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08 September 2008

Mortgage Agreement and Keys The outcome of the bursting of the real estate bubble that ran from 2004 into early 2007 has exposed a lot of problems with how real estate agents go about their regular business. Bloodhoundblog's Greg Swann has long advocated reform in Realtor ® business practices and has just published an e-book on the topic: A Consumer's Guide to the Divorced Real Estate Commission.

That pretty dry title masks Greg's powerful arguments for a very profound concept: the buyer in a real estate transaction is much better served if their agent has the right incentives to represent their interests.

That concept of better aligning the incentives of the buyer's real estate agent to reinforce the buyer's interests contrasts sharply with how the real estate business is done today. In the e-book's introduction, Greg asks and answers three real-life questions that illustrate the deficiency of the current approach to buyer agency (we've re-arranged the text so that the answers appear immediately after the question asked):

Question #1: "Potential buyers for our home ($800K - California) have a realtor but he did not find our home for them. The buyers did and have visited both times without him. He has played no role whatever in bringing us these buyers. If we accept their offer why on earth should we give him 3% ($24K) of our home’s equity for contributing nothing whatsoever?"

Answer #1: If you want to hang onto the buyers, you’re probably stuck paying the do-nothing agent. Grin and bear it.

Question #2: "When looking at homes on our own and calling the listing agents ourselves to set up appointments, does that obligate us to go with the listing agent if we decide to place an offer on the property?"

Answer #2: You are not obliged to have the listing agent represent you, but he will almost certainly not agree either to compensate a buyer's agent for you, nor to waive the buyer's agent's commission.

Question #3: "Since the amount of work involved doesn't really differ according to the value of the house, financially, it seems like the percentage commission would make higher prices more favorable from a buyer's agent's perspective. If this is the case, why would the buyer's agent be motivated to help negotiate the price down?

Answer #3: Ethical buyer’s agents and whores-with-hearts-of-gold do exist, but paying a buyer's agent a percentage of the sales price is a misalignment of incentives: The buyers would rather pay less, but the buyer's agent earns more when the buyers pay more.

That misalignment of incentives accounts for much of the public's distaste and distrust of those in the real estate industry. Greg describes the unseen issues that affect every real estate transaction and proposes a viable solution:

The real estate licensing laws do not exist to provide you with consumer protection. They exist to "protect" you from cheaper competition. The IRS "safe harbor" income-reporting exclusion for real estate brokers virtually assures that 90% or more of all new agents will fail within their first two years in business — but not before they’ve had the change to wreck the financial lives of innocent consumers with their "state-licensed" inexperience and ineptitude.

There's more, but by far the most significant "secret" issue in residential real estate is the way that buyer's agent's are compensated. The current system virtually assures the betrayal of both the buyer's and the seller's interests, with this fate being avoided only by accident. Moreover, it occasions as a secondary consequence the citadel of secrets and lies known as the MLS system.

The residential real estate industry is not a true business in its present form. By means of legislative fiat and its own internal structures built on secrecy and deceit, it is a cartel — a vast conspiracy against the consumer. But of all the reforms I could name to correct this atrocious situation, the one that would make the most immediate, most consequential difference would be to divorce the real estate commissions — to restructure the way we account for funds as the closing table so that the seller pays only the listing agent and the buyer pays only the buyer's agent.

By divorcing the commission paid to the buyer's agent in a real estate transaction from the value of the transaction itself, the deck would no longer stacked so heavily against the buyer. The buyer's agent would be free to negotiate for their client's best interests, rather than have a powerful incentive to push the transaction through as quickly as possible on terms favoring the seller.

It's an ethical reform that enhances both fairness and trust, one that might go a long way to restoring the real estate industry's tarnished image. And it's why we would recommend the dryly titled Consumer's Guide to the Divorced Real Estate Commission for anyone who plans to buy a home in the market as governed by the current ethical environment for real estate agents.

As they say, knowing how the deck is stacked against you sets up the best chance you have to get an even shake.

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