Thursday, June 13, 2024

How commission changes could lead to transactional transparency

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May is Commission and Compensation Month here at Inman. We’ll sort through the noise and misinformation and provide you with the most up-to-date facts and strategies about how to prosper in the wake of the commission settlements. And look for straight-to-your inbox updates with Inman’s new weekly digest, Commission Chronicles.

Consumers have spoken and courts have agreed, as shown by the continual flow of lawsuits and commission settlements: Transactions are murky at best for the average consumer, and, as a result, the industry is going through a major transformation.

While online portals provide the semblance of an open marketplace, they are only a curated collection of listings sourced from various Multiple Listing Services (“MLSs”). The residential real estate transaction itself, and many of the agreements and processes underlying it, remain opaque and outdated. Transformation of the residential real estate landscape, however, is underway.

On Feb. 16, 2024, the Department of Justice filed a statement of interest in the antitrust lawsuit Nosalek vs. MLS Property Information Network et. al, calling for the decoupling of seller-side and buyer-side real estate brokerage commissions. A month later, on March 15, 2024, the National Association of Realtors announced a settlement with plaintiff classes representing homesellers, agreeing to some of the DOJ’s decoupling proposal.

Under the terms of the settlement, sellers and their agents will no longer be able to unilaterally set buyer-broker commissions in the MLS, which they had effectively done in the past. While such commissions were theoretically negotiable, negotiations rarely took place, and the buyer broker commissions in listing agreements served as actual buyer broker commissions. Sellers remain free, however, to offer contributions toward buyer broker commission, although such offers may not be published in the MLS.

The hope behind the NAR settlement is that the separation of seller-side and buyer-side commissions on the MLS will encourage buyers and their agents to negotiate such commissions either between themselves or with the seller.

At least in multiple offer scenarios, one can see how a buyer would benefit by paying buyer broker commission themselves rather than asking for any seller contribution. While the NAR settlement certainly encourages commission decoupling, it falls well short of requiring it.

Conflicts of interest

Few commentators have pointed out that the broker compensation scheme challenged by the DOJ also led to practices rife with conflicts of interest that harmed consumers — both sellers and buyers.

At the one extreme is the practice of dual agency, still legal in 42 states, where a single real estate agent represents both the seller and the buyer in the same transaction. The inherent conflicts of interest of this practice are too obvious and egregious to warrant a discussion.

At the other extreme is an unrepresented buyer. In both cases, the listing brokerage got to keep the full broker compensation even though there was no buyer broker. A similar conflict of interest is also present when real estate teams try to internalize buyer-broker fees by favoring buyers represented by their members. Keeping commissions out of the MLS will hopefully have the effect of significantly reducing these conflicts of interest.

Add to the mix the growing practice of private exclusive listings. Here, brokerages keep the listings to themselves, typically for a specific period. These so-called “pocket listings” have the effect of internalizing buyer broker compensation within the listing brokerage.

Unfortunately, keeping commissions off the MLS may actually increase the use of these off-market listings, much to the detriment of the average seller who would benefit from more exposure for their listing. Only widespread online transactional transparency can help reduce this practice.

While the separation of seller-side and buyer-side commissions as envisioned by the NAR settlement will make it more difficult for listing agents and listing brokerages to capture the buyer side commission, actual decoupling is necessary to eliminate the incentive for self-interested behavior.

Additionally, transactional transparency in the form of explicit buyer requests for buyer broker commission will encourage buyers to pay their own agent’s commission, as buyers compete to make their offers more compelling. All other terms being equal, an offer without such a request is stronger than one with a request.

Finally, there is the perverse incentive implicit in the previous compensation scheme for buyer agents not to negotiate a lower price for their buyers. The higher the price, the higher the commission. Now that buyers can negotiate their fees directly with agents, they might not agree to such a compensation scheme.

Collective action problem

The persistence of high overall real estate brokerage fees has resulted almost directly from persistently high buyer-broker fees. The high buyer-broker fees, in turn, arose from a specific collective action problem (a market failure) implicit in the traditional commission structure.

A collective action problem refers to a situation in which individuals or groups, each pursuing their own self-interest, face barriers that prevent them from achieving a common or mutually beneficial goal.

This arose when individual agents and brokerages, each seeking to maximize their own interests, collectively charged the “customary” buyer broker commission for fear of excluding potential buyers represented by agents who would steer their clients away from lower buyer broker commission properties.

While some argue that steering of buyers away from low-commission listings was either non-existent or limited because of ethical constraints, those in the industry know that it was real.

Even MLSs recognized the possibility of such misbehavior, preventing property searches with buyer broker commission as a criterion. Simply put, it was much easier and more lucrative for listing agents to sell a home if their seller offered the “customary” buyer-broker commission. When all listing agents faced the exact same dilemma, business as usual prevailed and “customary” buyer broker fees persisted.

The NAR’s Participation Rule, combined with MLS practices and the continued use of “customary” buyer broker commissions, led to an effective floor on overall broker compensation. All available empirical evidence supports this claim of persistently high overall broker compensation nationwide. The collective action problem described above had the effect of dampening price-based competition for real estate brokerage services and forcing higher prices on consumers.

The collective action problem continued

The NAR settlement may help resolve this collective action problem by encouraging negotiations on buyer-broker commissions. Ultimately, however, true decoupling of seller-side and buyer-side commissions is necessary to completely resolve the collective action problem and to break free from the lack of buyer commission negotiation and the persistence of high broker compensation.

By shifting the responsibility of buyer-side broker commissions to buyers themselves, the industry may now see increased price competition that benefits real estate consumers.

Keeping commissions off the MLS will hopefully not just eliminate the floor on overall broker compensation, but it would also mitigate many conflicts of interest and encourage innovation. No more mention of buyer-broker compensation in the MLS. No more steering buyers away from low-commission listings.

The role of demand elasticity in determining harm

The vast majority of commentators on the subject of the commission lawsuits have surprisingly ignored the complicated role of demand elasticity, the measure of how sensitive consumer demand is to price.

The sensitivity of the demand for homes to price is influenced by such factors as market conditions and geographic location. Some argue that because homebuyers were the only ones bringing money to the table (i.e., the ultimate purchasers), they were the ones harmed.

This is the logic of Batton 1, Batton 2 and other cases in which the plaintiffs are homebuyers. Others have successfully claimed that sellers were the ones harmed because of lower net profit from excessively high brokerage fees. This was the central claim of the Sitzer | Burnett and Moehrl cases in which the plaintiffs were homesellers.

So which set of plaintiffs is correct? It depends. If home demand was highly sensitive to price (buyer’s market), sellers bore the brunt of the higher commission by absorbing it and making less profit. If demand was highly insensitive to price (seller’s market), buyers were the ones who were hurt as the higher commissions would simply be passed on to them. The answer to the question who was harmed, therefore, depends on both timeframe and geography.

The NAR settlement has only addressed the seller plaintiff classes. The buyer plaintiff class action lawsuits linger and have validity, at least in the context of the seller markets witnessed in much of the country over the past decade. It remains to be seen how the courts will treat the buyer class action lawsuits and how the NAR responds to them.

Removing commissions from the MLS was a crucial step in breaking free from the lack of buyer commission negotiation and the persistence of high broker compensation.

By shifting the responsibility of buyer-side broker commissions to the buyers themselves, the industry may now see increased price competition that benefits real estate consumers. Keeping commissions off the MLS will hopefully not just eliminate the floor on overall broker compensation but also mitigate many conflicts of interest and encourage innovation.

A transformative journey for residential real estate

By addressing conflicts of interest, enhancing transparency and fostering competition, there’s potential to create a more competitive, innovative and fair market.

While the industry is far from true commission decoupling with the NAR settlement, it is a step in the right direction. Market dynamics may lead to it without additional regulatory action, as more sellers refuse to pay buyer broker commissions and more buyers agree to pay their own brokerage.

Regardless of how the industry arrives at it — market dynamics or further regulatory action — true commission decoupling should be embraced as an opportunity to transform the residential real estate landscape.

Increased competition could also lead to the growth of new brokerage models. The dominant one-size-fits-all model that caters to real estate agents could be replaced by more consumer-centric approaches. Specifically, the adoption of decoupling could foster the growth of open and transparent brokerage models.

Many of the self-serving norms and practices of the real estate industry are in large part why most consumers, without exactly knowing why, distrust real estate agents so much and hold them in such low regard.

For full disclosure, this is in large part why I co-founded my brokerage, one of a new breed of brokerages that emphasize transparency and consumer control. With my company’s software, offers are submitted online, buyer broker commissions are negotiated openly, buyers can compete openly and fairly, and sellers can track their home sale from start to finish.

Such transparency is just as critical to a thriving and competitive real estate marketplace as is the decoupling of brokerage commissions.

Only such openness can truly eliminate the conflicts of interest, self-dealing and opacity that still exist today. Most importantly, only such transparency can improve the general public’s negative image of the industry. While buying a home is unlikely to ever be fully digital, there is no reason more of the transaction could not be online, or why the process could not be more transparent.

The journey toward off-MLS commissions is not without its challenges, but the rewards — enhanced transparency, consumer trust, and a more competitive marketplace — are well worth the effort.

Hopefully, the residential real estate industry will embrace the changes of decoupling and adopt more transparent business models. If so, it has an opportunity to redefine itself, placing the interests of consumers at the forefront, and ushering in a new era of competition, innovation and fairness.

Bob Mathew is the principal broker with in the Washington, D.C. area. Connect with him on Facebook or Instagram.

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