Brian Boero of 1000watt recounts a dinner conversation and throws down some challenging questions and assertions:

This particular debate centered on the following question:

“Have we reached the end of the real estate story now that FSBOs and discounting have lost their menace?”

As Brian puts it, there were two camps, comprised of him in one camp and everyone else in the other camp:

Methods have changed. Markets have changed. The balance of power between brokers and agents has shifted. Consumers have access to enough data to choke a horse.

But the basic structure of this business remains remarkably intact.

There are two possible conclusions to be taken from this:

A. Real estate is exceptional. The complexities and emotions that characterize the real estate transaction will forever shield it from structural change. Bill Gates, Barry Diller and about a billion dollars in VC have been thrown against the barricade with no transformative impact. The story is over.

B. We’re due for a cataclysm. The forces of change, of technological innovation, of inchoate consumer frustration, are stacked high against the dam of Real Estate As We Know It. It will not – it cannot – hold. The story is far from over.

My dinner pals were in the “A” camp. I argued for “B.”

Given that the whole thrust here is theoretical and futuristic, I can’t help but charge in foolishly where wiser men fear to trod.

Basic Structures of the Business

If we’re going to talk about changes to the basic structures of the real estate business, then we must talk a bit about basic structures as they are today.

In my uneducated, and quite possibly ignorant view, there are four key factors.

1. Compensation & Control of Customer Relationship
2. Intermediary Services
3. Non-Commodity Goods
4. Purchase Cycle

Any discussion of “changes to the basic structure” must include changes to one or more of the above four.  Everything else is just cosmetic, incremental changes.

Compensation & Customer Relationship

Compensation today is governed by the 1099 independent contractor status of most agents, coupled to the post-RE/MAX revolution in the relative power between brokers and agents.

According to Jeff Wheeler, COO of Coldwell Banker United, whom I have referenced before, there was a time when consumers worked with the broker, who then farmed out the actual execution to contractors, aka, agents.  Business development and customer relationship management were responsibilities of the broker whose name is on the paperwork.  Compensation, accordingly, was tilted heavily towards the broker, with the agent receiving a smaller percentage of the commission, and perhaps a bonus for bringing in a customer.

After RE/MAX, consumers work with an agent — who is encouraged to develop a book of business and actively market her services to her ‘sphere of influence’.  Business development and customer relationship management responsibilities shifted to the agent, and compensation accordingly followed suit.  Splits unheard of in the Broker-centric era became commonplace.

Companies like Keller Williams have taken the model to an extreme: 100% agent splits after a fixed amount (“Cap”).  And even further refinements on the agent-centric model are in development.

I consider this to be a fundamental basic structure of the industry, because the implications are legion.

First, the broker’s business essentially transforms from providing services to buyers/sellers of real estate (aka, brokerage) to providing services to agents.  The oft-maligned “body shop” or “churn and burn” brokerage models of today result directly from the basic compensation/CRM model.  When the broker’s margins from each transaction is tiny, the only way for the broker to make money is to make it up in volume, especially in the high-margin volume of low-performing, high-splits agents.

Consider that a new, part-time agent on a 50/50 split who manages to list her sister’s $300K house will generate $18K in commissions, and $9K for her side.  The broker will take $4,500 from that single transaction.  A high-performing superagent on a 90/10 split will need to do $1.5M in sales to generate $45K in commisions for her side for the broker to generate the same $4,500 in revenues.

Second, with such lower margins, the broker has less and less incentive to reinvest in support costs, such as brand marketing, property marketing, new technology, and the like.  The key question will not be whether such support will result in better brokerage services, but whether such support will result in attracting more agents to the brokerage.  Anything that is unlikely to impact recruiting and retention will be pushed off to the agent, who is now taking home the lion’s share of the brokerage commission.

That in turn, reduces the bond between broker and agent to a point that retention becomes a straightforward comparison between lowest-cost providers as far as the productive agent is concerned.  After all, the broker isn’t exactly providing a whole lot of services to her; why should she stay with that brokerage if the competitor is offering slightly higher splits, or throws in some goodies, or whatever.

Third, as far as the consumer is concerned, his relationship is with the real estate agent, not the brokerage.  Many consumers can’t remember the name of the brokerage to which the agent listing their house belongs.  Nor have they really bothered to learn, because brokerage affiliation has no meaning to them.  The consumers are customers of the agent, not the broker, and if an agent moves or goes independent, she may be assured of taking her book of business with her.

This is the fundamental reality of today’s brokerage industry.

Intermediary Services

Another fundamental fact is that real estate brokerage is about being an intermediary between principals — hence, “brokerage”.  The broker or agent doesn’t own any product, doesn’t produce any product, and actually makes very few decisions regarding purchase or sale of any product.  While real estate agents are fond of talking about “inventory”, it isn’t the same thing as inventory in other industries.

Everyone knows this in their hearts, but few people really apply what this means for marketing, for operations, and for structure.

For example, the Marketing people inside most brokerages concern themselves with marketing properites for sale.  Newspaper ads, online ads, listings syndication, company website, agent websites, etc. are all promoting homes for sale — as if the realtor is a retailer of homes.  She is not.  She is an intermediary providing services to principals.

Closer to home, too many realtors are approaching the Internet, social media, and other such channels using templates from e-commerce, consumer packaged goods, and retail without thinking about whether those templates are valid for intermediaries.  The classic example is the agent whose blog is filled with posts about some listing or another she’s trying to sell.  That might work for a company that makes products — like Apple or BMW — or for retailers who have 3,000 copies of a DVD in stock, but how those posts help market her actual business is unclear.

Non-Commodity Goods

Furthermore, even amongst intermediaries, realtors are unique in that they act as middlemen for non-commodity (and in some respect, un-commoditizable) goods: real estate.

Stockbrokers are intermediaries, but at least they are peddling stocks and bonds, which are easily interchangeable, can be priced as a group, etc.  Creating data on commodity goods is much, much easier — prices on the NASDAQ don’t distinguish between one particular share of MSFT stock vs. another particular share of MSFT stock.

One implication of trading in non-commodity goods is that providing decision support to the client is one of the most important services an intermediary can provide.  Other service elements — such as responsiveness, friendliness, and the like — are all important, but pale in comparison to knowledge.

For example, investment bankers who do M&A work are also dealing in non-commodity goods: companies that are for sale.  And the single biggest service that they provide clients is a pricing opinion.  What do the experts at Goldman Sachs think is the fair value for Acme, Inc.? and does the post-transaction experience bear them out or not? become the key questions to be answered.

From a basic structure standpoint, then, the key ability for a real estate professional to possess is the ability to provide pricing and to back up that opinion.  Whether the majority of realtors actually have that ability is an open question.  Whether brokers and other organizations train real estate agents to provide valuation services, and the degree to which that training is stressed, and to efficacy of such training are all open questions.

Purchase Cycle

The final basic factor — for my current thinking, anyhow, although it’s not only possible but near-certain that I’ve missed a basic factor or two — is the consumer purchase cycle.

The average consumer spends seven years in between real estate transactions.  A newlywed couple who buys their first starter home in 2009 won’t be back in the market until 2016, on average.

This has enormous implications for customer relationship management, for marketing, for branding, and for operations.

For CRM, given the seven year cycle, it’s extremely difficult to establish concepts such as “Best Customer” or “Frequent Flyer” type of approaches that dominate traditional CRM.  Traditional CRM, after all, is concerned mostly with getting customers to be repeat customers — creating brand loyalty and repeat business.  Unless you are dealing with an investor client who is frequently (and always) in the market to acquire and dispose of properties, no matter how good your effort, you have a seven year purchase cycle to work through.

Plus, for such a long-range CRM plan, the materials used have to fit the purchase cycle.  Sending postcards or emails about the Just Sold house down the block, or New Listings This Week, to a couple who bought a new house a year ago isn’t exactly cost-effective.  In fact, it’s likely to get a bunch of “Unsubscribe” notices.

However real estate agents and brokers deal with the changes in consumer behavior, one of the fundamentals they have to consider is the Seven Year Cycle and what that means.

The Next Chapter

When Brian states that the real estate industry is due for a cataclysm, and he points to “forces of change, of technological innovation, of inchoate consumer frustration,” I can’t help but be sympathetic.  There are enough inefficiencies and oxymoronic practices in the industry that the reasonable mind thinks, “Surely, this can’t last….”

At the same time, technological innovation of itself won’t bring about cataclysmic change.  Nor will inchoate consumer rage.  If those types of motivations do not lead to actions which impact one of the fundamental realities of the industry, then we’re looking at cosmetic changes instead.  Realtor.com brought about change, but I would argue that it wasn’t a “fundamental change” because none of the four factors listed (or another one I’ve overlooked) are impacted.  Realtor.com doesn’t change compensation or customer ownership; it doesn’t change real estate agents into retailers or manufacturers; it doesn’t make housing commoditizable; and it doesn’t change the consumer purchase lifecycle.

Looking at it that way, I think only one of the four factors I’ve described is within the control of agents and brokers: compensation and customer ownership.  None of the other three could possibly be changed by technology or consumer rage or changes in the economy or whatever.

In that context, I find this post on ActiveRain interesting (h/t: Pam O’Connor for tweeting it):

It will be exactly what the book Blue Ocean talks about. The change will be the opposite of what is happening in the industry. If every brokerage is focusing on recruiting agents, the new brokerage will focus on quality of agents. The new brokerage will be as the Red Shirt Warriors. Elite agents will be chosen to be part of the brokerage because of their abilities. Not simply because they have a pulse. There will be a subconscious pressure for people to perform the best they can in order to be a part of the elite group.   The change will be 3 fold. 1rst: the brokerage will only focus on quality of agents. 2nd: the structure of how an agent works will change. 3rd: the service given to the consumer will be instant results, knowledge, and services. The consumer will also see the value of this New Brokerage because there won’t be inexperienced agents charging the same commission as the experienced agents. Regarding the change in structure, I’m talking about how agents’ work will change. If you read the E-myth you will read why businesses fail. The New Brokerage which focused on quality agents will have a new structure. Today’s model of an agent’s business fails 90% of the time. The structure will meet the other 10%. What about the service given to clients? 80% of clients browse the internet to look for a home. 70% of those, don’t call their brother or cousin to go look, they drive by the house on their own. The new brokerage model will give these people what they want. The new business model will get these people in the homes that instant, when they want to see it. How do I know? Because I know why people are calling me to help them buy a home instead of calling their brother. I know why other real estate agents are calling me to sell their own homes or to help their clients. I am seeing the change firsthand. People want a higher level of service.[Emphasis added.]

What I can’t quite understand is why “higher quality of agents” leads to a “New Brokerage” structure and model.  If you take the current model, and stock it chock full of “elite agents”, unless there is a change in the compensation structure or the customer ownership, I don’t see how that’s different from your standard model.

Perhaps Utah Dave, the author of the post above, could explain the New Brokerage structure and model.  Perhaps others would provide greater insight, or correct my analysis of the situation.

But until then, the next chapter of the real estate story remains to be written.  When that chapter is written, my bet is on a major shift in compensation and customer ownership.  Everything else is just cosmetics.

-rsh