trust the sale of their million dollar property to a discount seller?? The amount the seller would save would be approximately 1%-1.5% (im assuming a 2% commission is too low to maintain, but more like a 3%-4% is realistic). This would only save the seller around 10,000 to 15,000 dollar on a million dollar property. I don’t know about you but i would rather pay the extra money just to feel like im in good hands.
It works the same way from the buyers perspective, why should i look to a discount broker when i want to make a multi million dollar transaction?
A lot of people here seem to miss that a realtor that is handling a million dollar deal most likely has some reputation and/or a prior relationship with the client. Less experienced clients will usually be looking for the lower end deals and are more likely to deal with a random realtor. Higher end clients are more likely to have a track record with a realtor they like, or one that has a good reputation.
A good reputation like a long client relationship takes time and effort which properly should be compensated. A ten million dollar a year ball player is not twenty times better than a half million a year rookie.
I would say that handling a $1,000,000 transaction might actually take 10 times as much work as handling a $100,000 transaction. It seems likely that there is a lot more hand holding and showing around. Also, each showing of a $1 million home probably has a lower chance of resulting in a sale.
Here is a related but IMO much more interesting puzzle: Why do buyers pay their agent in a way that is positively correlated with the price they pay for the home? Doesn’t that mess up your agent’s incentives?
Another more amusing puzzle:
My in-laws sold a house some time ago. They hired an agent who informed them that apparently, in Berkeley, CA, you should expect all buyers to make offers above the list price. Why would that be?
I’m betting it’s collusion between agents. Without an agent to explain the custom, you’ll have a hard time buying or selling. A buyer without the agent will make an offer that is too low. (a wealthy gentleman from out of state just offered to pay the list price and was flabbergasted to have it be refused) A seller without an agent will list a price that is too high.
How does the housing market work in the US? Why are there buyers’ and sellers’ agents? In the UK, if we want to sell a house, we usually put it with an agent, who will advertise, arrange viewings etc. If we want to buy a house, we look round the agents’ adverts until we see a house we like the look of, then if we like it, make an offer.
If we want to sell a house, we can stick a advert in the paper and avoid agents fees altogether.
If the sale is agreed, we then go to a solicitor to sort out the legal bits.
If you wanted to sell a house over there, what is to stop you arranging it all privately and avoiding fees? 6% seems a hefty wack to pay.
Harold,
There are reasons we have buyers’ agents. One, a good buyer’s agent is honestly almost like having a lawyer with you. He/she (if high quality) will be able to explain the intricate complexities of buying a house. There are tons of regulations and customs to know. Furthermore, they should be well versed in the intricacies of the pricing of the local market and what you should be paying for what you’re getting. It’s also just convenient when you want to present an offer and your agent works it all up for you and negotiates for you… If you don’t have a lot of time, they certainly can save you time.
Harold: There’s nothing stopping people but custom and perhaps the desire to hire an expert or avoid doing the necessary work themselves, as Josh mentioned. I have bought and sold two properties here in the US without agents involved on either side, although in my case, the transactions were with people I already knew.
There’s also a burgeoning FSBO (For Sale By Owner) market that bypasses the agents’ monopoly on the Multiple Listing Service (MLS) by using Craigslist and so on. MLS is still the primary way to advertise a house here but it’s gradually being eclipsed by the alternatives.
Josh, Rowan, thanks for the info. It seems that the culture is pretty powerful. One could argue that a buyers agent in the UK would offer all the advantages that Josh describes, yet they are all but non-existent – at least at the end of the market where I have experience (clue: not $1million). The pervading culture seem to determine the behaviour. So a subsidiary question to Steves, why are people willing to pay 6% in the USA, but only 1.5-2% in the UK?
I can see how a seller’s agent can provide valuable advice on marketing, presentation etc. that could more than offset any tweaking of the commission, especially at the higher end. However the buyer’s agent primarily reduces search costs, and it’s less clear that these would be higher at the higher end (smaller supply)? And for ‘protection’ anyone can hire an inspector (with actual building expertise) for a relatively modest fee.
Fees based on % of sales price in general seem suboptimal for the ‘principals’ — even the seller’s agent might well prefer to earn fractionally less by underpricing a bit and avoiding extra weeks or months of showings etc. A better approach for both would seem to be something like a flat fee for achieving an agreed-upon “fair” price, plus a % bonus on any incremental ‘profit’. Of course I’ve never even proposed such a strategy myself. Other than the ‘cartel’ explanations that the current customs serve the agents’ interests (and are thankfully eroding), perhaps many people also just value simplicity; again, some otherwise smart people have told me “the buyer doesn’t pay the commission”. (The question is, is this “rational” ignorance in this case?)
iceman,
The buyer’s agent can provide valuable services: advice on whether a property is reasonably priced; more experienced (and dispassionate) negotiation; and for first-time home buyers, help navigating what might be a complex and anxiety-producing transaction. I agree that not everyone needs them, but I don’t agree that no one does, or that they are less needed in larger sales.
Sorry I meant to say “*it seems to me* the buyer’s agent primarily reduces search costs”. To your and Josh’s points, to me the paperwork convenience is essential, but worth a modest flat fee. I agree many people want/need the security blanket aspect, but as others here have observed, a system based on % of sales price is not really conducive to providing objective pricing advice and negotiating. And as you’ve observed the internet is making it much easier for anyone to obtain pricing comps. Finally the stuff about local customs etc. seems less relevant for the majority of people who move fairly locally. I totally agree when moving longer-distance one has little choice but to use an agent (for the shoeleather costs alone). Still doesn’t explain the current fee structure though. BTW if I felt like I really needed a lawyer I would hire one separately (as many people do) rather than rely on an agent for legal advice.
Iceman, the only problem with setting up a flat fee for tr services of a buyer’s agent is that you would be paying him more than you have to. The buyer’s services are a transaction cost and only when a transaction occurs does he or she get laid. Essentially, you can think of a buyer’s agent as being paid by the seller’s agent for the buyer. Are you going to tell the seller’s agent he can’t split the commission with her? Even if you managed to do that, they could still continue the practice… All the seller’s agent would have to do is pay the buyer’s agent outside of closing. So in essence if you pay your buyer’s agent a flat fee, you’re probably paying more than you have to.
And I hope the point came across in my last post that you’d be paying more because you’d be paying for the flat fee AND the commission (or whatever amounts of the transactions costs were falling on you originally).
I assume you meant “only when a transaction occurs does he or she get *p*aid.” But hey, what they do with the $ is their own business.
On the fees, again one thing that can be done within the current ‘custom’ is what I actually did when I bought my house: agreed on a flat fee with the agent to do the paperwork, let him collect his normal share of the commission and cut me a check after closing for the difference. (I’m sorry if you are in fact a realtor and this offends your professional sensibilities.)
And I would even be happy to pay more along the lines of the idea I floated above: a flat fee that represents the normal (or preferably slightly lower) commission for what my agent and I agree on as a ‘fair’ target price, plus a % of the profits if he/she got me a better deal. Thoughts?
Question: “I see something that looks a lot like a competitive labor market where different workers receive substantially different wages for doing pretty much the same thing. Economic theory says that under very general circumstances, that can’t happen. Why is this market different from all other markets?”
Answer: The labor market for real estate agents is no different than the labor market for company executives. On average, the larger the company, the higher the stakes, the higher the compensation. Some folks, whether in industry, medicine, law, sports, coaching or even real estate, actually are more productive and employers will pay more for that actual or perceived benefit.
Think the Dream Team (Johnny Cochran, Barry Sheck, F. Lee Bailey, Alan Dershowitz) v. Marcia Clark and Christopher Darden; Bill Belichick v. Marty Schottenheimer–who brings more to the table, who would you be eager to pay more for?
My point of view is that the “6% standard commission” is driven by the cartel behavior of the realtors and brokers. The FTC report at
http://www.ftc.gov/reports/realestate/V050015.pdf has a good discussion of the key tactics used by the real estate agent guild to limit price competition. Specifically mentioned in the report are 1) legal & regulatory obstacles (e.g. rebate bans, minimum service requirements), 2) use of the MLS to impair brokers & agents with alternate business models, and 3) the baility of industry incumbents to withhold cooperation from brokers & agents undermining the price collusion. If these obstacles were removed, commissions might average around 3%, with commission percentages varying by the sale price of the property.(www.umac.mo/fba/irer/papers/past/vol5_pdf/012_039US.pdf)
Iceman, correct me if I’m wrong but you had already found the house you wanted and had already agreed to a price before engaging your agent, correct? I just think you would have a hard time getting a buyer’s agent to agree to reimburse you part of his commission check if that weren’t the case.
Anyway, I just think you’d have a harder time getting your agent to agree to pay you anything out of his split commission if you were starting “fresh” with him. On some level though what you’re saying makes sense … If you know he’s going to be getting 2% from the seller’s agent, then you can request whatever amount you want to from him from those earnings. If he says no then you keep looking for someone who will give you what you want. I personally would wonder how hard and motivated my agent would be working for me if he knew he was going to have to write me a check. Im not a real estate agent btw.
I think one needs to look at RE agents and fees as luxury goods. People selling an expensive house want “quality” agents working on selling their property and not (in their minds) cutting corners on presenting, showing, marketing their home because they are rushing off to work on another house so they can make an adequate commission.
Also, as others have mentioned, commissions are negotiable at this level but I have seen a true luxury good effect in the San Francisco Bay area where certain agents are “known” for selling expensive homes at the best price and therefore can command high commissions. Expensive home agents are the master at using “staging” companies to bring in appropriate furniture to best show off the house.
There has also been the introduction in the market of “fixed fee” agents that sell your home for a flat fee. However, everyone knows you are NOT going to get anything other than a multiple listing, sign, some pamphlets and a few open houses.
Very interesting. The same thing happens in the private equity/venture capital market–the fees are basically identical for all but the very top managers. Everybody charges a 2% fee and a 20% carry, even though you’d think the new guys would have incentive to compete on price. Seems like all these ‘relationship-driven’ markets do not clear on price but on status?
Volume?
You can sell five $200K homes in the same time it takes to sell a single $1mn mansion. (Or hovel, if you live in San Francisco.)
To expand on the comment about Redfin above, note that in order to sustain their rebate of part of the standard commission, they only operate in select markets (that have higher prices than most markets), and they have a minimum price to which the refund applies.
“why do mutual funds charge the same percentage management fee, regardless if you have $10,000 in the account, or $100,000?”
But this is not true of all mutual funds. Vanguard (and others) have share classes with lower expense ratios if you have more in the fund for exactly this reason.
Consider the alternative: For $750 you can take a week-end course and sit for the real estate agent licensing exam. Then you can post your house on MLS and represent yourself. (I have friends that have done this.) How much of a commission would you pay to avoid that?
There’ve been some online sellers with lower commissions in California, although I don’t know how well they survived the crash.
(Seller bears the full 6% commission, so Buyers don’t care (I know the model says Buyers bear a portion of the commission, but amongst the things to care about, hypothetical costs don’t register).)
I find this an interesting discussion, especially since I’m a real estate broker as it provides insight into how it looks from the “outside”.
The main oversights/misconceptions I see in the comments above are 1) the idea that real estate agents (and their respective skills, experience, services provided, etc) are fungible, and 2) a minimum accounting of risk.
Not all homes listed are sold; and sellers may repeatedly change listing agents before their home eventually sells. Other risks are more obscure, but there’s little benefit in talking inside baseball.
As a 30 year practitioner I don’t really have a dog in this fight. Most of my clients are repeat and referral and I don’t compete on price. But I am open to alternate compensation methods that better suit a client’s needs.
If you’re looking to pay the lowest real estate fee possible (whether buyer or seller), I suggest you formulate an agreement wherein you pay your agent a retainer fee against an hourly fee billed monthly. Obviously, you’ll also need to specify the services in which you want them to engage, as well as what marketing fees you’ll want paid out of your retainer.
If you’re engaging a selling agent (a buyer’s agent), you’ll specify any selling side commissions realized (in the event you actually purchase) will be an offset against your retainer (RESPA only disallows fees paid to outside parties).
If you’re engaging a listing agent, you’ll still need to offer a selling agent commission if you want your house shown. But this can be an amount you specify (although some MLSs preclude selling office commissions of $1 or similar). Certainly you can specify a fixed dollar amount.
The obvious deterrents to the above include the need to pay the retainer in advance of a sale. Many people don’t have the funds to do so and instead rely on the buyer’s ability to obtain financing as the source of funds to pay the real estate fees.
By varying the hourly compensation you offer you can select an agent who will provide the level of service and expertise you desire. Don’t need a lot of expertise? Find an agent willing to accept a lower hourly fee. Expect to pay more if you’re at the other end of the scale.
Similarly you’re able to only pay for time spent in the event your home sells in an hour, or you’re a buyer who has already found the home you want. (Note many states do not allow a real estate agent to be paid only to generate a purchase and sale agreement as it infringes on the domain of the attorney cartel.)
It may or may not obviate the compensation issue when a listing agent also acts as the selling agent. Personally, I won’t engage as a dual agent unless the buyer and seller already know each other and I’m acting purely as a facilitator. I’ll find another agent to provide independent representation for the buyer.
If you have concerns or doubts about your agent performing, you should engage a more suitable agent.
Just my perspective on the issue.
I can weigh in on the mutual fund point. Most mutual funds do charge lower fees as the investment amount increases. They typically have institutional share classes for just this purpose. Also in the private fund space, management fees are negotiable and will often be reduced for large investments. Incentive fees are less often reduced.
To Kevin’s point, you typically do not see quality PE/VC/hedge fund managers compete by advertising lower fees. The reason is that a market-standard fee is a signaling mechanism. It implies that the manager is high quality. If their track record bears that out, investors are typically not willing to nickel and dime over the fees.
Lee M – great perspective, however it still seems like an hourly fee would provide no incentive for a quick, or optimal (or any?) sale. Have you ever seen anything like I floated above for either side — a flat fee for a mutually agreeable target price plus a % of any incrementally better outcome? That would seem to get the incentives more in line.
Economiser – institutional class shares discriminate at the level of the individual investment, but don’t fully address the issue of economies of scale; why do / how are funds able to charge any given class of investors the same % for AUM of $1B, $10B, $100B? Perhaps there are a few PE firms with such stellar reputations investors feel lucky just to get in, but the general persistence of these customary arrangements (e.g. in light of ample evidence that for most ‘past performance does not predict future results’) are a puzzle to many people including some prominent business school profs.
Steve, your question implies you believe 6% is an artificially high price. That may be so, but I do not think so. I think it is closer to a floor price one sees in fully evolved competitive industries to make it worthwhile to be in the business. Just like mark-ups in the retail clothing business seem high on the margin they are really priced to the bone.
The real estate market is already ultra-competitive. 6% is the fully evolved competitive market price—until something better comes along.(As to your 10 houses to one example, what car sells more volume, the Camry or the A8L Audi? I am sure equally good salesmen would sell 3-4 times more Camry’s per year than the A8L Audi—-but a similar dollar volume).
Are we equally surprised that car dealers target average fixed commission percentages? Are we suprised that most clothing stores charge 100% mark-ups on the margin yet are in a highly competive business; or that Boeing and Airbus have extemely narrow and similar profit margins built into their competitive bids? Or that Kings and Shoprite charge the same for a week’s groceries?
We have seen countless attempts by entrepreneurs to create a different pricing model in real estate brokerage. Examples include US Realty.Com, Assist-2Sell, 2 percentcommission.com etc.. Plus there are hundreds of local discount brokers. So there are clearly alternatives to the 6% commission brokers. Yet they are a small part of the market. They seem priced right for their services, yet have far less market share than the big brokers.
The 6% guys dominate the market. Why? Compared to discount brokers, the 6% brokers have far better true local knowledge, especially at the higher end. They already have all the motivation and knowledge needed to make the “optimal sale” (i.e., Price as a trade off with time). Why do apartments on Jane St in Greenwich Village sell for more than those on East 15th street off Union Square? I have no idea (it could be the cobblestones), but they do. The same is true throughout every town, city and hamlet in the US. Discount brokers have less local knowledge and treat selling like a commodity.
The 6% guys dominate the market. I have no specific explanation as to why 6, but not 5 or 7 percent. While the 6% price is negotiable, like any price, it is not without difficulty, nor necessarily in the interest of the seller. Most sellers of their homes are competing with other homeowners who pay the 6%. Houses are not pure commodities and buyers can be easily redirected. (As an aside, I would bet the average commission is closer to 5.5%)
There is a bit of an illusion created by focusing on the commission percent. For the agent to receive the same dollar commission at 5% as 6%, the house would have to be sold for 20% more. But I just need to sell my house for 1% more to justify the extra 1% commission. To justify paying any commission at all, I need only a 6% higher price than doing it on my own. From my own experience the risk of using discount brokerage (or heaven forbid, sell on my own) is far too high and leveraged a bet against me to justify that route. It would only make sense if I had the same knowledge as a 6% broker.
As others have commented, buying and selling agents are not on the same side in individual deals but are on the same side in there overall business. But I do not think this really gives them Cartel power. Cartel power implies they can raise prices from time to time; not merely not lowering them. But they cannot raise it to 7%. Why not? Because it already is a fully evolved competitvely priced industry.
P.S. I hate paying that commission—-as we all do. The better question is why do we think the commission tends to be too high—when it really is not?
I’d argue that selling a more expensive house is in some way harder than selling a less expensive house, assuming the price of the house is highly correlated with quality.