03/17/2024
Who really pays buyer and seller commissions? (Hint: it’s NOT the Seller). This opinion is entirely my own, don’t blame anyone else.
The recent jury decision and settlements in commission lawsuits has led to a lot of speculation about the future of the real estate brokerage industry. Since most of my life has been spent in a (somewhat lonely) existence on Planet Reality and in real estate, I feel compelled to attempt to insert what many previous supervisors have called “those pesky facts” into the conversation.
There are three implicit assumptions in the lawsuits that I think are severely flawed, and are in no way supported by real world experience. I think the flaws in the assumptions are obvious without further discussion. The three assumptions are these:
1) Home Sellers have been needlessly paying listing commissions that include a payment to a Broker that brings them a willing and able buyer for their house.
2) Millions and millions of home buyers in the U.S. have, for decades, been stupidly overpaying for houses by about 3% to pay for services they neither need nor want, AND WILL CONTINUE TO DO SO, despite no longer having access to said services, or having to pay for them out of pocket.
3) Home Sellers would have pocketed an additional 3% or so of the amount they received, absent the current system of funding commission payments (so-called “damages”).
All of these assumptions are based on a fundamental misunderstanding of the difference between ACCOUNTING for expenses and PAYING those expenses. Every penny of cash that pays closing costs, including commissions for both sides, is brought to closing by Buyer, NOT Seller.
Here is how this works in practice, assuming all transactions are in cash, purchase price is $500,000, and the only closing cost is a 6% commission shared equally by Brokers for Buyer and Seller. Seller goes to closing and contributes a deed and no cash. Seller leaves the closing with $470,000 in cash. Buyer goes to closing and contributes $500,000 in cash. Buyer leaves the closing with a deed and no cash. The commissions are paid using the cash brought to closing by Buyer.
Now assume none of Buyer’s $500,000 will be available to pay for a Broker to assist them in what is a very high stakes transaction. Knowing the new system, Buyer would be an idiot (well, certainly would have no incentive) to offer a price for a house that no longer included compensation for their Broker. Buyer, very rationally, will only agree to pay $485,000. Seller, accepting that offer, will still leave closing with $470,000. That does assume other prospective buyers can do the same math as Buyer. The value of the house that no longer includes paying a Buyer Broker commission will reflect that unbundling. It also assumes aggregate demand for Seller’s house remains unchanged under this scenario.
Aggregate demand remaining unchanged is a lousy assumption. The market value of Seller’s house, no longer including a Buyer broker commission, would likely be materially diminished by more than the amount of the commission for Buyer’s broker. The existing custom that rolls Buyer’s broker commission into the price of the house maximizes the number of ready, willing, and able prospective Buyers, i.e. DEMAND. Reducing DEMAND by reducing the number of prospective buyers will almost certainly reduce the maximum amount Seller will receive for their house. (See Econ. 101: Supply, Demand, Price).
It will be very interesting to see how markets evolve under the new circumstances. Americans are and have historically been very astute consumers – astute enough to raise serious doubt about all three initial assumptions above. What data does exist indicates the market (i.e. Buyers, and Sellers who need a Buyer if they are going to sell their house) has consistently rejected any number of discount brokerage models. Despite the proliferation of sites such as Zillow and Redfin, the number of Buyers using real estate brokers to purchase a home in recent years has increased, not decreased.
I can’t forecast what will happen with much certainty. I can confidently say that free markets, left unfettered by excessive government interference, work. My expectation is the existing custom evolved because it maximizes benefits for all parties. Given that, it is reasonable to expect a new custom that looks a lot more like the existing one than most parties seem to expect.
