There’s always something to howl about.

Skinning elephants: The lifelong salutary benefits of negotiating your compensation with your buyers

Here’s how Mike Elsberry, my home inspector, charges for an inspection for one of my clients:

  • A sliding-scale price based on square footage
  • A sliding scale price based on the age of the home

Bigger homes take somewhat longer and entail somewhat more work to inspect than smaller homes. Older homes may have more wear and tear, also resulting in a longer, more arduous inspection. Mike has a little pricing grid, and taking those two numbers, square footage and age of the home, he can plot the precise price point on his matrix.

You could argue that he could come up with a more predictive pricing scheme, but the genius of his system is obvious: It’s reasonably objective, making it hard to argue with, and Mike can price a job from his cell phone, while driving, with his mouth half full of burrito. Lo-tech don’t mean no-tech.

Okayfine. Now let’s sell a couple of houses.

I’m about to do a Facebook deal with an old friend from high school. I will be representing her son in the purchase of the condominium he will live in while attending graduate school. Approximate purchase price: $80,000. Gross commission to me: $2,400.

I’m also about to help a very nice couple buy a small hacienda in Paradise Valley, one of the wealthiest towns, per head, in the United States. Approximate purchase price: $800,000. Gross commission to me: $24,000.

Obviously the differences between the two transactions are myriad, but here’s the one that matters most: The $80,000 condo will almost certainly take a lot more of my time than the $800,000 hacienda. I’ll get paid maybe $50 an hour for the condo, and possibly as much as $1,500 an hour for the hacienda.

How does that make sense?

Home inspector Mike Elsberry’s pricing scale makes sense, even if you could argue that something more complicated might make even more sense. The compensation buyer’s agents receive bears no relation to the time and effort expended. As the Freakonomics boys point out, the incentives are misaligned, as well: I get paid more if my buyers pay more, even though their best interest is to pay less. But even ignoring all that, basing the buyer’s agent’s compensation on a percentage of the purchase price, regardless of the amount of that price, is plainly absurd.

Why don’t buyers object? Because they’re not thinking about it. Because they believe their representation comes to them “free.” Because they never stop to work out the consequence of 3% or 5% or 8% or 16% buyer’s agent’s commission on their monthly payments — 3% or 16% of every dollar borrowed times 360 monthly payments plus compound interest — all of that reckoned against the opportunity costs of that money, again plus compound interest.

For the $800,000 house, the $24,000 I might scrape off the closing table will cost the borrowers $143.89 a month, for each one of their monthly payments. If they make all 360 payments without refinancing, my commission will have more than doubled to $51,800. They should just buy me a BMW.

How about new home buyers who unwittingly pay “their” agent 8% on their new $250,000 dream home? That’s $20,000 to the agent at close of escrow, but it’s $43,168 after 30 years. The kids will eventually move out, but “your” Realtor is going to be suckling on your checkbook for decades.

At the other end of the pay scale, exactly how much due diligence and zeal can I afford to expend on a $50,000 homestead, if my compensation is to be $1,500 — or even less — at close of escrow. That might sound like a lot of money to a buyer, but our monthly nut, the amount we need to earn each month to keep the doors open, is many multiples of that amount. I could sell ten $50,000 houses a month, 120 houses a year — a lot of houses — and finish the year broke.

This is broken, broken at both ends of the buyer’s agent’s pay scale. Even in that sweet spot between, say $175,000 and $350,000, a percentage-based commission still doesn’t make sense. One house can take fifteen hours of my time, the next can take 150 hours. And the incentives are still misaligned.

Misaligned in both directions, it is worth noting: Buyer’s agents are acting contrary to their own interests when they negotiate the purchase price downward — and god bless ’em for doing it anyway. But buyers have no cash at risk in the shopping process, and therefore they have no incentive to limit their searches to a reasonable number of homes in a reasonable span of time. Other pricing plans — and there is no limit to how many we could think up — would make much better economic sense for both the agent and the buyer.

As it happens, for the $800,000 hacienda, I’m rebating back all but $5,000 of the buyer’s agent’s commission to the buyers. This was an idea we came up with about 30 months ago, and it went nowhere at warp speed. Buyers simply did not care that, as in this case, they could save $19,000 at close of escrow. That’s a savings of $41,008 over 30 years, but absolutely nobody cared.

I’m actually doing two houses at a $5,000 flat fee right now, and I’ll do them all day for buyers smart enough to ask the question sellers never, ever fail to ask: “How much do you charge?” There is usually more work for me to do than the buyers anticipate, but, practically speaking, no more than we would end up doing for a $3,000 paycheck on a $100,000 tract home. But on the other hand, because we have openly acknowledged the elephant in the room — the buyer’s agent’s compensation — I can take this kind of buyer though everything, teaching them how to guard their interests every step of the way.

“An educated consumer is our best customer.” This is a motto to live by. What I’m really writing about is supplanting the National Association of Realtors, but this is how we will effect that seemingly impossible task. We have to do right by our clients, even when that might seem to be damaging to our own short-term pecuniary interests, and we have to train our clients to see and seek and insist upon better representation — at prices that align our interests with theirs. Even if we can’t get rid of the co-broke today, we don’t have to perpetuate its twisted, anti-consumer consequences.

Does that mean you won’t end up selling $50,000 houses for 2.5%? You probably will, alas — although it never hurts to raise the subject of compensation with buyers who can afford to pay for what they’re getting. But when you’re dealing with that $500,000 buyer you can look ’em in the eye and say, “Fair is fair, and $5,000 is more than fair for the amount of work I’m doing on this house. Why don’t you use the balance of my commission to update the kitchen?”

If you think that this kind of thinking is for suckers — good. We know that our business is built — and will grow — on delivering better value to our clients — a better quality of real estate representation at a better price. The more we can educate consumers — our own clients and the marketplace at large — the more difficult it will be for the anti-consumer policies of the NAR to persist. True capitalism — the mutually-voluntary exchange of values for values — is the only effective antidote to criminality in the marketplace.

If you want to supplant the NAR for good and all, here’s a good way to start the process: Instead of waiting for your clients to ask, “How much do you charge?” — a question they may never think to ask — go ahead and shoot the elephant in the room: “Before we get too carried away looking at houses, can we talk a little bit about my compensation?”

At a minimum, you will find out who you are dealing with right away — giving you the chance to forebear to work with people who are only going to cause you problems later.

Beyond that, that language or something like it is the ultimate qualifying question. Any sort of stalling or sputtering, in response, is proof positive that you’re not working with a motivated prospect.

But the beautiful thing about being completely honest, completely transparent and completely forthcoming about your compensation is that you will forge a much deeper, much more trusting, much more cooperative relationship with your buyers from that moment forward. The unspoken secret has been given voice, and now you are both on the same side. You’ve taken a wary, temporary affiliation and turned it into a lifelong association — replete with repeat transactions and referrals — and possibly even a lifelong friendship.

Just to avoid at least one “yeah, but” objection in the comments: You don’t have to settle anything right away. You may not know how the buying process is going to work out until it is 75% completed. But you can bring up your compensation at the start of the home search, with the understanding that it’s something you’ll be addressing again, later in the transaction. And without being mercenary about this, resolving how much you will get paid might be just the calming influence your buyers need when they get the jitters late in the escrow period.

Doing the right thing is always so right, in so many ways, that I can never think to catalog them all. But the best thing about addressing your compensation with your buyers — no matter how much you choose to charge — is that you will undermine the NAR-erected citadel of secrets and lies that is the co-broke fee. We’ll get rid of it completely in due course. But you can eliminate it from your own relationships with buyers right now — today! — simply by openly acknowledging its existence and arriving at a mutual agreement of what to do about it.

Do buyers have a right to know what they’re paying for representation? Do you dare say they don’t? They do, and because they do, they have every right to have the full discussion about compensation, even if they don’t know — or don’t know quite how — to bring it up themselves.

Or: More simply: You’ll skin more cats if you start out by skinning elephants.