The Strange Song of Subsidies

Posted By Rob Hahn April 6, 2012, Filed under: Management, Marketing, Real Estate@ 12:19 PM

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Over on the Raise the Bar Facebook Group, I posted a question to the thousand-plus members:

Question for this group, because it has so many ultra-engaged and informed people in it.

If your MLS proposed to change fees from a flat-fee subscription to a percentage of closed transaction (NB: FMLS in Atlanta area does this), would you support such a change or oppose it?

Please explain your reason, if you can.

The answers were fascinating, mostly for the reason that they were pretty much uniformly against the idea because it would subsidize the unproductive. A few examples:

The responses are not surprising, since the entire Raise The Bar movement has as a theme the idea that there are too many bad real estate agents out there who are giving a bad name to the good agents. Furthermore, the existence of too many of these “accidental salespeople” in the words of David Charron, CEO of MRIS, hurts the business opportunities of better agents.

But the question of subsidies is a bit more complex than that.

Subsidies Go Both Ways

First, given that upwards of 50% of members in a MLS does not a single transaction in a year, there is no question that the current system of monthly subscription fees results in subsidies of the productive by the unproductive.

The contemporary MLS has an economic model similar to a health club. Everyone pays the same fee, but some work out five times a week while others show up once every couple of months. Without the payment from those inactive members, the health club could not stay in business without substantially raising fees on the active members. Similarly, an agent who is constantly using the MLS system generates costs to the MLS, whether in administrative support, tech support, compliance (more listings = more compliance), or system upgrades. The unproductive agent, who maybe gets a random inquiry once in a blue moon, does not.

A similar mechanic exists for health insurance: the healthy subsidize the sick. An insurance plan filled only with people constantly needing expensive medical treatment would soon go bankrupt. Without people who pay in more than they take out, no insurance company would stay in business for long.

What makes one subsidy great and a different subsidy awful is a bit unclear. I think I can argue for the present subsidy (where the unproductive subsidize the productive) on a policy basis: paying the same no matter the level of usage creates incentives to become more productive.

Like a health club, if someone chooses to pay and not go to the gym… well, it’s her loss. The incentive is to go to the gym, work out all the time, and get healthy, to get your money’s worth. The reverse, where one pays based on usage, creates an incentive not to work out.

For real estate, I can see a strong argument that MLS fees should create an incentive for agents to be as productive as possible, to maximize their usage of the MLS. Everyone benefits, from the agents to the brokers to vendors to mortgage lenders, title companies, and every other entity connected to real estate.

The Consumer Subsidy

Which leads us to the other big subsidy: productive consumers subsidizing the unproductive consumers.

It cannot be seriously argued that how real estate works today results in successful buyers and sellers subsidizing the unsuccessful. Because realtors do not get paid until a successful close of transaction, they spend a great deal of time working with “clients” who end up doing nothing at all, whether because they changed their mind, or because of circumstances (e.g., the lender refused to fund the mortgage, something comes up during inspection, etc.).

The risk to the agent is quite significant. They could end up spending hours upon hours of time, not to mention expenses of driving a buyer around or marketing a property, only to end up with nothing. The result, then, is that those consumers who do end up actually closing on a transaction must pay more in order to keep the real estate agent in business.

What none of us knows is just how much this “risk premium” to the consumer is. Agents I’ve spoken to about the risk premium have given me answers ranging from 25% to 50% of the total, but even that isn’t accurate since agent compensation also depends upon the sale price. It may be that the risk premium is lower for lower-priced homes that tend to get to closing more frequently, and much higher for luxury segment where more work has to be done to get to an actual closing, simply because the buyer pool is necessarily smaller.

There is no question, however, that the contemporary compensation structure leads to the productive consumers subsidizing the unproductive.

The question, then, is why is this okay? What is the incentive structure created here?

If changing the MLS fees to one based on usage leads to the perverse incentive of encouraging the not-serious, part-timer, the “folks who shouldn’t be in business in the first place”, then doesn’t the current commission-based compensation structure encourage the not-serious buyers and sellers who shouldn’t be in the market in the first place?

NAR tells us that one out of three purchase contracts in January failed. That’s a substantial amount of work by a couple of real estate agents down the drain — showing houses, writing up the offer, negotiating it, etc. etc. Would those buyers have acted differently if they had to bear the cost of the contract failure? There is little doubt in my mind that they would have.

Demand Change? Raise the Bar?

Logic dictates that raising the bar amongst real estate professionals cannot be done without raising the bar amongst consumers. After all, if consumers are incentivized to regard realtors as free labor, they will continue to use realtors as free labor, and the incentive for realtors then becomes working with as many consumers as possible in the hopes that a few of them will actually make it through to closing. It isn’t substantially different from playing the lottery.

And out of economic necessity, realtors have to charge the successful buyer and seller a fee that does not correspond to the actual work put into the transaction, in order to cover their costs from providing services to all of those consumers that paid them nothing. The informed consumer knows that he is subsidizing all of those others who used the services of his agent without paying for them, but he doesn’t have a choice: is it any wonder that consumer resentment pops up from time to time at having to hand over a $15,000 check at the closing table?

Three questions to close, then:

  1. Do realtors, particularly those committed to client service, who take fiduciary responsibility seriously, and who believe in transparency, inform the consumer that should they actually close, they will be subsidizing all those who did not?
  2. Do realtors, particularly those who believe that the productive agents should not subsidize the unproductive agents, support the idea that productive consumers should not subsidize the unproductive consumers?
  3. Are realtors, the Associations that represents them, and the brokers who hire and train them, working towards a pay-for-service model?

Consistency would dictate that there be a massive movement, especially out of the nascent Raise the Bar movement, to charge consumers for services either up-front or on an as-you-go basis. At this time, I’m only aware of one major brokerage that is taking a step towards this model: Koenig & Strey in Chicago. But then, consistency is the hobgoblin of little minds, so I’m open to the idea that one subsidy ain’t like the other.



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