It is possible to significantly lower buyer’s commissions, but it will take a change of buyer behavior to do it. Today’s post shows how this could be done.
Asking Price: $189,900
The Soup Nazi — Seinfeld
No soup for you! Next!
All businesses create expectations for service with their customers. The Soup Nazi is the best known example of a business owner whose product was so desirable that customers were willing to do whatever was necessary to get it.
Have you dealt with an attorney lately? Attorneys have trained their customers to expect to pay large retainers and to be billed enormous sums for every passing thought the attorney has about the client. They are second only to the Soup Nazi for training their customers to succumb to their wishes.
Realtors have done the poorest job of any industry that I can think of at setting appropriate customer expectations. The customers of buyer’s agents have been trained that it is OK to demand unlimited hours of an agent’s time to be driven around to look at dozens and dozens of properties for no compensation at all. Agents are actually willing to do this because they hope for the possibility of compensation if the looker actually becomes a buyer. As a result, buyers of real estate are subject to paying an inflated cost to cover the cost of those who look but do not buy.
For an agent, real estate commissions are like playing roulette; you don’t know when you will get compensated or how much it will be, but since commissions are so large, it is a game many are willing to play. It is the size of commissions that encourage realtors to play this game, and it further serves to create poor customer expectations.
Lowering buyer’s commissions requires reframing the compensation system to encourage a more efficient use of a realtor’s time. It starts with customers realizing one important point: when you pay a realtor a 3% commission, you are not just compensating them for the time you spent with them; you are compensating them for the time they spent with the other clients who did not buy a property and generate a commission.
This fact has two important implications for developing methods of reducing commission rates: (1) realtors can charge much less if they know they are going to get paid, and (2) realtors can charge less if they do not have to invest large amounts of time in non-paying customers. This efficiency is best achieved if compensation moves away from a commission basis to a pay-per-services model.
If the buyer and the broker have established a billing rate for the services performed, the buyer knows what they are paying for, and they are likely to be more judicious in their demands on the realtor’s time. For those who judiciously use their broker’s time, they will receive a commission rebate at the close. For those that go over their allotment, they may pay up to the typical 3% commission, but the commission will never exceed the amount specified in the listing contract.
What follows is not a service offering. As you may recall, we are in the process of forming a brokerage, but we are not DRE approved yet, so what follows is a hypothetical of how such a structure could be achieved.
What a buyer’s broker does
When you examine the tasks of a buyer’s broker, there are really only four major tasks they perform: (1) research properties for buyers, (2) show properties to buyers, (3) prepare formal bids and negotiate deals for buyers, and (4) coordinate the outside professionals during the escrow process. There is plenty of routine communication with phone calls and emails between broker and client during the process, but the four items listed are the ones that consume most of a broker’s time.
Once the key tasks are identified, a broker could establish a billing rate for each of these tasks and charge accordingly. Depending on the assurance of getting paid, the rates would be different, but the connection between time invested and compensation would be apparent to both the broker and the client. Once clients see that their actions have a direct association with how much they ultimately will pay for the service, they are incentivized to be more efficient in their use of a broker’s time; both parties benefit.
Traditional Commission Program
Many people will not want to be cost conscious when they purchase a property. They will want to take their time, look at many properties, and feel no obligation to be efficient with using a broker’s time. There is a commission structure for everyone, and those people will pay the full 3% (or whatever commission is specified in the listing contract) for full service.
Billable Hours Program
Lowering the commission is relatively easy with a pay-for-services model. In this model, the services demanded of the buyer’s agent are recorded, and a running total of billings is tracked. If a transaction takes place, the broker will be paid at the close of escrow for amounts billed up to the commission amount specified in the listing contract. If no sale occurs, the prospective buyer is not obligated to the broker for any of the billable time.
This model provides an incentive for buyers to be judicious in their use of a broker’s time, but it does not provide assurance that the broker will get paid. Due to the uncertainty of payment, the billing rates will seem rather high, but as previously noted, buyers who complete a transaction are paying for all those who do not.
The billable hours commission structure could work as follows:
- A minimum fee of $8,000 is charged at the close of escrow for coordination of the escrow process and other miscellaneous unbilled services provided during the sales process.
- Showings cost $200 flat fee plus $200 per property viewed on each tour.
- Brokers Opinion of Value reports, which are required before first written offer, cost $600 for each property.
- First written offer on each property costs $600.
- Subsequent written offers cost $400 each.
- The overall commission is subject to a 1.5% minimum charge. Any funds due to buyer’s broker from the listing contract in excess of the amount billed are returned to the buyer.
Example of a Billable Hours program:
Assume a buyer has a budget for properties in the $800,000 range. During the course of the search, they go on 3 home tours and visit 8 properties. They write offers on 3 properties, and after 5 counteroffers, they end up buying a property worth $780,000. How much would their commission be?
$600 – three showing appointments
$1,600 – view eight properties
$1,800 – first written offers on three different properties
$2,000 – five counteroffers required to close the deal
$8,000 – escrow coordination and realtor compensation
$14,000 – total broker compensation
$23,400 – listing contract buyer compensation at 3%
$14,000 – fee to broker
$9,400 – refund to buyer after closing
The buyer would pay a total fee of $14,000 to the broker. Since the commission paid at the closing table would be $26,400, the buyer would receive a check for $9,400 from the closing ($23,400 – $14,000 = $9,400). That works out to a 1.8% commission.
Billable-hours programs such as this one are most favorable to high-end buyers because the fees will quickly consume a 3% commission on a low-cost property. Despite this disadvantage, the potential is there to reduce commissions at most price points.
To get to the lowest possible price point, a broker must know they are going to get paid for the time and effort invested in the process. Since buyers are so accustomed to getting this service for nothing, a typical billable-hours scenario will not succeed because people who do not buy simply will not pay the invoices when the bills come due. However, if a billing rate is established up front—a lower billing rate than the non-retainer structure due to the assurance of compensation—and if a buyer is willing to put up a retainer to guarantee payment, then a low-cost minimum compensation structure can work for both parties. This will be most advantageous for a buyer who (1) knows with certainty they are going to purchase, (2) does most of their own research, and (3) will not be lowball bidding on dozens of properties. A buyer who fits these criteria can get a significant refund at the closing table.
The Retainer commission structure could be structured as follows:
- A minimum fee of $4,000 is charged at the close of escrow for coordination of the escrow process and other miscellaneous unbilled services provided during the sales process.
- A retainer of at least $4,000 is required to qualify for this program.
- Showings cost $100 flat fee plus $100 per property viewed on each tour.
- Brokers Opinion of Value reports, which are required before first written offer, cost $300 for each property.
- First written offer on each property costs $300.
- Subsequent written offers cost $200 each.
- The overall commission is subject to a 1.0% minimum charge. Any funds due to buyer’s broker from the listing contract in excess of the amount billed are returned to the buyer.
Example of a Retainer program:
Assume a buyer has a budget for properties in the $500,000 range. During the course of the search, they go on 4 home tours and visit 10 properties. They write offers on 3 properties, and after 4 counteroffers, they end up buying a property worth $480,000. How much would their commission be?
$400 – four showing appointments
$1,000 – view ten properties
$900 – first written offers on three different properties
$800 – four counteroffers required to close the deal
$4,000 – escrow coordination and realtor compensation
$7,100 – total broker compensation
$11,400 – listing contract buyer compensation at 3%
$4,000 – retainer paid in advance
$7,100 – fee to broker
$8,300 – refund to buyer after closing
The buyer would pay a total fee of $7,100 to the broker. Since the buyer paid $4,000 in advance, and since the commission paid at the closing table would be $11,400, the buyer would receive a check for $8,300 from the closing ($11,400 + $4,000 – $7,100 = $8,300). That works out to a 1.5% commission.
In general, the retainer program will result in the lowest commission rate. If this same example is repeated for the $880,000 property in the first example, the commission would be subject to the 1% minimum charge.
Bottom line is that people must be compensated for their time, or they will not perform the task. This is not greed or avarice, it is just a fact of life.
What is stated above is not a service offering; it is a hypothetical example of how alternate commissions could be structured to make the industry more efficient. Perhaps some area brokers reading this post will implement these ideas, perhaps not. As with the post, The New Real Estate Sales Business Model, a discussion of ideas in the public realm is a good thing. The 6% commission model is broken, and its days are numbered. The industry needs to start looking for alternatives to take its place.
Asking Price: $189,900
Income Requirement: $47,475
Downpayment Needed: $37,980
Monthly Equity Burn: $1,582
Purchase Price: $300,000
Purchase Date: 11/24/2004
|On Redfin:||85 days|
Cathedral ceilings add volume and spaciousness to this largest 1
bedroom plan in the Lake Condos tract. Living room and balcony overlook
streams and waterfall with ducks. The tract includes pool, spa, tennis
courts and clubhouse. Quiet interior location on a greenbelt away from
the noises of the street. Adjacent to Irvine Valley College, shopping,
restaurants and both the 5 and 405 freeways.
If you were going to stage a picture to make the kitchen look as small as possible, could you do better than today’s picture? This place isn’t fit for hobbits.
P.S. Check out the post at South Coast Homes. Kelli Hart has picked up the story on the Laguna Beach HELOC abuse.