There’s always something to howl about.

Smashing the idols: Understanding market value in full context . . .

Nominate me Ikonoklastes, for I am come to raze this temple of half-baked ideas. I want to come back to the MLS later in the week, and I have a deep need to expose the motivations of brokers, as these are distinguished from the motivations of lesser licensees. But for now I want to take on the idea of market value.

Jeff Brown, whom I admire without limit, asks of me:

I’m still wondering though about the apparent premise underlying your argument that says the buyer pays everything.

That premise is this: That somehow the market value of the home is controlled by something other than supply/demand, and the other factors of which we’re all aware. Would you please clear this up for me?

There are actually two different issues on the surface there, and there is still a third issue buried in the underlying premises.

First things first: In every economic transaction, unless the seller is taking a loss — or unless the seller pays for something outside of the transaction — the buyer pays for everything. This is true of anything that can be bought, and it is why — in every business except real estate — the buyer is given the red-carpet treatment. The seller (of anything) brings the value to be sold, but the buyer brings every dollar of the money, and every dollar that is disbursed to the seller and to any other involved parties is disbursed from the buyer’s pile of dollars.

In real estate, we make believe that the money is first transferred to the seller and then instantaneously distributed to the other parties, but this is a sleight of hand we effect in order to get the sales commissions past the lender. It might once, historically, have described a sequence of events, but even then the activity was a pantomime.

The seller does not cause the sale by claiming to pay for it. The buyer causes the sale, and no uncoerced sale ever happened until the buyer caused it.

Moreover, nothing in the laws of god or man ever prevented a seller from paying sales commissions out-of-pocket, in advance, instead of their being extracted from the proceeds of the sale. For obvious reasons, this does not happen.

The buyer pays all the sales commissions, all the title fees, all the lender costs, all the miscellaneous charges and everything else that gets paid for in the transfer of title of a home. The seller brings the house. Unless the seller is upside down, the buyer brings all the money. The buyer pays for everything.

I will consider this much to be settled art unless someone can offer a cogent argument to the contrary. Not, mind you, a feel-good warm and fuzzy sentiment. Not a harrumphing “but-we-like-to-look-at-things-backwards!” harangue. If you have a case, prove it. If not, take a seat while I kick away the other stilt you’ve been leaning on.

(And, for god’s sake, if you do effect to make an argument, make it in public, either in a comment here or by linking back to this post. I’m sure it’s fun beating up on straw men in what you presume to be your secret lair, but it’s simply childish. If you don’t know who I am talking about, it ain’t you.)

Here is a specious argument that has been floating around: That even if the buyer were to come into the transaction unrepresented, the price of the home and the sales commissions disbursed would be the same. But this describes an irrational artifact of the listing contract, not an economic necessity. In a rational negotiation, the seller might agree to do things differently if he were not presumptively contractually bound to pay some percentage of the list price as a buyer’s agent’s commission whether or not the buyer comes represented by a buyer’s agent.

This is Jeff’s argument of market value, I think: The idea that the sales price is going to be the same whether or not a buyer’s agent gets paid. This might be true — but it is true only in the present context.

The solution, obviously, is to divorce the buyer’s agent’s compensation from the listing agent’s compensation. I have suggested a way of doing this, and, ten days ago, while reading Jim Duncan’s Real Central VA, I found a better answer, as presented in Mark Nadel’s white paper on real estate commissions:

Buyers Should Know that Mortgages Can Include Fees Paid Directly to Buyer Brokers

In most cases, the fees charged by even non-traditional buyer brokers are paid out of the co-op fee offered by the listing broker or the seller. In some cases, however, listing brokers may want to see particular buyer brokers fail, particularly those the broker has targeted with adverse split arrangements. These listing brokers may refuse to adjust the purchase price to cover the buyer’s broker’s fee. This makes it more difficult to amortize that fee as part of the mortgage. That does not appear to be due to any formal rules deterring banks from granting buyers mortgages based on a total sale price that includes the fee paid directly to the buyer’s broker rather than by the listing agent from the latter’s commission received from the seller. Nevertheless, many lenders appear resistant to regarding a fee paid directly to the buyer’s broker as part of the sale price, even if only out of ignorance. This may occur because some written lending standards may not have been officially revised to recognize that agents working with buyers are no longer usually subagents of the seller. Buyers and banks should be informed that these mortgages are available and accepted in the secondary markets.

This may or may not be lawful at present, and, even if it is, it may not be practicable without a lot of tap-dancing. But this one little paragraph offers the solution to a vast horde of real estate problems.

I am not kidding. I want to smash every idiotic idol in our insane practice. We have been wrong, badly wrong, and it is well past time to put things right.

So start with the idea that the buyer contracts for his own representation, with the lender agreeing to roll the buyer’s agent’s compensation into the home loan.

This is exactly what is happening now, except that buyers don’t negotiate commissions and we insist, contrary to easily discerned fact, that the seller is paying the real estate commissions.

There is a difference, however: There would be nothing to prevent the listing agent from demanding all or part of his compensation in advance, out of the seller’s own pocket. Then the seller actually would be paying a real estate commission!

In fact, commissions could be paid outside of escrow on both sides of the transaction, although I’m sure the Feds would frown on this, at least if there are Fannie/Freddie loans involved.

But consider: The whole idea of procuring cause just evaporated. The procuring cause of the sale is whomever the buyer has designated by contract. If a listing agent elects to invest a lot of effort in a buyer — which might be necessary if a property is challenged or over-priced — this earns that listing agent nothing from the buyer. If the listing agent wishes to negotiate additional compensation from the seller, that’s between them. But the buyer’s agent is being openly compensated by the buyer, not by a sleight of hand effected through the seller or the listing agent.

So what just happened to the “market value” of Realtors?

This is not the market value Jeff is talking about, but we now have a lens for understanding market value in context.

Where before the market value of Realtors was firm and fixed — a fiat of tradition and obstinance — with the simple reform of moving the buyer’s agent’s compensation to the buyer’s side of the HUD-1, we have completely changed the context in which Realtors are to be evaluated.

Is my trusty buyer’s agent worth 3% of the purchase price? That depends on the purchase price, doesn’t it? If I’m buying a $60,000 house, he might be worth more than 3%. If I’m buying a $6,000,000 house, I’m pretty sure he’s worth something less than 3%. How do we decide where to draw the line? By negotiation.

So suddenly the buyer — revered in every other business, historically disdained in real estate — inherits his rightful place at the head of the table.

Sellers have understood for quite a while how to negotiate commissions, which is why very few listing agents are getting 3% for their side of a multi-million dollar property.

But if buyers are able to take control of the buyer’s agent’s commission, the Djinn is out of the bottle for good.

So what does this do to the market value of the home? Maybe nothing, although my inclination is to reserve judgement on that. But by unbundling the sales commissions from the purchase price of the house, the true market value of the house will be the value of that home in the buyer’s estimation, not a value inflated by an arbitrary percentage — essentially hidden from the buyer.

At the same time, it is entirely reasonable to suppose that real estate brokerage costs will tend to decline as they become obvious to both sellers and buyers, so, in principle, sellers should net more money for their houses, and buyers should get more house for their money.

In both circumstances, ante- and post-diluvian, the home will have sold for its market value. But those values will be different, because the context will be different.

We have made a grand tour of Mare Nostrum — Greece, Arabia, Rome and Jerusalem: Merely divorcing the buyer’s agent’s compensation from the listing agreement is not sufficient to rip asunder this temple of craven idols and money-changers.

But it’s a start…

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