In less than a week, the first of two class action lawsuits that take aim at the NAR’s commission rules will kick off. These lawsuits threaten to radically reshape the residential brokerage landscape, and could be the catalyst for a fat decline in the annual commission pool as well as the industry shedding as many as 80% of agents, according to a team of analysts at Keefe Bruyette Woods.
In a 75-page report, the analysts broke down the structural impacts that a change to the NAR’s Participation Rule would have for agents, brokerages, mortgage companies, real estate portals and — most importantly — consumers.
This is an extremely complex and dense subject, so we’re only going to break down a couple key takeaways in this edition of DataDigest. You are forewarned — there are charts!
Let’s start at the top —the analysts at KBW believe that a court-ordered injunction could “unbundle” commissions nationally by early 2024, eliminating the longstanding practice of listing agents and sellers setting and paying buyer agent commissions.
In doing so, the annual $100 billion commission pool could shrink by 30% over time as consumers become aware of the transparency changes. Relatedly, the commission rates could decline by 200 bps or more.
“A key question, however, is whether consumer inertia and agent entrenchment will outweigh economic theory,” the analysts wrote. “Homebuyer survey data may provide some clues.”
If you’re a real estate agent, hearing about a potential 30% decline in commission volume and rates dropping by 200 bps is quite scary. But the most frightening — or exciting? — projection is undoubtedly that between 60% and 80% of agents could wash out in the industry as buyers find alternatives to their services, MLS networks/NAR weaken, and the power paradigm shifts dramatically to sell-side agents.
Who’s most exposed? Well, according to the team of analysts, the big traditional brokerages have the most to lose if the NAR’s co-broking rules are thrown out. But that statement comes with a big asterisk.
KBW analysts said Anywhere Real Estate, Compass, RE/MAX, eXp Realty and Douglas Elliman are among the publicly traded companies that would have to navigate commission pool pressures.
“Because commissions represent the majority of brokerage revenues (the remainder generally from ancillary services, recurring franchise fees, or lead generation), the aforementioned estimate that the overall commission pool could shrink by upwards of 30% is undoubtedly negative for the sector,” the analysts wrote. “However, we think there could be some offset as industry capacity subsequently right- sizes itself in response to the shrinking commission pool, and it will be the marginal agent most likely to leave the industry. That should result in some market share ‘up for grabs,’ and we think the full-time agents are the most likely to capture it. In a market with more variability in commission levels, agents will need to demonstrate their value and differentiation, and we think community-entrenched, local expert agents will be net beneficiaries over the long-term.”
Steering to grab that bag?
One of the larger controversies about the current co-broking system is the notion of “steering.” Agents generally insist that they are a fiduciary for their client and work to get them the best deal, not pursue their own financial incentives. Citing a survey by consulting firm 1000watt, most agents believe that properties with a higher co-broke commission do not sell for more money. More than three-quarters also said that agents might be more likely to show a property that has a higher co-broke commission. Interesting, no?
Ultimately, buyers don’t believe they are getting great value from their agents, according to the 1000watt survey.
Respondents said they felt buyer agents are overpaid and they would consider alternatives if they were required to sign a contract with their agent and compensate them “out of pocket.”
About 40% of respondents said they thought a 2.5% commission for a buyer agent was too much (the exercise assumed the agent worked 150 hours over 2 months, implying $83/hour, to earn $12,500 on a $500,000 home purchase). When explained a scenario where a buyer was required to sign an agreement with their agent and pay “out of pocket” for their services, just 14% said this was acceptable. Roughly 53% said they would have some reservations but likely still hire an agent, while 16% said they would probably seek agents who offered lower fees or allowed them to work with other agents, and 8% said they would just work with the seller agent.
Here’s how current buy-side commission rates compare in other countries.
If 1 million agents disappear?
The KBW analysts said that based on conversations with brokerage industry participants, they believe the top 20% of agents are responsible for 80-90% of transactions, while the top 10% of agents are responsible for approximately two-thirds of transactions.
“We believe agent participation in the industry could decline materially with a complete unbundling of commissions and ensuing reduction in the annual commission pool,” the KBW analysts said.
In comparing agent counts relative to annual home sales in 10 other countries, the analysts found that the ratio in Canada, which has a similar market structure to the U.S. with a dominant trade association and cooperative compensation policy, is virtually identical to the U.S. system.
“Excluding the U.S. and Canada, the ratio of home sales to agents generally ranges from about 10 to 20, with a median of 16,” the report reads. “This suggests that the agent count in the U.S. could theoretically decline to approximately 300,000 to 600,000 over time, or by 60-80% based on current NAR membership of 1.6 million.”
A real challenge for brokerages in the coming years will be articulating the value proposition of buy-side agents, particularly given that many homebuyers find the home the purchase on the internet. Perhaps even specialists or hybrid models could gain traction?
A workaround with mortgage?
Let’s assume the courts issue an injunction and the relevant NAR rules are no more, there is one potential workaround that could solve immediate affordability challenges for buyers who are suddenly staring at paying for their own agent’s services directly. Yep, rolling it into the mortgage.
“Under the current structure, a homebuyer is implicitly able to finance real estate commissions into the mortgage loan since agent commissions are in effect paid out of the proceeds to the seller for the purchase price of the home,” the KBW analysts wrote. “While there is not an efficient mechanism for a buyer to finance a commission paid to a buyer agent directly today, we believe mortgage lenders and the Federal Housing Finance Authority (FHFA) could create a workaround without material disruption to the existing underwriting and origination process. Our conversations with industry participants indicate the topic is actively being discussed by key stakeholders such as Fannie Mae, Freddie Mac, and the FHFA.”
We’ve got more stories coming in the next week about the possible dislocations from these lawsuits, so check back for more.
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The chart and data from “Days on Market for Listings with High and Low Commissions” is from 1998-2011 in Massachusetts. One thing to note is that Buyer Agency didn’t really start to be common practice in MA until 2003 or so. Prior to that, the vast majority of agents working with buyers were sub-agents and did not represent the buyer at all. Under sub-agency, the agent has a fiduciary duty to the seller and not the buyer.
In addition to very different legal structures of representation over the time frame studied, there were monumental shifts in how properties were marketed to agents and buyers given the rise of online listing portals. I’d be more interested to see this data from 2010-2020.