Free Markets Work: Thoughts on Agent Compensation Post Apocalypse
Now that we have the DOJ's preferences, we can speculate better
Since you are a Notorious reader, you know that the United States has weighed in on what it wants to see from the real estate industry vis-a-vis buyer agent compensation. Now we can speculate as to what the future post-apocalypse compensation schemes may be.
The immediate response from some of the voices on the interwebz is a mix of “OH NOES!” and outrage. The most popular theories — even in my comment section — are some mix of the below:
Dual agency will take over;
First time buyers and lower income buyers can’t afford representation;
This is government interference in the free market.
I would like to urge everybody to calm down, take a deep breath, and think through things with me. I hope this is ultimately a hopeful white pill post.
The Likely Future
First, let’s outline what the likely future is, based on the DOJ’s intervention in the Nosalek settlement. That intervention lays out what our overlords would like to see going forward.
No offer of compensation from the seller or listing agent at all.
Buyer may request compensation as part of the offer.
Diversity of business models for buyer agency.
Lower commissions overall.
All of that is relatively clear from the intervention, as I wrote about in the VIP post. The key insight here is that they want the future system to eliminate (or come very close to eliminating) steering by buyer agents, not just at the showing homes stage, but at the mid-transaction stages all the way up to writing up an offer.
If the DOJ gets its wish, the MLS will no longer have any compensation information in it and the rules will actually prohibit offering compensation, even if off-MLS. Think RESPA and how that operates.
The simple model then is: Buyer pays buyer agent, seller pays seller agent, buyer may ask the seller to pay the buyer agent (as he could ask the seller for whatever his heart desires) and that whole thing will be subject to negotiation.
The Objections
As I mentioned, the real estate commentariat is filled with objections to this new scheme. We need to go over each one, and at least address the logical flaws.
Dual Agency Will Take Over
The idea here is that no buyer will use a buyer agent going forward, since they have to pay for said agent. So listing agents will just double-end those deals.
First problem with this line of thinking is why any listing agent would ever double-end a deal without getting paid for the buy-side work. The assumption appears to be that listing agents will charge 6%, not give 3% to the buyer agent, and keep both. Except that’s a flawed assumption. The more likely outcome is that the listing agent will charge 3%, offer nothing to the buyer agent, and leave buyer agent compensation to the offer stage.
Why would any agent take on additional work without getting paid?
If the listing agent would charge the buyer independently, then the buyer is apparently willing to pay an agent. Why not pay your own agent who has no conflict of interest?
The second problem is the one that is endemic in all of the objections: the assumption is that the buyer agent fee will remain 3%, just paid by the buyer.
First Time Buyers and Low Income Buyers Get Screwed
We need to spend a bit more time on this one, because it is so prevalent and seems extremely logical. It is, in fact, one of the key policy oppositions by NAR itself against mucking with the commission system of today.
Let me use a tweet from Melissa Savenko (@melissasavenko) who is a real estate agent and a lawyer, and most importantly, very smart, even-keeled, and quite open to debate. Here’s the tweet:
I also think the DOJ's suggestion that the buyer negotiate the buyer's agent compensation at the time of offer creates SO MANY ISSUES! What if the seller says no? Which seems completely realistic in this market.
Has the buyer's agent just worked for free for months on end and oh well, too bad!
Is the buyer's agent obligated to continue to represent the buyer, even if the buyer cannot pay them directly, because of that agent's fiduciary obligations to their clients?
How in the world could this work? I'd love the brain power of folks like @SMB_Attorney or @landlawyerbrian to think through this with me.
It seems to me compensation should be negotiated at the time of engagement. If that compensation is a flat fee or hourly, I think the buyer broker should definitely require a retainer. If the seller agrees to pay the buyer broker's compensation, that retainer can be credited back at closing.
The effect = first time buyers and lower income buyers can no longer afford buyer broker services. Am I wrong?
I argue that Melissa is wrong, because of one simple assumption she (and everybody else) makes… which is that buyer agent compensation would remain in the 3% of sales price range.
Of course low-income and first time buyers can’t afford to write a check for $12,000 since the median home price in American is north of $400K. That’s a given.
And if the seller says No, then yes, that buyer agent has now worked for free.
Thing is, there are at least two, maybe three considerations here.
First, no buyer agent anywhere would take the kind of risk of not getting paid at all, without either (a) huge upside, or (b) minimized downside. Think contingency fees for lawyers, who take 30-40% of the recovery routinely because of the risk of not getting paid at all. Minimizing downside likely means what Melissa described: some kind of a retainer up front to minimize risk, then a refund/net-out system if the seller does agree to compensation.
Second, why should we assume that buyer agent compensation would remain at the 2.5% or 3% or whatever is “customary”? Every agent might go to the market with the customary fee and hear a lot of “No thanks!” But some agents somewhere are going to quickly figure out that they can make more money by discounting their fees and making it up in volume. Unlike today’s discount brokerages, this one-sided discounting has zero impact on “cooperative compensation” so there’s little reason for the non-discounters to get bent out of shape.
Sure, an agent discounting his buyer agency fees puts pressure on other buyer agents. That’s called competition. Just like Southwest put pressure on Delta, or Walmart on K-Mart, or what-have-you. Price competition is competition, and that’s called the free market.
Once one agent, one brokerage, one team figures out how to make more money by charging less, others will follow suit… until an equilibrium is reached between the consumer’s willingness to pay and the agent’s willingness to work.
Third, the above leads directly into the first time buyer and low-income families issue.
If buyer agency fees are $15,000… then sure, the argument that it means housing is only for the wealthy has some bite. What if agency fees are $500? Does it still hold that low income buyers can’t afford representation? If there is some agent somewhere who is willing to work with a low-income buyer for $500, perhaps a less experienced agent trying to work hard and grow a business, is that a problem for others who won’t? You’re an experienced luxury agent; you don’t work with first-time homebuyers. Why would you care what some other agent charges people who aren’t your target market?
If the whole racial angle is an issue, what prevents an agent or a brokerage firm from deciding to offer steeply discounted (or pro bono) representation to people of color? The world is filled with companies and organizations who offer preferential pricing for low-income people, for under-represented minorities, and the like.
If you care so much about low income buyers and people of color, then how’s the saying go? Put your money where your mouth is. Otherwise, you’re just using “impoverished buyers” as human shields for your greed. Kindly have a STFU sandwich instead of yapping about inequality in representation.
Government Interference in the Free Market!
Finally, let me dispose of this ridiculous objection.
I’m a radical libertarian; I am all for getting the government out of the free market. But every single person crying for “no government intervention” has a job because of a government-granted license. Said license interferes with the free market.
For a licensed industry to advocate for the free market is entirely lacking in self-awareness. Stop it.
A Few Likely Options for Agent Compensation
In speaking with a number of extremely well-informed and educated friends both inside and outside the industry the last few weeks, I think I see the following options for how buyer agents get compensated in the future.
I fully acknowledge my own biases here, since I’ve been talking about these issues for years and years. Disagreement and debate are both very welcome.
Please note that every one of these options will require a signed Buyer Agency Agreement of some kind. I am a big fan of those, as long as they’re not abusive or entirely one-sided with the scale tilted towards protecting the agent.
Hourly Rate & Flat Fee
The most obvious to me is that buyer agents will shift more and more to hourly rates and flat fee models.
It minimizes risk for the agent, provides price certainty for the buyer, and creates incentives for efficiency.
The idea that the hourly rate will be based on top-tier agents who charge 3% of the selling price is unwarranted. The free market will quickly tell us all who can charge what to whom.
The 20-year veteran with specialties in dealing with unique historic properties will charge one rate, while the 20-hour newbie who has done zero transactions will charge a very different rate.
The advantages are many (that may be a separate post) and the disadvantages are a cap on earnings (no awesome payday on a $10 million house, etc.) as well as a specific issue I’ll discuss below.
Retainer Plus Net-Out
The most popular path, it seems to me, would be what Melissa talks about: retainer with a net-out.
I think the way this will work is that the agent will ask for an up-front retainer which will be netted out against any compensation paid by the seller.
So for example, say the agent collects a $2,500 retainer up front. The offer is written with a request for $10,000 compensation. During negotiations, that amount is reduced to $7,500. Agent would refund $2,500 to the buyer, or just have the escrow company send $2,500 to the buyer and $5,000 to the agent.
This way, the agent is protected on the downside where the minimum earnings will be the retainer, but has upside exposure with the possibility of the seller-paid compensation. The buyer benefits since she has a level of cost certainty (a max of $2,500 out of pocket with the possibility of zero out of pocket) as well as knowing that no steering has taken place. The seller is in the same situation as today, except that no steering has taken place and his agent hasn’t pressured him to unilaterally offer out $10,000 because “customary compensation” stuff.
Different agents working different markets may charge different retainer amounts, and request different compensation amounts from the seller during the offer process. That’s the free market in action.
Seller Compensation Only, With Expense Reimbursement
The third path I could see is one where the buyer agent agrees to only get paid whatever the seller agrees to, and the buyer agrees to reimburse the buyer agent for out of pocket costs.
There may be some fiduciary duty issues with this one, since the buyer would have to agree in advance that she’s okay with losing the house because of the high compensation request in the offer, but as long as there is informed consent, I don’t see a problem.
And by having the buyer at least reimburse the buyer agent for direct out of pocket expenses (fuel expenses, messenger fees, ordering reports, etc.), the risk to the agent is slightly decreased.
A Quick Observation: Buyers Going Solo
Another fear of the industry is that once buyers have to pay their own agents, most would just decide to go it alone. Go unrepresented and save 3%!
Except that Americans spend about $52 billion a year for “lawn care.” Meaning we spend billions so we don’t have to mow our own lawns. But those people are suddenly going to buy a $500K house without professional help? Riiight.
Many won’t pay $25,000 for professional help, but they would pay for help if the price is right. And we covered pricing above. So… I’ll just say any agent who is a decent, honest and hardworking professional has nothing to fear.
The Problem of Default Setting
The image at the top of this post is from David Foster Wallace’s “This is Water” parable. Two young fish are asked by an older fish, “How’s the water?” and one young fish turns to the other and says, “What the hell is water?”
It is the uncommon person who can imagine something other than what is. Every single one of us takes reality for granted, and years and years of the same mundane reality gives us a default setting. We can’t imagine anything else.
That’s the issue with the “customary compensation.” There isn’t a broker or agent alive today who lived in a world without customary compensation. Just about every one of us thinks “buyer agent compensation” is somewhere between 2-3% of the price of the home. So it is impossible to imagine how buyers struggling with down payments will be able to afford such a cost.
But as I illustrated above, once we leave the default setting and imagine a world where a wide diversity of compensation schemes could exist, then it turns out the free market works.
The other default setting that we all operate under is the reality of hypercompetition in real estate. In 2023, there were about 3.8 million existing homes sold, versus 1.6 million REALTORS. That’s about 2.4 homes — or 4.8 transaction sides — per REALTOR.
The idea that a REALTOR would somehow be blasé about telling a buyer, “You can’t afford me; go find someone else” is simply unthinkable if the default setting is that said REALOR only has 4 buyers a year.
But what if the changes ahead of us means a smaller denominator: far fewer REALTORS? What if the 50% or so of REALTORS who do zero transactions can’t possibly convince any buyer to pay them a retainer, and certainly not a high hourly rate. So they leave and find something else to do with their time. What if another 25% or so can’t make it work on $20 an hour and end up as a paid assistant on an agent team? 7.6 million transaction sides divided by 400,000 working REALTORS is more like 19 transactions per REALTOR.
A $2,500 retainer x 19 transactions = $47,500 in annual income vs. the average of $44,813 in January of 2023. A $5,000 retainer with every seller refusing to compensate you is a $95K a year job. We all know that some sellers would be willing to take an offer with a compensation request built in, because their net would be higher, so the $95K a year is a floor, not a ceiling.
That’s what folks are fighting against? Where the average working REALTOR would make $100K a year with upside for more?
Bring on the apocalypse then. It might be the end of the world as we know it, but y’all should feel fine.
-rsh
I am not an agent, but work with many really good agents that are primarily listing agents. Although probably half their income is from the buy side.
I've been an independent contractor for decades and what I'm describing below is essentially how every statement of work I've ever written and negotiated with a client has worked.
That said, here is what I am willing to pay a buyer's consult for during the home purchase process.
A) To help me develop a prioritized list of Must have, Should have, Nice to have features for house, location, schools, price range etc.
B) work with me to sort through the plethora of options available via IDX on the Internet portals prioritized based on the "buyer requirements list developed in A"
C) Advice me on which attorney, lender, inspector has qualifications and fees that suit my budget.
D) Acts as a "voice of caution" when visiting a property to ensure I look at the property objectively based on the requirements list without being blinded by "that's a really nice kitchen" enthusiasm.
E) Offer me pricing and negotiation suggestions for making an offer and finalizing the transaction.
For those consultive services I'm happy to pay a reasonable fee. Including hourly consideration for things that are time based such as property visits.
I'm not sure how I could be talked into making seller reimbursement a condition for closing. The consultant worked for my benefit not theirs.
If I were writing a buyer's consultant agreement certain of the items would be fixed price while others would be time based. I accept that these are fees that I am responsible to pay. Beginning with a down payment and then progress payments as required. Final payment at closing.
A buyer's consultant (agent) isn't a sales person. Their role is to provide me information and insights based on their knowledge and experience. Sales people work for a commission, consultants work for a fee based on their experience, knowledge and insights.
One man's view
Real estate is probably one industry with the most government intervention. Starting with GSE's Fannie and Freddie that provide mortage loans which are backed by the full faith and credit of the United States government. Flood insurance through the National Flood Insurance Program. The Mortgage Interest Deduction. The voluminous amount of tax credits the federal government offers. I could go on. It is rich for anyone in real estate to say it is a free market.