In the comments of this post, I wrote that THE challenge facing real estate is how brokers move from 3% profit margins to 10% profit margins. And I just got off a fantastic teleconference featuring the likes of Kris Berg, Marty Frame, Pam O’Connor, and other experts talking about the industry.
Then Kris, Jay Thompson, and I got into a Twitter discussion about broker profitability and the path to it. The 140-char limit is not conducive to real discussion, so… this post.
Let’s set the stage.
I have heard from various sources who ought to know (e.g., COO of a very large brokerage in the South, president of major franchisor, etc.) that the average profit margin for real estate brokerage is about 3%. This means that some are over 3%, but a huge portion are actually below 3%. (Remember, average, not median.)
The average profit margin for corporate America over the last 25 years is 8.3%.
As of today, 30-year Treasuries are paying a 4.5% coupon, and yielding 2.66%.
So by taking ZERO risks with my money and investing it into 30-year Treasuries, I will make 2.66%; by taking all sorts of risks (litigation risk, business risk, etc.) and for taking on the headache of managing a whole bunch of real estate agents, I’m going to make 3%.
There is so little incentive to become a broker if this is the situation.
More facts: The average company dollar for real estate brokerage (based on the REAL Trends Brokerage Performance Report) is 26.8% — meaning that for every dollar of GCI revenue, the broker receives 26 cents. Then out of that company dollar, the broker has to pay for all the overhead, the office space, the advertising, the websites, so on and so forth.
So the question is, how does a broker improve his profitability? Because if profitability is so low, then he might as well just put his money into Treasuries and earn more.
Kris Berg suggests that the answer is for the broker to stop giving agents all these ridiculous, unused, useless tools and gadgets, and to just get out of the way. Jay Thompson echoes her thoughts and points out that he’d make more money from a really good agent at 10% split than a crappy newbie at 40% splits.
Okay. So, the issues are:
1. Profit ($$) vs. Profitability (%)
Profit is raw dollars; Jay probably does make more $$ from a top agent at 90/10 splits. However, his company dollar is 10; his maximum profitability from that agent is 10%. After taking all of the costs of having that agent into account, I suppose Jay could calculate the profit margin of that particular agent. If it’s 2%, then I have to recommend to Jay that he fire the agent, take those dollars he would have invested in keeping that agent (e.g., overhead, utilities, whatever) and put it into Treasuries paying 2.66%. He’d actually end up making more money.
This is something no one truly knows. No doubt Jay’s actual profit margins are higher — he’s estimating maybe even 9% or so. That puts his profitability in line with corporate America, trend-wise, and makes it worthwhile to keep being a broker.
But does this translate to say Crye-Leike? No one actually knows.
And the impact of margins get outsized as the actual dollar volume increases. Going from 9% to 7% for a small operation might mean profit decreases from $90K a year to $70K a year. But if you’re a Big Brokerage, then going from 9% to 7% could mean going from $90M a year to $70M — those $20M dollars could have gone into things like investment in more innovation, a better website, whatever.
Conversely, if you take two large brokerages, and one makes 9% and the other 8.5%, that could still mean a $5M a year advantage for the one making 9% to reinvest into the business. After a few short years, those millions will start to have an impact on the weaker business — whether that’s through more effective branding, better training, or better consumer website that the extra $5M a year can buy.
The key question, I think, is that of incentives.
If a broker is seeking to be a low-cost, low-value provider to the agent, what exactly is the agent’s incentive to pay the broker a larger share of GCI?
And if the answer is None, then the claim absolutely must be that for a broker to increase profitability, it must be done by cutting costs other than labor costs. In fact, the money saved from eliminating all those ancillary tools and overhead must more than make up for the inevitable decline in company dollar.
Consider. If today, you’re giving me $10,000 worth of tools and services, and I’m paying you 20% splits… it is entirely irrational for me to agree to keep paying you 20% splits if you drop what you’re giving me to $1,000. So that $9K you’re saving by dropping your services to me to $1,000 had better be more than the company dollar you’re going to lose when I demand higher splits (let’s say to 95/5). So 15% of my GCI production for that year has to be less than $9k you’re saving for this to end up improving your profitability.
Is there a scenario where this could work? Possibly.
I just can’t imagine it. The incentives are completely out of whack.
Seems to me that at the end of the day, it comes back to an issue of Productivity. Somehow, I as the broker, have to get more productivity out of my agents without raising my labor costs significantly.
Well, since Productivity is classically defined as “Output per unit of labor” the only two ways to increase productivity is to raise output (i.e, GCI in our case) or lower per unit labor costs (i.e., agent commissions).
Raising output then means somehow, the agents you already have, without any additional assistance, tools, or services, simply have to make more deals happen. It’s possible, of course, if the market conditions improve, or they just get better at selling homes. But that strikes me as an exercise in “hope and faith as corporate strategy”. Just Do It! is rarely an effective business strategy.
Lowering per unit labor costs is similarly fraught with difficulty. If someone is making 80% of GCI on a split, what exactly is his incentive to make less, if you are giving him nothing more?
So… I come back to this: Technology.
The only proven way to improve output per unit of labor is to invest in technology. A farmer using a horse-drawn plow can produce more grain if he’s given an International Harvester. A shoemaker producing two shoes a day using a hammer and scissors can produce two hundred if he’s given an automated modern factory with an assembly line and modern inventory management.
It’s the only known answer we have.
So if a broker wants to improve profitability, seems to me that he has no choice but to invest in technology to make his agents more productive, while either demanding more money (since he’s giving them more) or keeping labor costs constant (since he’s giving them more).
Am I missing something here?