Why do you still need an agent to buy a home?

Department of complaints.
Aug. 16 2004 9:47 AM

Realty Bites

Why do you still need an agent to buy a home?

Illustration by Mark Alan Stamaty

"The first thing we do, let's kill all the lawyers," a character in a Shakespeare play famously remarks.

I have a different suggestion: Make it realtors.

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Here's why: Americans will spend about $1.14 trillion buying 6 million homes this year—both records. Yet the flat commissions paid to the realtors who handle the vast majority of those sales, averaging 5.1 percent, act as an enormous tax on the transaction process, taking wealth from both buyers and sellers in what for both is often the biggest financial transaction of their lives. It's true that selling a house is a complex task. But so is writing a will, and an attorney doesn't ask for 5 percent or 6 percent of your net worth as compensation.

And what do Americans receive in exchange for that commission, which can total up to $24,000 on a $400,000 home? In many cases, not much. A realtor's license can be had after as little as 50 or 60 hours of training (the person who cuts your hair probably has 1,000 hours or more). I've dealt with a half-dozen realtors during the past seven years, while selling two homes and buying three others. Last year, for instance, we sold a home in the $500,000 price range in the town of Newcastle, east of Seattle. It wasn't a perfect home—a typical suburban place with too much garage, not enough yard—but a very nice one, including a full theater room and a fantastic home office. We wanted to sell to make a move to Port Townsend, a little town in the northwest corner of Washington. One realtor we used to sell it was utterly incapable of articulating how our house differed from nearby, newer ones that basically were thrown up overnight and had cheap interior finishings. Another was clueless as to how to market a house in our price range, printing a cheap single-sheet black-and-white information flyer. (Our experiences were generally better on the buy side, except for one seller's agent who sought to discredit a skilled building inspector we hired who found that the foundation of a circa-1880 home was a rat's nest of rotting wood, faulty concrete, falling insulation and, well, rats' nests.)

But the real knock on realtors is a bit of simple economics that many people don't understand. Whether you're buying or selling, they rarely work in your interest. For the buyer, a realtor may seem like a dream—a "free" home-finding chauffeur, who then negotiates the best possible price. But the service isn't free—the sellers have likely factored the buyer's agent's 2.5 percent or 3 percent of the take into their price. Moreover, it's in the buyer's agent's interest to have you pay the most that you're willing to pay. After all, the higher the price, the larger their commission.  

What about the sellers? They know only too well the service isn't free—they're stuck paying the commission for their own agent plus the buyer's. But "their" agent really isn't interested in seeing the seller get the best possible price. Instead, that agent's incentives favor a quick sell, at any price. Look at it this way: Let's say you've listed your home for $290,000, and you owe $150,000 of that to the bank, leaving you with $140,000 in equity. The home may well sell for that $290,000—in a few months. But if the agent can persuade you to sell it for $270,000 in a few weeks, he is better off having forgone only $500 or $600 in commission while saving a great deal of time, energy, and uncertainty. That deal, though, will cost you $20,000 in equity. When we sold the Newcastle house, in fact, "our" agent actively worked against us in the final stages of the transaction, doing more than the buyer's agent to knock down our price.

All of this was supposed to change with the Internet, which essentially put travel agents out of business and stood stock brokerages on their heads. And it's true that nearly everyone with Web access does at least some shopping via the Internet when looking for a home. But the basic real-estate transaction model remains  utterly unchanged from what it was 50 years ago: Homes are listed on a regional Multiple Listing Service, largely controlled by local realtors. Virtually all of those homes have a listing agent, and when buyers finally get around to shopping they'll almost inevitably have an agent drive them around. And in the end, the seller will lose as much as 7 percent of their selling price in commission. True, as I mentioned, the average commission today is 5.1 percent, which is down from the 5.5 percent average of a few years ago. But since 2000 home prices also have risen by 20 to 30 percent nearly everywhere in the nation—in California, by that much just in the past year—and agents' commissions have of course risen, too. Moreover, the Web seems to have done next to nothing to make the real-estate industry more efficient. The average realtor today sells about six homes a year—a figure unchanged from a decade ago. About 1 million homes are sold by their owners each year, a figure that is inching up with help from the Web.

Why the fossilization? Mostly, it's because of the power of the National Association of Realtors, which protects its members' turf like a crazed wolverine defends its offspring. The organization has defeated efforts by some of the nation's biggest banks and even Microsoft to start their own real-estate listings, and have largely protected the sanctity of the Multiple Listing Service, enabling regular folks to scan bare-bones listing on the Web, but keeping most of the good info for themselves. Overall, the NAR has ensured that nearly all residential real-estate transactions still are conducted between two agents in cahoots. And they're largely responsible for keeping commissions close to that 6 percent level when any normal law of competition would suggest they'd be lower.  

Now the NAR is taking aim at what many realtors see as a genuine threat: the growing numbers of "discount" brokerages. One of the most prominent is ZipRealty Inc., which was founded in 1999 and currently is planning an IPO. ZipRealty lists homes on its own site as well as the Multiple Listing Service, offering sellers a 25 percent discount on commissions while still paying buyer's agents their full commission. It also extends rebates of 20 percent of the commission to buyers who come directly to ZipRealty. This knocks the total commission into the 3 percent range and attempts to completely unwind buyers from their agents.

But ZipRealty's efforts to drive down commissions and even eliminate the buyer's agent have drawn the NAR's ire. Early next year the NAR plans to implement new rules that would allow local brokerages to bar their listings on ZipRealty's site, a move that strikes directly at ZipRealty's model. The NAR also wants to prevent online brokerage sites from funneling customers to agents in exchange for a fee. That targets upstarts such as LendingTree, which uses the Web to match customers and agents, then rebates to customers part of the fee it collects from brokers. The NAR's moves have gained the attention of the Department of Justice's antitrust folks, and have been delayed twice already.

I'd like to see a strictly FSBO (For Sale by Owner) world. After all, escrow companies and home inspectors already do much of the heavy lifting in a real-estate transaction and add more value than most realtors while working for a flat fee. The Internet, meanwhile, provides a perfect forum for buyers and sellers to meet, just as eBay has transformed the marketplace for everything from lace doilies to Ford F250s. I understand that isn't going to happen anytime soon. Selling a home is indeed a hassle, and realtors at least offer the promise of one-stop shopping. And there's the issue of showing homes—realtors perform the legitimate service of vetting buyers and safeguarding a seller's property. Out-of-towners can benefit from a local realtor's expertise. And I've heard from sellers who have had agents who really "got" how to market a home, probably earning their commission and more.  

Still, I'm hoping that upstarts such as ZipRealty, LendingTree, Foxtons (a discount broker in the Northeast), and Catalist (a California discounter) will soon blow away the traditional realty transaction model like they're Puerto Rico playing the U.S. men's basketball team, dropping total commissions on a house sale to 3 percent, or even 2, while still offering the services people seem to desire from a realtor. Certainly, most people realize that a 6 percent commission—or even 5 percent—is nuts, given that e-mail alerts, Web-based home tours, and other services can easily give buyers and sellers as much information as their realtors. It will be a painful change for the 1 million real-estate agents out there—alas, a number that is growing rapidly. But a little Darwinism is needed to thin out the herd, and when it happens it won't give me much grief.

Douglas Gantenbein is the Seattle correspondent for the Economist.

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