Showing posts with label commission. Show all posts
Showing posts with label commission. Show all posts

Wednesday, May 15, 2024

The Origin of the 6% Commission Standard

The recent
National Association of Realtors (NAR) Settlement is in the process of changing how many real estate brokers and salespeople conduct business. The terms of the settlement all but abolish cooperative compensation amongst brokers. Although this may not be a substantial change for markets in which every buyer offers through a Buyer's Broker and every seller is automatically represented by a Seller’s Broker, the effects will be greatly felt in other markets. Some of the larger real estate markets have developed complex systems of agency that will now be simplified by one premise--in a residential real estate transaction, a buyer will now have to pay a Buyer’s Broker and seller will have to pay a Seller’s Broker.

Gone are the days in which real estate agents could expect to be paid directly from the proceeds of a transaction. Each party is now responsible for their own broker. Gone also are the days in which brokers incentivized their competitors to show their listing by offering and advertising cooperative compensation on the local MLS, as the NAR Settlement  bans the inclusion or posting of cooperative commission splits on MLS's. The world of real estate sales post-NAR settlement is a much more competitive place, where brokers are incentivized to be beholden to their clients and not to the profession. As this new era of competitive real estate begins to dawn, let’s take a look at how this stare of affairs came about.

The seminal moment which facilitated NAR’s acquiescence to a settlement was a federal jury finding NAR guilty of violating the Sherman Antitrust Act and colluding to fix real estate commissions in the Sitzer-Burnett case. Doing so opened the door for other plaintiffs to sue NAR for the same offense and a number of cases were filed shortly thereafter. The verdict in the Sitzer case, however, arose from a more general sentiment that residential real estate commissions are inflated. Since about 2019, many real estate purchasers, sellers, attorneys and consumer advocates expressed skepticism over the fact that real estate commissions have not varied much and were insulated from any market dynamics that took place in the past 15 to 20 years. There seemed to be a common belief, reflected in many of the commission lawsuits that NAR recently settled, that housing sales could be made cheaper, if brokers didn’t collaborate as much. Although the origin and vitality of that belief is discussed in the upcoming TRET podcast episode 18, to be released later this month, one unquestionable fact is that real estate commissions remained at or around 6% for over 15 years.

Understanding the origins of the seeming standardization of residential real estate commissions brings more perspective to this matter. Although historical commission data shows that real estate commission have hovered around 5.5% for some time, the most recent commission standardization happened during the wave of residential short sales that took place from about 2007 until about 2017. During this period, real estate commissions were typically approved for 6% by banks and financial institutions, who oversaw these sales and approved the commissions. Although most short sale commission agreements from this time period included legal disclaimers that such commissions were subject to bank approval and could vary, as endorsed by NAR, the vast majority of the time, commissions were granted at or around 6%. Since this practice was standard for about ten years, the residential real estate market grew accustomed to paying out 6% for sales. The 6% rate was further solidified as the rate that banks paid real estate agents for its Real Estate Owned and other distressed sales.

As the real estate market has stabilized over time and distressed sales have played less of a role in the sales market, consumers have begun to question the 6% commission. Whereas distressed sales typically involved owners selling at a loss and banks paying real estate broker commissions from the proceeds of the transaction, the traditional home sellers of today's market have to pay sales commissions of pocket. While banks had trading hedges and insurance to mitigate their losses on mortgages that were foreclosed or satisfied at a loss and could thus write off broker commissions as a part of that loss, traditional owners have no such protection. It is therefore understandable that real estate owners in today's market are seeking ways to lower commissions. Taking these tactics from the negotiation table to the courtroom, however, marks a new approach in this quest to lower residential commissions.

The complaints written to start the various commission court cases speak of hypothetical savings that could be gained merely from less collaboration and more competition amongst real estate brokers. They describe NAR as an orchestrator, seeking to protect the inflated price of commissions. This type of rhetoric has proven successful, as it ultimately resulted in a favorable verdict for the plaintiffs in the Sitzer-Burnett case. What seems to be lost in the most recent conversation on commissions, however, is that the standard 6% that existed in the market, was less an invention of NAR and more a convention, established by financial institutions.