The U.S. Realtor is the worst idea in the history of American finances.
The highest form of tragedy and horror is always embedded in irony. The old practice of blood letting sick people is an example of how the prescription just accelerates the illness, which leads to more of the same counterproductive treatment.
It isn’t just a little ironic that hiring a real estate professional is counterproductive. The 6% real estate commission is the biggest scandal in the history of US capitalism. It is akin to bloodletting your home equity. I will return to the assertion that the U.S. homeowner is overpaying by $66 billion a year for services, on top of another 11% homeowners are losing by virtue of Realtors systemically under pricing property, totaling nearly $148 billion dollars in financial waste each year. This is to say real estate agents reduce the net worth per capita of homeowners by almost $1.5 trillion dollars every ten years. How is this possible?
There are a 3 issues simultaneously at work:
- A percentage fee inherently causes homeowners to pay in gross excess of the Realtor’s effort and value. Fees double and triple and quadruple, etc., but the effort involved in selling does not. It is not inherently twice as hard or time consuming to sell a $500k home than a $250k home, and so on. Economists refer to this phenomenon as social waste.
- A 5–6% fee is profoundly inflated. Why isn’t it 1–2%, or .5–1%? It was completely arbitrarily decided on in the 1940s, and it stuck. A higher percentage inevitably kicks-in excess payment at lower selling prices, close to the nations median value, causing everyone to overpay, whereas if a 1–2% fee was customary, it would alleviate 400–500 times the waste homeowners currently pay. Variable rate compensation has long been associated with sales people peddling insurance and other lower cost items. When dealing with housing prices, a homeowner with $100k in equity selling a $350k house has to fork over $21k. The 6% fee consumes 21% of his equity.
- Realtors under price property. This issue is as expensive as commissions themselves. By virtue of the over-supply of Realtors and rampant sales culture, Realtors empirically sell homes for less money than identical homes sold by for-sale-by-owners. By owner: $250k, same house by Realtor: 235k. This is an additional 11% sacrifice, amounting to $81.5B annually.
In the future, we will look back on the irony of the Realtor in horror: Realtors sold our homes for a lower selling price, and charge inflated fees to do it.
The evidence:
- A percentage fee inherently causes homeowners to pay in gross excess of the Realtor’s effort and value:
A percentage fee climbs right alongside the selling price:
The fee doubles, triples, quadruples, while the effort is inherently stagnant. There is absolutely no correlation between higher selling prices and additional effort:
“Though competitive pressures ordinarily force an industry’s fee structure to reflect its costs, real estate broker commissions are strangely unrelated to either the quantity or quality of the service rendered or even to the value provided. Rather, this fee has been based solely on the price of the home. (It is as if tax preparers set their fee as a percentage of a client’s gross income, irrespective of how difficult the return was to prepare or how much their efforts saved the taxpayer). Oddly, not only is there no evidence that it is any more costly to sell higher-priced homes than median-priced properties, but it is possible that the opposite may be true! Furthermore, the straight percentage fee formula creates little incentive for real estate agents to provide home buyers or sellers with additional value.”
2. 5–6% fee is profoundly inflated:
“Globally, we see much lower residential commission rates in most of the other highly industrialized nations, including the United Kingdom (UK), Hong Kong, Ireland, Singapore, Australia, and New Zealand. Fees in Hong Kong, typically 1% for the seller, are among the lowest in the world even with the extra charges for lawyers typically incurred at closing. In the UK, the commission rates average less then 2%.”
In a world of internet, networks, and software, the real estate brokerage industry is an anachronism. Therein lies the problem, we are turning to brokerages and commissioning sales people that have no more training than an Herbalife rep. They are not asset managers or advisors. The fee Realtors receive is grossly disproportionate to the value and expertise they provide.
3. Realtors lose homeowners price:
As a licensed real estate agent, I can attest to this systemic issue. When I interview for a listing, I'm surprised to learn how many Realtors advise the seller to list the house for substantially less than what it ends up selling for. You can always reduce the price, but if you lose price out of the gate that money is gone. Underestimating property value is a side-effect of a sales-driven industry, full of quotas, sales scripts and thousands of agents bumping around, all desperate for a paycheck. Anyone with three months and $300 bucks can obtain their license, a barrier to entry so low, that it floods the market with an over-supply of agents, keeping commissions high by default:
Consider:
There are 2 million real estate agents and just 5.5 million homes sell each year. That’s only 2.75 homes to go around per agent, not nearly enough for everyone to thrive. And I don’t know who is the bigger offender, the starving bottom feeder that just wants a commission or the top-producer, whose burn and churn business model does a disservice to homeowners.
A damning study showed that for-sale-by-owners were able to achieve selling prices $14,800 dollars higher than Realtors who sold identical homes for clients. When Realtors sold their own homes, they too sold their home for more than what they were getting clients with identical property. The study showed an undeniable pressure applied to listing price and negotiation in favor of the Realtor’s interests, not their client’s. When the roles are reversed and the Realtor sells their own home, they behave similarly to an owner-seller.
In conclusion:
U.S. homeowners spend approximately $80 billion annually on real estate commissions. Economist describe the inherent excess in involved in fixed commissions as a “social waste”:
Additional studies show Realtors not only do not pay for themselves,
“Our key finding is that Realtors do not offset the cost of their commission; they do not get you a higher price.” —Aviv Nevo,University of Pennsylvania
Department of Economics.
and they are underselling houses, by 11% on average:
The results suggest that on average there is a large positive premium for selling on FSBO, roughly an 11 percent premium or 14,800 dollars. Since the dependent variable is the sale price, and not the sale price net of commission, this premium is on top of the saved commission.
One way to value service providers, plumbers, cardio-thoracic surgeons, etc., is to consider the costs you’ll incur in the absence of their service. Ignoring a recommended procedure can leave you with costs substantially higher than the fee itself. In essence, the service pays for itself. The transaction is a net positive for consumer, and the service provider is paid an amount commensurate with their expertise, that is finite. This is the case in a industry with a balanced supply and demand. Realtors, by virtue of fixed fees and antitrust violations, like requiring the seller pay the buyer’s agent, Realtors are a cancer on American finances. Not only are Realtors overpaid, they are overpaid to undervalue the homes they sell. Not everyone can fix their own plumbing, or represent themselves in court, but anyone can sell their own home.
There are two ways to calculate the totality of wasted home equity.
The first is by comparing what Realtors earn with the actual, practical costs involved in selling a home. Realtors, on average spend between 12–15 hours selling a home. This is true for myself, I have sold dozens of homes ranging from $70,000 to $1,000,000. A cardiothoracic surgeon commands approximately $200 an hour. By building risk into the fee, such as photography costs if the home doesn’t sell, we can safely arrive at $2,500, which yields $166 an hour for 15 hours worth of work. Cohen Milstein, the firm representing the plaintiff the National Association of Realtor class action lawsuit, is seeking a permanent injunction against Section 16 of the Clayton Act, that would ban the seller from paying the buyer’s agent. Under these circumstances, this model saves homeowners $66.2 billion a year, which is to say consumers are overspending by $66.2 billion annually. Built into this model is the assumption that Realtors are selling homes for as much as the home can command, which they don’t…
By extrapolating findings that show agents are undervaluing property by 11%, or $14,800, there is an additional $81.5 billion dollars in unrealized equity across 5.51 million transactions. The sum of these amounts is $147.7 Billion dollars a year, or $1.5 trillion dollars every ten years.
In a perfect world, American homeowners would increase their net worth per capita by $1.5 trillion every tens years. But we are currently at the mercy of a legacy system, that is fused with culture and consumer psychology.
In the coming months, I am launching a peer-to-peer, residential real estate platform, that will connect buyers with sellers directly, and facilitate communication and transactions. As a brokerage, we will provide full-service expertise, with the objectivity required to appropriately price property. Our model, at complete scale, would reverse the over-payment of $70 billion dollars each year, and would realize the $81 billion in unrealized gains by pricing property without desperation, in an objective and data-driven way.
Citations:
1. A Critical Assessment of the Traditional Residential Real Estate Agent
2. Commissions and Social Waste in the Real Estate Industry
3. How Much Value do Real Estate Brokers Add? A Case Study
4. The Costs of Free Entry. An Empirical Study of Real Estate Agents in Greater Boston
5. The Impact of Commissions on Home Sales in Greater Boston
6. The Relative Performance of Real Estate Marketing Platforms
