Real Estate Rip-Off?

Douglas Gantenbein asks a question I’ve posed to myself more than once, “Why do you still need an agent to buy a home?

Americans will spend about $1.14 trillion buying 6 million homes this year—both records. Yet the flat commissions paid to the realtors who handle the vast majority of those sales, averaging 5.1 percent, act as an enormous tax on the transaction process, taking wealth from both buyers and sellers in what for both is often the biggest financial transaction of their lives. It’s true that selling a house is a complex task. But so is writing a will, and an attorney doesn’t ask for 5 percent or 6 percent of your net worth as compensation.

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But the real knock on realtors is a bit of simple economics that many people don’t understand. Whether you’re buying or selling, they rarely work in your interest. For the buyer, a realtor may seem like a dream—a “free” home-finding chauffeur, who then negotiates the best possible price. But the service isn’t free—the sellers have likely factored the buyer’s agent’s 2.5 percent or 3 percent of the take into their price. Moreover, it’s in the buyer’s agent’s interest to have you pay the most that you’re willing to pay. After all, the higher the price, the larger their commission.

What about the sellers? They know only too well the service isn’t free—they’re stuck paying the commission for their own agent plus the buyer’s. But “their” agent really isn’t interested in seeing the seller get the best possible price. Instead, that agent’s incentives favor a quick sell, at any price. Look at it this way: Let’s say you’ve listed your home for $290,000, and you owe $150,000 of that to the bank, leaving you with $140,000 in equity. The home may well sell for that $290,000—in a few months. But if the agent can persuade you to sell it for $270,000 in a few weeks, he is better off having forgone only $500 or $600 in commission while saving a great deal of time, energy, and uncertainty. That deal, though, will cost you $20,000 in equity. When we sold the Newcastle house, in fact, “our” agent actively worked against us in the final stages of the transaction, doing more than the buyer’s agent to knock down our price.

Excellent points all. I’ve bought two homes and sold one. My experience as a buyer was largely positive. The first realtor I had was a nice guy but absolutely incompetent (he showed me homes seemingly randomly, totally ignoring my rather clear specifications as to what I was looking for and showing me houses well below and well above my price ranges) but that was simple enough to determine and I quickly fired him. The next realtor was superb, found me a house on the first morning, and helped me get through the rather daunting process. I used her to sell the same house four years later. My realtor here was absolutely superb.

Clearly, realtors perform a valuable service and a good one is certainly worth paying for. If they’re any good, they know the market and can steer an unsuspecting buyer away from some huge pitfalls. The problem, as Gantenbein suggests, is that it’s insane to pay a commission on the order of 5% for a what amounts to 12-15 hours of work. A starter townhouse in this area is now in the neighborhood of $350,000 and even a modest house is $500,000. Is the realtor’s service really worth $25,000?

Gantenbein suggests that the answer is the widespread use of a “For Sale by Owner” model with the help of the Internet. While that has basically happened with much of the economy, real estate has resisted change.

Why the fossilization? Mostly, it’s because of the power of the National Association of Realtors, which protects its members’ turf like a crazed wolverine defends its offspring. The organization has defeated efforts by some of the nation’s biggest banks and even Microsoft to start their own real-estate listings, and have largely protected the sanctity of the Multiple Listing Service, enabling regular folks to scan bare-bones listing on the Web, but keeping most of the good info for themselves. Overall, the NAR has ensured that nearly all residential real-estate transactions still are conducted between two agents in cahoots. And they’re largely responsible for keeping commissions close to that 6 percent level when any normal law of competition would suggest they’d be lower.

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Still, I’m hoping that upstarts such as ZipRealty, LendingTree, Foxtons (a discount broker in the Northeast), and Catalist (a California discounter) will soon blow away the traditional realty transaction model like they’re Puerto Rico playing the U.S. men’s basketball team, dropping total commissions on a house sale to 3 percent, or even 2, while still offering the services people seem to desire from a realtor. Certainly, most people realize that a 6 percent commission—or even 5 percent—is nuts, given that e-mail alerts, Web-based home tours, and other services can easily give buyers and sellers as much information as their realtors. It will be a painful change for the 1 million real-estate agents out there—alas, a number that is growing rapidly. But a little Darwinism is needed to thin out the herd, and when it happens it won’t give me much grief.

My hope is that, instead of putting most realtors out of work, the result would be a more realistic fee structure. Realtors provide a valuable service. Just not one as valuable as the current system suggests.

FILED UNDER: Economics and Business
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Paul says:

    YIKES! I could not disagree more.

    My first realtor was an absolute abysmal nightmare. She was quickly dispatched and I wandered life realtorless for nearly a decade.

    Then I found Dawn.

    Dawn is wonderful. She had every piece of paperwork at her fingertips and knew her market like the back of her hand.

    I would not DREAM of buying or selling another house without her. (And I use her enough that I tell people “I have a great realtor” like some would say about their Doctor or Dentist.)

    6% for 12 hours work?!?! HA! What about all the people she (he) has to drive around who could not buy a loaf of bread with a co-signer? Or the people who have no clue what they want?

    Let’s review- I buy a piece of property at $120,000 and she gets 3% from my pocket. That’s 3,600 bucks to make sure the deal goes smooth. If she is worth her salt, she found the house 3,600 below value anyway so she earned it.

    And I promise you she has saved me 8000-9000 in stupid problems she has found over the years. She’s a 2 houses to the good.

    Knowing WHO your realtor works for is EXTRAORDINARILY important. It varies from state to state. Find the answer before you buy your next house.

    I tell ya what- If you want to start paying realtors $75+ bucks an hour like you would any other professional then maybe you have a point. But remember- That means you pay even if you don’t buy.

    And the MLS in my town is fantastic.

  2. James Joyner says:

    Around these parts, realtors pre-qualify buyers. They won’t drive people around who can’t get a loan. That’s not the case elsewhere.

    On a $120,000 house, 6% is $7200. That’s enough to eat away any equity that someone who has lived there only a few years has earned. So, you put in four years making monthly payments and get nothing and the realtors put in a few hours and get all the equity?

    And, of course, $120,000 will roughly cover the cost of the lot in some areas. Again, on a half million home–which is a moderately expensive townhouse or a fixer-upper single family home in these parts–fetches $25,000 at only 5% ($30k at 6%). That’s half a year’s pay for most people around here.

    Reggie, my realtor here, is a pro and I’ll almost certainly use him again if I sell and buy around here again. But $4000-$5000 would be a lot more reasonable transaction fee than $25,000-$30,000.

  3. joy says:

    I bought a house FSBO in a very hot seller’s market. While it was worth it in that situation, I wouldn’t do it again unless I was very familiar with the area I was buying into and I had time on my hands. (Let’s put it to you this way, houses would get bid on before they hit MLS, since at least where I was, there was a three day waiting period before getting on that list. This benefitted folks who were working with realtors in the same listing office or folks who found out about the sale from word of mouth.)

    Also, apparently FSBO is made harder or easier in certain jurisdictions. Where I was, I actually wasn’t required to use a lawyer, but I made damn sure I did.

  4. Jane Galt says:

    As it happens, my mother is a realtor, and she does a lot more than 12-15 hours of work to sell a house. Of course, that’s all you see, because you only see her when she’s showing the apartment. You don’t see her when she’s spending hours getting the entries in the computer right, whiling away her Saturday evenings fielding calls from other brokers who want to know about the house, screening your buyers to make sure they can get a mortgage, looking up the other houses in the neighbourhood to estimate the price, and all the other things that pass unnoticed by disgruntled customers.

    The fact is, you can sell your house by yourself right now. It’s just that if you do that, you need to be the one who comes home from work early to show the place, who places the ads and answers the eight-zillion phone calls wanting to know whether the zoning will let them put in a petting zoo, who looks up all the other deals in the neighbourhood to find out where they’re selling, and so forth. You have to check each and every person who wants to bid in order to see whether they can get a mortgage. Those services are clearly worth at least $30K to you, or you’d do them yourself.

    Commissions, in New York at least, are generally split between buyer’s broker and seller’s broker. The fee you suggest is ludicrously low, both because brokering a house involves a lot more work than you seem to think, and because no one could make a living off that sort of commission structure. You’d have to sell 20 houses a year just to make $40-50K. What sort of agent do you think you would get, buyer or seller, for that sort of price? Would they be willing to put in any work for you, or would they shove you into any old thing to get shut of you and get on to the next victim? A good agent is worth her weight in gold — she’ll price your house right, negotiate for you, tell you whatever minor mods need to be made to get the most for your money, word your classified ads to attract the buyers you want, and so forth. From a buyer’s perspective, she or he is a gold mine of tacit knowlege about neighbourhoods and houses that you could never, ever replicate on your own, will help you get your paperwork ready, and so on. If you succeeded in putting a FSBO model, you’d find you’d destroyed the buyer’s agent as a source of value, and replaced it with a Caveat Emptor middleman.

    The commission also compensates the realtor for risk, and time. At least in the NYC metro area, there’s at least a sixty day delay between deal and closing. That’s a pretty long time to wait for payment. Plus their income is highly variable, both randomly and with the economy; when you pay people on commission, you should expect to pay them a higher average sum than when you pay them on salary.

    This is not to say that the realtors are not conspiring to jack up fees; undoubtedly 5% is above the market-clearing price for their services. But 0.5% is undoubtedly well below that price.

  5. McGehee says:

    When my wife and I needed to sell our house in Alaska to move down here to Georgia, we made the mistake of listing our house with a realtor who apparently had never been a seller’s agent before — because my wife wanted the points from using a realtor in that particular nationwide organization, and this one was the only one in Fairbanks.

    Fortunately, since the move was a government transfer we had a backup in case the agent didn’t sell the house. And when we contacted a realtor down here who is also with that nationwide organization, he turned out to be excellent, helped us find our current house, and has answered queries from me about related subjects a number of times in the five years since.

    You can’t even judge a single company by the quality of any one realtor, let alone the whole real estate business.

  6. James Joyner says:

    Megan,

    A lot depends on the local market. In the DC area, a house generally sells the first day or two it’s on the market. The average house is somewhere on the order of $800,000. A 5% commission on that is $40,000. That’s an enormous boon for a short period of work.

    It’s true that the $40,000 is split among the listing agent and the selling agent if they’re not from the same company, but then so is the work. And it works both ways: One gets paid for simply signing a listing that someone else sells.

    It’s also true that there’s a lot of work that the client doesn’t see. But much of that work is amortized among several houses and clients. That is, the time it takes to learn about a single listing will be spread among all the clients to whom one shows that house.

    If a realtor averaged $5000 for every house they sell or list, they only need to sell one a month to get to $60,000.

  7. John "Akatsukami" Braue says:

    Based on the experiences of a realtor that I know, I suggest a counter-proposal: the prospective buyer and seller each put up a non-refundable fee of 0.25% of the taxable value of the property.

    That means really non-refundable: if the seller blows the deal by walking around in the nude when the realtor is showing the property to a prospective buyer, or if the buyer blows the deal by getting bored and vanishing without leaving a valid phone number, the money’s gone.

  8. Jim says:

    The problem I have is there is no in between. I can certainly appreciate what an experienced realtor brings; however, I pay the same 6% for the agent who got his licensce yesterday as the one who has been in the business for 30 years. Additionally, there is no break for anyone who does not need the full services. For example: I sold my home to a co-worker who was relocating. I did not need advertising, listing, etc. but paid for “the total package”.
    While I’m at it: I don’t see why the fee should be a percentage. Does the agent do more work for the $150K sale than the $120K sale? Why then should I pay more for the service? Besides, I think that if a flat fee was instituted there would be more competition between Real Estate Companies.

  9. Jane Galt says:

    James, I’d question those numbers. New York City is an even hotter market than DC, and the average home here doesn’t go for those kinds of numbers — unsurprisingly, since it implies an average family income in the DC area of over $150K. This seems high for a city so dominated by government workers. And while homes go fast here, where there’s practically nothing on the market, they take a little longer than a day to sell. They take a little longer than a day to put in the computer, as your commenter pointed out.

    Some of the work gets amortised over a large number of people, but more of it doesn’t. The time spent negotiating bids on your house is not amortised, nor the time spent showing it to people who don’t buy, nor the time spent fielding inquiries about it . . . I understand why people don’t want to pay a lot of money to sell their house, and I certainly understand the resentment at the cartel behaviour. But people have wildly unrealistic expectations about what they can actually pay in a clearing market.

    In your example, a $4k-$5K fee, that fee gets split four ways: buyer’s agency, seller’s agency, buyer’s broker, seller’s broker, leaving your brokers with $1K-$1250 for probably 60 hours work apiece, all things considered. They would each have to sell four houses a month to make that $60K, a wildly unrealistic number, because markets like yours and mine have short supply which makes it impossible for any broker to find that many houses to sell every month. (My mother is extraordinarily good at what she does, lives in a market even hotter than DC, and probably sells ten homes a year. The problem isn’t a shortage of buyers; it’s a shortage of listings. She wastes a huge amount of her time dragging around buyers who end up deciding not to move because there’s nothing to buy, another hidden cost you don’t see.) And at that, they couldn’t afford to live in your area, if home prices are even half what you say they are. Especially when you remember that the self-employed have a 5.5% tax surcharge for the “employer’s” portion of FICA.

    Almost everyone has had a job that others assumed was a license to steal; being a technology worker was one in the 1990’s, and I got a fair amount of shit from people who assumed that all I had to do was break things so I could fix them and collect a check. I sympathise, and I’d be happy to see the cartel done away with. But the notion that brokers basically only interrupt their lives of carefree bon-bon eating in order to stick up homeowners for outrageous sums and laugh all the way to the bank simply ins’t true. It’s a tremendous amount of work, and if you want good professionals to do it, you’ll have to pay for the privilege.

    I suspect that in the end we’ll migrate to a low-fee system, and then sellers will complain about the miserable work of showing their apartment to every Tom, Dick and Harry who shows up and getting ripped off by people who say they can get a mortgage and then renege after wasting a month of your time. Buyers will wonder why they paid top-dollar for a house downwind of a sewage plant. Perhaps that’s worth saving money on a broker. But my understanding is that people who sell their own homes do worse, on average, than those who use a broker, even net of fees.

  10. James Joyner says:

    Megan,

    You simply can’t get into a single family home even out where I live–a 45-60 minute commute from DC–for under $600,000. A modest townhome such as I bought for $270,000 last September is now selling for $375,000. In the District proper, I don’t think anything habitable is available under a million. I know Manhattan is far worse than that, even.

    Houses here sell fast. Presuming that they’re priced within market parameters–granted, something a professional realtor is handy for–it’s very unusual for a house to remain on the market for as long as a week. Homes in particularly desirable neighborhoods quite often sell for more than the asking price, with three or more bids on them the first weekend. Usually, closing takes place within a week or two of the sale, unless the seller stipulates more time in order to find a follow-on home. It’s very much a seller’s market here.

    You’re right that the fees are split several ways, unless the listing firm sells the house. Still, in an area where typical workers make $50-70,000 a year, $35,000-$50,000 is an awfully steep transaction fee.