Tuesday, October 10, 2006

Do Brokers Compete or Hold a Monopoly?

There's a lot of press these days on how much real estate agents are charging to sell houses. The House Subcommittee on Housing and Community held a hearing a couple weeks ago on residential brokerage services, where groups like the Consumer Federation of America (CFA) and American Homeowners Grassroots Alliance bemoaned the current commission-only business of real estate agents across the country.

To hear the CFA's take on these independent contractors (who have no job security, biweekly pay check, benefits, vacation/sick leave or traditional company support), they are all totally overpaid and consumers are being fleeced by a "fixed" commission rate that's being protected by the industry at large.

Obviously, I know a lot of real estate agents. Some are doing very well financially, on the other hand -- with the current state of the market -- some are looking to get out of the business. Most agents I know make a good living, but nothing extravagant. They draw in about the regional median income, but do not have the benefits that come with a full-time job. In fact, they have to pay for all their expenses – everything from paper clips to expensive advertising and marketing.

They get to pay for all of this, because they're taking a risk to make an above-average income. You won't see too many of them defending the latest commission charges these days because many markets across the country are off by as much as 30 to 40 percent. Instead, they are out looking for business. They're trying to get sellers to price right and buyers to get off the fence; meanwhile, the mortgage is due, the kids still want to eat and they have to market clients' properties with no guarantee of getting paid for it.

Mr. Stephen Brobeck, executive director of the CFA, calls the current residential brokerage system "a cockamamie system that restricts competition and consumer choice," in his testimony on July 25, 2006. Much was said in his testimony, thus I'll limit my response to the part where he calls on the real estate industry to be regulated like a utility -- you know, the power and gas companies.

What's really scary is that he is saying this in front of some pretty influential and powerful people in this country who may not really understand how a real estate agent makes his or her money.

Yes, they get paid on commission. And when you look at the average price of a house in the Washington, D.C. market, it makes some in Congress wag their heads at how much each agent must be walking away with from the settlement table.

Well, let's work in real numbers. Last year, the local MLS reported the D.C. area real estate market created roughly $44 billion in sales. The average commission, according to Real Trends, an industry watchdog group, stands at 5.1 percent (not the 6 to 7 percent touted in Mr. Brobeck's testimony). At that rate, with a commission split of 50/50 between brokers and their 30,000 agents, the average commission income would be roughly $37,400 each.

To be totally upfront (something I didn't see portrayed in some of the testimonies I read) the 80/20 rule can be applied in real estate -- except I would surmise it's more like a 70/30 rule: about 70 percent of the sales are done by 30 percent of the agents. Thus, you have some very successful agents on the top, and the rest are digging around for the remaining commission dollars.

A lot of money exchanges hands in this business, being divided between a lot of people. So while the dollar amounts sound expensive, they really only create an average income compared to any other industry in the region. But here's the catch -- agents only collect their pay if they are successful.

They only collect their split of the 5.1 percent commission if the transaction actually goes through. There's no reward for second place. If the agent gets the listing, spends her own money up front to market it, charges all her gas to her credit card, then she hopes to get paid back once the sale goes through … if the sale goes through.

Unlike other professions where the attorney gets paid even if his client goes to jail, or the surgeon gets paid even if his patient dies -- the real estate agent only gets paid the commission when the house sells. There's no paycheck for failure in real estate.

Published: August 11, 2006

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