Introduction to “A consumer’s guide to the divorced real estate commission” — the eBook

[This is the introductory text to an eBook I have prepared discussing the idea of divorcing the real estate commissions, a topic I have discussed here at some length. You can find the eBook by clicking here. If you like, you can post a button linking to this book — there is code at the end of this post. But my primary motive for putting this together is to appeal to the various consumer-facing personal finance weblogs. I don’t foresee any meaningful reform in the real estate industry originating from the inside, so I am doing what I can to arm consumers against the pernicious evil that is the National Association of Realtors. –GSS]

 
Introduction

Here are three interesting real estate questions, two that came to me directly and one that was commended to me by Rudy Bachraty of Trulia.com.

Question #1: “Potential buyers for our home ($800K – California) have a realtor but he did not find our home for them. The buyers did and have visited both times without him. He has played no role whatever in bringing us these buyers. If we accept their offer why on earth should we give him 3% ($24K) of our home’s equity for contributing nothing whatsoever?”

Question #2: “When looking at homes on our own and calling the listing agents ourselves to set up appointments, does that obligate us to go with the listing agent if we decide to place an offer on the property?”

Question #3: “Since the amount of work involved doesn’t really differ according to the value of the house, financially, it seems like the percentage commission would make higher prices more favorable from a buyer’s agent’s perspective. If this is the case, why would the buyer’s agent be motivated to help negotiate the price down?”

Now, there are nice, long, complicated answers for each of those questions, and nice, long, complicated answers are the very essence of a certain type of salesmanship. It’s called Tap-Dancing, and it works — at least if you’re easily confused. But here are much shorter, much more truthful answers to those three questions:

Answer #1: If you want to hang onto the buyers, you’re probably stuck paying the do-nothing agent. Grin and bear it.

Answer #2: You are not obliged to have the listing agent represent you, but he will almost certainly not agree either to compensate a buyer’s agent for you, nor to waive the buyer’s agent’s commission.

Answer #3: Ethical buyer’s agents and whores-with-hearts-of-gold do exist, but paying a buyer’s agent a percentage of the sales price is a misalignment of incentives: The buyers would rather pay less, but the buyers’ agent earns more when the buyers pay more.

Even better, here is a very short answer to all three of these dilemmas, plus dozens of others: Divorce the commissions.

Each one of these problems is caused by the insane way we compensate buyer’s agents in the residential real estate market. From the beginnings of real estate brokerage, sellers have set the amount of compensation for the listing agent, and the listing agent has set the amount of compensation for the buyer’s agent. The buyer’s agent’s incentives are misaligned with the buyer’s interests because the seller, historically, was paying the buyer’s agent to get top dollar for the seller — a complete betrayal of the buyer.

Things are still done this way because nobody ever thought to change them, but the entire Rube Goldberg contraption is absurd: Sellers pay the listing agent to pay the buyer’s agent to betray the seller’s interest. Buyers believe they are getting real estate representation “for free,” when in fact “their” agent is being paid by the seller and the listing agent in the hope that the buyer’s agent will betray the buyer — often with secret bonus payments to the buyer’s agent to sweeten the pot. All of this is a massive conspiracy devised by real estate brokers to enrich themselves by defrauding consumers.

Over the course of the last two or three years, we’ve had a wonderful information explosion in the real estate industry. Venture capital-funded internet start-ups — I call them Realty.bots — have sprung up, providing scads of information to consumers — information that was previously more difficult to obtain. But the owners of the Realty.bots are much like consumers themselves: They understand real estate at the surface level of transactions, but they really don’t know very much about what’s going on at the level of real estate brokerage.

This is not a criticism. No one understands sex like a gynecologist, but when an OB/GYN’s fancy lightly turns to thoughts of love, you might wince and change the subject. So while a great deal of previously undisclosed information is suddenly being shared with consumers, the most important issues in residential real estate representation are still concealed.

What are these issues? The real estate licensing laws do not exist to provide you with consumer protection. They exist to “protect” you from cheaper competition. The IRS “safe harbor” income-reporting exclusion for real estate brokers virtually assures that 90% or more of all new agents will fail within their first two years in business — but not before they’ve had the chance to wreck the financial lives of innocent consumers with their “state-licensed” inexperience and ineptitude.

There’s more, but by far the most significant “secret” issue in residential real estate is the way that buyer’s agents are compensated. The current system virtually assures the betrayal of both the buyer’s and the seller’s interests, with this fate being avoided only by accident. Moreover, it occasions as a secondary consequence the citadel of secrets and lies known as the MLS system.

The residential real estate industry is not a true business in its present form. By means of legislative fiat and its own internal structures built on secrecy and deceit, it is a cartel — a vast conspiracy against the consumer. But of all the reforms I could name to correct this atrocious situation, the one that would make the most immediate, most consequential difference would be to divorce the real estate commissions — to restructure the way we account for funds at the closing table so that the seller pays only the listing agent and the buyer pays only the buyer’s agent.

How hard would it be to effect this change? It could happen just like that — just by a change of policy by loan underwriters.

How likely is this to happen? Hide and watch.

But this is a vitally important consumer issue. There are a few Realtors who understand why this is so important, even if it might result in our earning less per transaction. There are similarly enlightened lenders and title reps. But for the most part, the entire real estate industry is opposed to this idea — and they’re way ahead of consumers because they know the issue exists, and most consumers do not.

That’s why I’ve put this little e-book together. It’s based on a series of weblog posts I wrote in November of 2007. I’ve updated them here and there, but the main argument stands — and, to my knowledge, no one has been able to dispute it in even the smallest way. There is simply no way to argue that the present system of compensating Realtors is in the best interests of consumers. It serves — and is designed to serve — the real estate brokers and their agents at the expense of the interests of consumers.

What can be done? The best recent hope for divorcing the commissions was the Department of Justice/Federal Trade Commission lawsuit against the National Association of Realtors. Alas, that ended in an essentially-meaningless whitewash settlement. It seems plausible to me that, in due course, a judge in a real estate lawsuit will take notice that buyer’s agency as it is currently practiced is in fact simply sub-agency — every agent works for the seller — in camouflage. And there’s always a chance that both the NAR and the Mafia will wake up one day and forswear their criminal ways forevermore.

But don’t hold your breath.

What we can do for now is arm ourselves with information. The sad fact is that most consumers don’t even know this issue exists, and they blithely grope their way through real estate transactions, convinced to the core that their agents really are acting in their best interests. The good news is, this is often true. The bad news is, the commission structure we have right now rewards and sanctifies the persistent betrayal of Realtors’ fiduciary duties to their clients.

So even though we may not be able to change anything right now, on our own, nothing will ever change until consumers learn that they must look out for their own interests in their real estate transactions.

So this is a matter of “consciousness raising.” If buyers and sellers understand how their agents are compensated, they can at least negotiate payment terms that aligns their agents’ interests with their own. Simply raising the issue could provide important clues about the honesty and trustworthiness of particular agents.

If you would like to help pass this word along, you can use one of the buttons shown below to link back to this eBook. The more people who know about this issue, the greater our chances of achieving reform. To deploy one of these buttons, just copy the code you see below the button and paste it into the sidebar of your website or weblog.

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If you walked into court to defend yourself in a lawsuit, only to discover that “your” attorney was being compensated by your opponent in the dispute, you just might be able to smell a rat. As you will learn in this small book, residential real estate is a rat’s nest. With your help — and your completely justified outrage — we just might be able to clean it up.

 
Elsewhere: The Philadelphia Real Estate Hub, Political Calculations, Bigger Pockets, Frugal Babe, RealCentralVA — Jim Duncan, Living Almost Large, On a Quest to be Debt Free, Consumer-Focused Carnival of Real Estate.

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