Why the traditional real estate commission model is broken and needs to be replaced . . .

by Greg Swann

Suburban Phoenix Real Estate Broker

Author website

These are the concluding paragraphs of Mark Nadel’s white paper on real estate commissions. The executive summary has been quoted all over, but I think this text is more compelling.

For what it’s worth, I think Nadel has hit a home run. There are things he doesn’t know about, which we’ll get to in a minute. But he has the whole residential real estate industry dead to rights. This is an important thesis. If you don’t make time to read the whole thing, as least read this summing up:

The traditional, straight percentage-of-sale-price residential real estate brokerage commission does not serve the interests of either home buyers or sellers. Fees are unrelated to the quantity or quality of service provided by brokers and their agents. The rate structure creates little incentive for agents to provide the value-added services of which many are capable, and also produces some serious harms to buyers and sellers. These harms include buyers not being alerted about available homes meeting their search criteria because the listing broker or seller has not offered an attractive fee to the buyer’s broker; and providing sellers’ agents little incentive to invest the effort to raise the net sale price of a home. The traditional commission rate structure has become structurally unsound and should be rebuilt.

The foundation of a new fee structure should have buyers’ brokers setting their own fees or negotiating with buyers; not relying on standard, default commissions set by sellers’ brokers in the MLS. The traditional practice of sellers’ brokers specifying the fees that buyers’ brokers charge to the latter’s own clients, should be recognized by appropriate governmental bodies as at least an attempt to fix market prices. Antitrust law simply does not permit one firm to attempt to set the price that its competitors charge for a competing service.

The situation today is very different from that of twenty years ago. At that time, sellers’ brokers noted their co-op fee offer in their MLS listing because they were making an offer to the agents working with buyers to join the seller’s broker in serving the interests of the seller. There was nothing anticompetitive about posting an offer seeking to engage a subagent. Today, however, most buyer brokers commit to serve buyers’ interests, and their fiduciary duty is to buyers. There is no longer any reason to permit listing brokers to set the default prices that these competing buyers’ brokers charge to serve their own customers.

The NAR claims that the elimination of interbroker compensation would destroy the MLS, but that prediction is simply not true, as explained in detail by one lawyer who has long represented many MLSs. The NAR’s real fear about this approach, however, is understandable. The elimination of interbroker compensation would diminish the ability of traditional brokers to frustrate vigorous price competition, and thus likely lead to a dramatic fall in broker revenues.

Therefore, policymakers eager to aid consumers and foster economic efficiency through competition should support this separation of fee setting. It would also eliminate the harm now caused to competition by state anti-rebate laws and disputes over which broker was entitled to the buyer broker fee as the “procuring cause” of the buyer’s offer. Policymakers should also act to ensure that consumers have the same chance to amortize their broker costs as part of their mortgages, whether or not the seller agrees to include that fee in the sale price of the home.

Brokers should remain free to set their fees as percentage commissions, but for routine brokerage tasks, effective competition would almost certainly lead consumers to prefer brokers who set flat fees, hourly rates, or some combination of the two, as discussed in VII. Consumers will probably continue to prefer brokerage agreements that defer any payment until the relevant transaction was completed, but broker contracts should allow brokers to receive some reasonable minimum level of compensation in the event that the client terminates the relationship after receiving valuable service, but before a purchase or sale.

Percentage-based fees should not disappear, but they should be used to motivate real estate agents to generate incremental value. Sellers should offer their brokers’ agents (alone, without any splits with others) a substantial share, e.g., 20 to 50 percent, of any increase the agent can secure in the selling price above some agreed upon benchmark. In volatile markets, however, benchmarks should include variable elements pegged to the most recent sales of comparables or inventory levels. Buyers, meanwhile, once they selected a home, should offer their brokers’ agents a substantial share of any price reduction the agent is able to secure. Both buyers and sellers might also offer bonuses for quick results to agents who met designated deadlines.

Reaching this result will be difficult, given the understandable resistance from traditional brokers to a reform that could cost them $30 billion in annual revenues. Still, pressure from declining home prices could be a catalyst for change. Also, superior agents should recognize that the new environment would lead to a mass exodus of the least qualified agents. This would enable them to increase their billable time while spending less time prospecting for clients. In fact, one might expect that the best agents would earn higher incomes, while consumers would receive higher quality service at lower prices. Yet given NAR’s strong effort in state legislatures to protect the traditional system, success will require effective work by consumer advocates. The consumer media and housing counseling agencies must prompt consumers to interview agents about the six matters discussed in detail in Section IX, which should ensure that they pay only competitive prices for only the valuable real estate brokerage services they need or desire.

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