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Real Estate in the Age of the Internet Volume 8

Critique of Traditional Real Estate Brokerage Compensation Model

Given the apparent paradox between real world endurance and academic/political criticism the current real estate brokerage compensation model, a review of recent literature on the topic provides a structure for parsing out the relative merits of the current percentage-based split commission model as well insights as to how it may evolve in the future.

In their 2007 paper, “Is the Compensation Model for Real Estate Brokers Obsolete?” authors Miceli, Pancak and Sirmans (2007) argue the traditional percentage-based split commission model for brokers has become obsolete, given contemporary legal agency relationships and technology-driven information availability. As a result, they conclude buyers and sellers experience substantial transactional inefficiencies during the two primary phases of the real estate transaction, matching and bargaining. They then proceeds to mathematically model the existing compensation model and identify alterations, which would mitigate the inefficiencies he describes. Finally, Miceli et al. (2007), proposes a list of policy actions, which if undertaken, could facilitate the emergence of the compensation model they propose. This paper reaches some useful conclusions in terms of policy actions, however some of the assumptions upon which the supporting argument is made, may neglect certain functional roles of real estate brokerage. In addition, the proposed the compensation model, while elegant, does not address the fundamental basis for why real estate brokerage services, have, up until this point in time, been delivered wholesale. Never the less, Miteceli at al. (2007) is an useful in formulating a vision of how compensation in real estate brokerage may evolve.

The main assumption Miceli et al. (2007) make upon which their central argument is made, is in oversimplifying real estate brokerage services into two all encompassing functions: matching and bargaining. While doing so allows Miceli et al. (2007) to formulate an economic model of broker compensation, it excludes many of the functions brokers perform, which have economic value, but which have here to fore lacked independent pricing due to the existing bundled service model.

As discussed previously, the agent provides a range of services, not only subsequent to the matching and bargaining phases, but within these phases as well, which are omitted by Miceli et al. (2007) in the interest of modeling broker compensation. For example, decisions regarding pre-listing activities such as level of property fix-up (requiring monetary investment) and home staging decisions are often critical in the matching phase and can have substantial impact on the final sales price. Alternatively, decisions involving choice of appraisal company can influence property valuation, thereby influencing the probability of a successful a bargaining phase. In the Miceli et al. (2007) model, these types of services are essentially considered to have zero economic value, as Miceli et al. (2007) advocate for a collective listings aggregations model in lieu of the process by which brokers search for listings: “we will argue however, that unlike an unimpeded search for buyers, competition for listings is unproductive in that it does not increase the likelihood of a sale…” Miceli et al. (2007). It is precisely within this process that brokers and agents market their skills (compete) in the aforementioned examples and affect sale price. The underlying supposition in the Miceli et al. (2007) analysis is that all seller brokerage services are commodities.

Another potential weakness in the Miceli et al. (2007) broker compensation model, is in their economic overvaluation of the role of the broker during the matching phase as associated with property search. Miceli et al. (2007), argue the emergence of information technologies has allowed buyers to search through property listings information independently of the real estate agent, which they juxtapose to the era when agents controlled access to such information. Their argument posits that free and unfettered public access to listings information should have resulted in a reduction in broker compensation, to reflect the reduced value add of the broker: “The traditional compensation model for brokers has not evolved to reflect their diminished role in the matching stage” Miceli et al. (2007). In reality, the persistence (growth) of the traditional percentage-based split commission compensation model in the face free listings information on the internet and disaggregated real estate service providers reveals a fundamental truth: for-sale property listings information in and of itself has little economic value; access to information was used as an inducement to enter into a formal agency relationship, during which value added services were provided. It follows from this, that use of traditional brokerage service would remain steady and no reduction in broker compensation would be seen when such information is made freely available. And in fact, this has been the case, as is demonstrated in the reduction in the rate of FISBO’s seen since 1987 and persistence of brokerage commission rates over the same period. “Between 1998 and 2005, the real median real estate broker commission per transaction grew by 25.5%. However, commission rates remained relatively stable during that time irrespective of market conditions, home prices, or effort to sell a home (US Government Accountability Office (GAO), 2006).”

Perhaps the most instructive oversight in the Miceli et al. (2007) argument is in their lack of treatment of the true economic justification of the current compensation model, which is based on risk and reward. Currently, in real estate brokerage, agents and brokers assume 100% risk in the transaction purchase sale and sale process. They incur tangible and intangible expenses throughout the entire process without guarantee of payment. Buyers and sellers on the other hand assume no risk and only make payment upon successful consummation of a transaction. In this respect, the real estate brokerage model exhibits attributes of an insurance model, with wholesale payment for services rendered upon successful transactions required to compensate for expected losses on unsuccessful transactions. In order to justify his compensation model, Miceli et al. (2007) make the leap to a future point in time when the provision of disaggregated brokerage services are proven to be independently economically feasible and more importantly, to when the provision of such services does not undermine the structural “insurance” dimension of real estate brokerage; the attribute which allows buyers and sellers to incur no upfront expense in the purchase and sale of real estate.

The traditional percentage-based, split commission compensation model in real estate brokerage is still prevalent today because it crudely, yet none the less effectively, compensates brokers and agents for their direct and indirect expenses. While there is evidence the industry has engaged in anticompetitive behavior on an institutional level, these actions are a rational given the potential unintended consequences associated with undermining the economic underpinnings the industry. However, while anti-trust proceedings continue to move forward, the very same trends the industry has sought to curtail, such as unfettered access to MLS listings by the public and the emergence of limited service discount brokerages, have taken place none-the-less. And yet, wholesale real estate brokerage remains the dominant business model and the percentage-based, split commission compensation model continues to endure. The main conclusion which can be drawn from these circumstances is that the primary value agents and brokers bring to the real estate value chain is not associated with information control but rather, with information management. In the long and complex real estate transaction, agents and brokers collect, analyze, interpret, and transmit data. Given the relative infrequency of sales transactions, the public at large does not attain the collective skills to engage in these activities, wholly or partially. The risks and costs associated with engaging in these activities motivate the public to contract with traditional wholesale brokers and agents as opposed to experimenting with alternative models.

However, the information intensive nature of real estate makes the industry particularly susceptible to advances in information technology. The efficiencies to be gained from technologically enabled agents and brokers will result in competitive advantages, which will magnify over time (to be discussed in Section 2). Ultimately, disaggregated service offerings will be available to the public on a per fee basis, but the bulk of these services will be offered by traditional wholesale service brokers and agents, who have developed economically-feasible technologically-enabled partial service models within the context of their full service practices.