Why Disrupting Real Estate Brokerage is Hard (Part II)

Why Disrupting Real Estate Brokerage is Hard (Part II)

03-06-2019

My home’s A/C is broken. It needs to be fixed. On top of the list of things I am not looking forward to next week is paying for fixing my A/C. I can imagine it now: thanking the technician, pulling out my checkbook, and then signing on the dotted line.

The act of physically paying for something tends to bring with it a little bit of discomfort. I’ve never met a person who danced a jig after stroking a check to the A/C technician.

But now, imagine a slightly different scenario. Imagine a scenario in which you don’t have to directly pay for something. You have to get your A/C repaired, but instead of whipping out your checkbook, the A/C technician leaves and the expense is just rolled into your mortgage - no check required.

That’s called an indirect payment.

Amazon Prime is a great example of alleviating the pain of direct payments. In the early days of e-commerce, I remember hunting around the internet to find a retailer that would include free shipping for whatever it was I wanted to buy. Intuitively, I knew that the shipping had to be paid for out of the purchase price, but it just didn’t feel good to directly pay for shipping. One of the many brilliant things Amazon has done was to turn shipping costs into an indirect payment that you, as a consumer, never have to directly experience again. The $120 annual fee for Prime membership just charges on your card and you get goods shipped to you for “free.”

The granddaddy of all indirect payments is the transaction costs associated with buying or selling a house.

When you buy a home, the perception tends to be that you are just paying for the house. You see a nice $400,000 house? Great! The seller gets $400k from you, and you get the house.

Buried in that purchase price, however, are a number of payments made on your behalf by the title company when the house changes hands at closing. The biggest of these tends to be commission payments to the real estate agents involved.

Nationwide, an average of just over 5% of the purchase price of the home goes to real estate agents’ commissions. Another big chunk goes to the title company’s title insurance premiums and escrow fees. On a $400,000 home bought in Texas, title insurance charges generally amount to almost 1% of the purchase price. Finally, if you’re getting a mortgage, the lender generally charges an origination fee of, conservatively, 1% of loan value.

All told, if you’re buying a house with a mortgage, at least 7% of the purchase price is indirectly being paid to various people involved in the transaction.

There are a couple layers of indirect payments going on: First, over 80% of home buyers use a mortgage when they buy a home, so they really only have to come to closing with a rather small percentage (generally 10-20%) of the purchase price. The mortgage lender wires in the rest of the cash and the buyer then pays that back, plus interest, over the life of the loan. Most home buyers, in other words, don’t have to actually come up with the entirety of the purchase price in cash. Thanks to the well-developed mortgage market in the US, many home buyers are easily able to borrow most of the purchase price.

Secondly, the money is almost never paid directly to the various parties in the transaction. Instead, a title or escrow company collects all the funds then disburses them to the various parties at closing. The buyer never writes his agent, the lender, or the seller a check.

These multiple layers between the payer (the buyer) and the expenses (commissions, fees, etc.) make the sting of the high fees involved in real estate transactions in the U.S. feel far less burdensome.

This opens up consumers to disingenuous messaging.

Realtors capitalize on indirect payments all the time in the advertisements they publish:

Why Disrupting Real Estate Brokerage is Hard

The reality is, if you are buying a home and you use a buyer’s agent to represent you, that agent is very likely to be receiving 3% of the purchase price of the home, paid to her indirectly at closing. As an example, in North Texas as of February 2019, there are just over 27,500 listings active on the market in the MLS. Of those listings, 1,742—only 6%—are offering less than 3% commission to buyer’s agents.

If you are buying a home in North Texas, there is a 94% chance your agent is being paid 3% of the purchase price of that home.

The National Association of Realtors (NAR)—the governing body for Realtors in the United States—has a Code of Ethics by which all Realtors must abide. Within that Code is Standard of Practice 12-2 which reads: “REALTORS® may represent their services as ‘free' or without cost even if they expect to receive compensation from a source other than their client provided that the potential for the REALTOR® to obtain a benefit from a third party is clearly disclosed at the same time.”

Yes, that’s right. Codified in the National Association of Realtor’s Code of Ethics is what seems to me to be tacit permission to lie to clients.

This permission from NAR creates one of the major headwinds facing would-be real estate brokerage disruptors. The entire home transaction is rife with large, indirect payments about which real estate agents mislead the home buying public.

Thought experiment: imagine that you had to write a check to your buyer’s agent prior to getting started. You’re in the market for a $400,000 home—thus your agent is anticipating a $12,000 commission. So, before you even go on your first showing with your buyer's agent, she extends her hand and you have to place a check for $12,000 in it.

I think it very likely that buyers’ behavior would be extraordinarily different if the indirect payment of commission were converted into a direct payment of commission.

If you’re thinking to yourself “everyone knows that their buyer’s agent gets paid,” the Federal Trade Commission begs to differ. As the FTC writes, "Because broker fees are paid indirectly, buyers may be less likely to negotiate over them. In fact, commentators have expressed concern that some buyers may believe that their brokers’ services are free.”

At Door.com, we give a significant amount of cash back to our buyer clients when they purchase a home with Door.com. I am passionate about this commission structure because 95% of people now look online when they are buying a home. Further, as of 2016, a majority of homebuyers found the home that they ended up buying themselves. Real estate agents are the procuring cause of home purchases in a minority of cases these days, they’re doing way less work than they did a couple decades ago, and yet they still command over 5% of the price of the home as commission.

However, when searching on Zillow—or any local brokerage website, for that matter—one thing is conspicuously absent: any mention of the compensation that will be paid to a buyer's agent involved in the transaction. Local Realtor associations prohibit the disclosure of buyer’s agent commissions with rules such as rule 9.05, from the North Texas MLS: “Participants and Subscribers may not publish or display to customers or clients the compensation offered to Other Participants [Buyer’s Agents].”

Because real estate agents are paid indirectly by consumers, and because their compensation is not disclosed on search portals, consumers are in effect shopping for a service (representation by a buyer’s agent) without knowing how much that service will cost.

What does this mean for real estate brokerage disruptors? It means that there is a tough-to-bridge educational gap that has to be crossed with a large swath of the home buying and selling public. At Door.com, we have had dozens of conversations with homebuyers in which we have to explain how it is possible that they are able to get money back when they buy a home with Door.com.

We find ourselves fighting years of misinformation from real estate agents that has conditioned people to assume that buyer’s agents' services are free.

Indirect payments certainly lessen the sting of paying for things. However, in the case of the real estate transaction, indirect payments leave homebuyers vulnerable.

Indirect payments open up homebuyers to being lied to by real estate agents: “don’t worry, my services are free.”

Disruptors have a hard time cutting through the noise of “use my free service” and educating home buyers as to the better, significantly less expensive alternatives out there. Further, home buyers’ are at a major information disadvantage when they are in the market to buy a home because local board of Realtors prohibit the publication of buyer’s agent commission in any form.

So, when you or a friend are buying a home, keep in mind how a buyer’s agent is compensated. Don’t accept the line “my services are free” from a buyer’s agent. Don’t accept the line “the seller pays my commission, so my services don’t cost you anything.”

Utilizing the services of a buyer’s agent does not represent the one magical service on earth that an entire group of people will do for free. In actuality, using a buyer’s agent is electing to use a highly-paid professional service provider who is paid by you, indirectly, when you bring your cash to closing. As a homebuyer, you’re the one bringing the money for the transactions, so yes, it is your money paying for commissions.

If you are interested in reading more about why disrupting real estate brokerage is hard, read my piece about price anchoring.

Alex Doubet CEO | Door, Inc.