Are 6% commissions exploitative?

Not far into my real estate career I began to question the sums of money we were getting paid. Getting a big fat check was supposed to be exciting, but one day I sold a home and the urge to celebrate faded away. Instead, I felt at odds with what I got in exchange for the work I did:

• Sales price: $505,000
• Buyer waived home inspections to be competitive
• 1 day on the market
• 3 hours worked (From listing presentation to open house, paperwork, data entry, phone calls, emails — literally everything)
• 2.5% selling-side commission: $12,625
• $4,208.33 per hour
• Professional photography and video: $350.00

I shared a few concerns stemming from my occupational, existential crisis with a couple colleagues. Their rationale was that the easy money averages things out when business is slow or you put in more time with a challenging sale.

I wondered how that is the sellers problem. This seller spent a lot of money updating and upgrading her home. It practically sold itself. It didn’t seem right that a seller should have to float their Realtor until their next closing.

Realtors will say, “I’m worth the full 6 percent” or “I don’t discount my commission.”

I couldn’t accept the grammar of these statements. Perhaps you too have wondered why someone with a $500k home has to pay twice as much as someone with a $250k home. The inherent effort involved is exactly the same. When Realtors say they are worth the full commission, they are saying they are worth $15,000 and $30,000 simultaneously. Of course, it’s the case that sellers are overpaying. These Princeton and UCLA economists refer to the excessive payment as social waste, and it costs homeowners tens of billions of dollars each year.

The 6% commission was conceived in the 1940s. Internet, email, databases like Zillow, and digital signatures like Dotloop and DocuSign have dramatically decreased the effort involved in buying and selling a home. So, why haven’t commissions been coming down right alongside? It’s because the residential real estate industry is as disastrous of an industry-architecture as you could ever possibly design. Low barriers to entry and price fixing has made it immune to the free-market forces that govern every other industry; keep supply balanced with demand, incentivize innovation and improvement, etc.

Lower Barriers to entry

There are approximately two million real estate agents and last year, 5.51 million homes sold. That’s just 2.75 home sales to go around per agent. There are so many agents bumping around, none of them have much of an appetite to lower their fees. Anybody with three months and $300 bucks can get their real estate license — a low bar that keeps ‘em comin’ and replacing progress with profound incompetence and mediocrity. Our aforementioned economists studied the Boston real estate market found that reducing commissions by one-half would reduce new-agent entry by a third, increase sales likelihood by 2% and would translate into $2 billion of savings for consumers and $900 million of cost savings from fewer real estate agents, in a short time period.

Price fixing

Fixing commissions into place inevitably creates a status quo, which has prevented outcomes from improving, or fees from coming down. In an ordinary market, poor service would command a lower the fee. Exceptional service would command a higher fee. In real estate, the fee is the same either way — it’s fixed into place, so there is no incentive for agents to go above and beyond. Even top agents do as little as possible, hoard listings, and attach a one-size-fits-all marketing plan to every property; farm, condo, town-home, single family with 2 acres, etc. In my discussions with vendors like Homejab, who offer aerial videos, 3D floor plans, and tools that are instrumental in helping a home stand out from the competition, admit that getting agents to spend a little more to bolster their listings is like pulling teeth.

“We can make as much money as doctors and lawyers, and they spend tens of thousands of dollars on their degrees,” says Rae Wayne, a Realtor® with the Bizzy Blondes team in Los Angeles.

Wayne makes an interesting point. According to Payscale.com, a Cardiothoracic Surgeon, on the high-end, earns $270.67 per hour. My slowest and most unprofitable sale was as a buyer’s agent. I showed over two dozen properties, had deals fall-through, it all amounted to about 20 hours worth of my time:

Sale price: $193,000

2.5% Buyer-Agent Commission: $4,825

$241.25 per hour

By definition, if you overpaid for something, the value isn’t there. But we could cut commissions in half and they would still be too high. Homeowners didn’t architect this industry, nevertheless they inherit the financial burden of its shortcomings; superfluous Realtors, mediocre marketing, and exorbitant fees.

The residential real estate industry baffles economists, and keeps anti-trust authorities very busy. These Stanford economists found selling brokers actually reduced the selling price of the typical home. You read that right. Their central finding was that the seller’s use of a broker reduces the selling price of the typical home by 5.9 to 7.7 percent. This was when we were transitioning into the internet, and brokers and Realtors were jumping up and down about the value their knowledge and expertise adds to the transaction. It turned out that they undervalue property. Malcom Gladwell and Steven Levitt touched on this in their bestseller, Freakonomics. The study showed empirically that their fee exceed the advantages of brokers’ knowledge and expertise by a wide margin.

In the Relative Performance of Real Estate Marketing Platforms, two economists showed again that for-sale-by-owners were earning a premium of roughly 9.5 percent, or $12,300 more for their homes compared to Realtor-assisted sales. This premium is on top of the saved commission. This is really embarrassing stuff for real estate agents. This is akin to sales for a product going up after the brand manager stops advertising. It’s an awful irony that when sellers pay a Realtor 5–6%, they are over paying to sell their home for less money. It’s very unfortunate that we live in a world where there is a retirement savings and a debt crisis. At the very least, people should be retaining their hard-won equity. If you overpay for popcorn at the movie theater, it’s not the end of the world. It’s arguably worth it — it’s all part of the experience. You get absolutely nothing in return for overpaying your real estate agent and you roll-back your financial progress and your net worth by years.

Wage exploitation occurs when productivity increases while wages stay the same. Commissions haven’t come down even though we have made serious advancements in technology that have drastically decreased the agent’s workload. A percentage commission will inevitably create social waste, let alone an exorbitant six percent. Sprinkle in the evidence that agents undervalue property to sell it quicker and it should become clear that the financially irresponsible thing to do is to pay a Realtor a traditional 5/6% fee. You’re bad with money if you agree to give a Realtor a traditional commission.

I would caution good, conscientious Realtors from interpreting all criticisms of their fee to mean a total disregard for their services; assisting with contracts, managing offers and deadlines, etc. Agents will dichotomize the issue, as though the only two conceivable options for sellers are pay exorbitant fees or go to the hardware store and buy a for-sale-by-owner sign. Agents tend to disregard valid criticisms and then proceed to provide anecdotes of how they have really helped people, and they run down a long list of all the things do in a transaction, completely missing the point. It’s not that Realtors don’t provide any value, it’s that at 5/6 percent their costs have far exceeded the benefits of their value.

Is there change on the horizon? Yes, absolutely.

Homeowners are currently aware of just two options:

1. Realtor
2. For-sale-by-owner

Realtors charge unfair fees, but they’re safe. Rexchange.com, Trelora.com, Reali.com, and Homie.com are safe and fair. When this choice is nationally available, a 3rd category will be born and 5/6% market share will evaporate.