Yesterday, I gave a presentation at the Pacific West Association of REALTORS Broker Summit which I named “Bring the Pain”. To be fair, I ask all my speaking clients whether they want the Light, Medium, or Heavy and PWR picked heaviest of the heavy.
One of the things I mentioned was a recent Working Study published by the National Bureau of Economic Research (NBER) called “Conflicts of Interest and the REALTOR Commission Puzzle”. I’ve embedded the PDF after the jump, and I had promised the attendees that I would make the paper available. I figured I might as well make it available to all my readers, who are the best informed readers in the real estate industry. 🙂
Cut to the chase: this study is truly disturbing, if it is valid. Basically, it undermines the justification for buyer agency and lays the groundwork for regulation/legislation banning the sharing of commissions. So yeah, it’s worth paying some attention to….
The Working Study
First of all, here’s the full paper:
Read the whole thing, although to be fair, unless you’re an economist or a mathematician, huge tracts of the paper will be as if it were written in ancient Greek.
Second, the authors of the study are what we might call formally as “Really Smart People”:
- Dr. Panle Jia Barwick, Cornell University
- Dr. Maisy Wong, Real Estate Department, Wharton School of Business, UPenn
- Dr. Parag Pathak, MIT
Relatedly, NBER isn’t some brand new think tank of Social Justice Warriors. It is one of the most respected economic research think tanks in the United States founded in 1920. From their About Us:
The NBER is the nation’s leading nonprofit economic research organization. Twenty-four Nobel Prize winners in Economics and thirteen past chairs of the President’s Council of Economic Advisers have been researchers at the NBER. The more than 1,400 professors of economics and business now teaching at colleges and universities in North America who are NBER researchers are the leading scholars in their fields.
In fact, NBER is the organization that calls when a recession starts and ends. It is extremely influential in economic policy circles and with policymakers throughout government and business.
So, what did this study actually say?
Assuming that most of you didn’t actually download and read the paper above, let me summarize their findings. First, the Abstract:
This paper documents uniformity in real estate commission rates across markets and time using a dataset on realtor commissions for 653,475 residential listings in eastern Massachusetts from 1998-2011. Newly established real estate brokerage offices charging low commissions grow more slowly than comparable entrants with higher commissions. Properties listed with lower commission rates experience less favorable transaction outcomes: they are 5% less likely to sell and take 12% longer to sell. These adverse outcomes reflect decreased willingness of buyers’ agents to intermediate low commission properties (steering) rather than heterogeneous seller preferences or reduced effort of listing agents. While all agents and offices prefer properties with high commissions, firms and agents with large market shares purchase a disproportionately small fraction of low commission properties. The negative outcomes for low commissions provide empirical support for regulatory concerns that steering reinforces the uniformity of commissions. [Emphasis added]
In plain English, what the above says is that properties whose cooperating compensation is below the norm for a market (e.g., if 3% is standard, then a 2.5% commission) are 5% less likely to sell at all, and even when they do sell, take 12% longer to sell. The only explanation for this — according to the authors — is that buyer agents are steering consumers away from lower-commission properties and towards higher-commission properties. Given that, they think their findings support “regulatory concerns.”
What might this regulatory concern be all about? Well, from the Conclusion:
Our findings provide empirical support for regulators’ long-standing concern of steering behavior contributing to the lack of variation in commission rates, despite consumers’ increased access to information and lower search costs due to the internet (GAO, 2005; FTC, 1983, 2007).
Compared to other industrialized countries, commission fees in the United States are high. For example, commission rates average less than 2% in the United Kingdom and the Netherlands, compared to the typical rates of 5% and 6% in the United States (Delcoure and Miller, 2002). As highlighted by our model, unbundling commissions has the potential to eliminate steering and reduce commission fees. Given the sheer size of aggregate housing transaction values, even modest reductions in commission fees could lead to a non-trivial reduction in transactions costs. [Emphasis added]
Again, translated into plain English mixed with industry jargon, what the above says basically is this:
Why are real estate commissions so high, despite low barriers to entry and all the advances in technology that should have reduced the cost of brokerage services? It’s because cooperation and compensation keeps commissions high through steering by buyer agents. The FTC and other regulators have been and are very concerned that consumers are getting ripped off, and this study shows that they are getting ripped off.
My oh my.
The Justification for Buyer Agency, Undermined
I’m not even going to bother trying to look at the meat of the study, which is pretty intensely quantitative. Here’s just a sample:
We refine the comparison in Figure 4 by controlling for firm attributes in the following regression:
1(TopRevlmt) = γ frcRtL25lm,t−1 +Xlm,t−1β +μmt +εlmt, (1)
where 1(TopRevlmt) is 1 if office l’s revenue is in the top quartile in market m and year t, X represents office controls and μ represents market-year fixed effects. The key regressor is frcRtL25lmt, the fraction of office l’s listings that is below 2.5 percent in the most recent three years t − 2 to t. The one-year lag of frcRtL25lmt alleviates concerns that it might be jointly determined with the dependent variable.
If you’re an actual economist, or a mathematician, please feel free to review the Study and let the rest of us know how valid or erroneous it might be. I know I couldn’t translate the above to anything.
Let me instead address the implications of the study, assuming that the authors’ findings are indeed valid and accurate for the 653,475 listings they analyzed.
Basically, this destroys the justification for Buyer Agency and undermines cooperation and compensation.
Buyer Agency was created out of sub agency because buyers were confused as to who was representing their interests. The key change was to make the buyer agent a fiduciary of the buyer with all of the heavy responsibility that entails.
The basic concept of a fiduciary is that the client’s interests come first and foremost in every situation. Well, if the Study’s findings are true and valid, then it appears that huge numbers of buyer agents are violating their fiduciary responsibilities. That’s what ‘steering’ means. The authors claim to have controlled for property quality and listing agent effort, so the 5% and 12% negative impact is explained by buyer agents steering their consumers away from the “low-commission” houses and towards the “high-commission” houses.
So that’s one.
More profoundly, the findings of the study suggest that cooperating compensation itself is harmful to consumers. The authors call that “bundling” of commissions. If that “bundling” results in steering effects that lead to artificially high commission rates, then well, we’ve got a problem. The Authors actually put numbers to that:
The calculation above suggests that sellers choosing the high commission rate pay $4455 more (roughly 1% of the sale price) in exchange for 20 fewer days on the market compared to sellers who initially list at a low commission rate.
Let me suggest that this is Not Good News.
At this point, there is no reason to panic. This is just a Working Paper. Yes, it’s by three very smart economists, and published by the leading economics think tank. Yes, NBER is very influential, but influence doesn’t mean direct power.
NAR still exists, and still remains very powerful, and it isn’t clear that anything will come of this Study. So relax. Don’t panic. At this point, this paper is interesting intellectually, and as a matter of tracking where the intellectual Elites are.
At the same time, it’s worth keeping an eye on, because the chance that average consumers and average voters would oppose any regulation/legislation that unbundles real estate commissions is nil. And there are people like Richard Cordray of CFPB (who is completely unaccountable to anybody) who could simply ban cooperation and compensation by fiat.