Full-service brokerage model going strong in downturn
Matt Carter
Inman News™
Editor's note: This is the first article in a multipart series focusing on low-fee real estate business models.
The full-service real estate brokerage model has emerged from the downturn largely intact, defying expectations that traditional companies would face stiff competition from brokerages offering commission rebates and discounts or a menu of fee-based services.
When information about property listings and housing markets once available only to Realtors started to become accessible over the Internet more than a decade ago, many predicted that innovation and competition among brokerages would drive down commissions paid by consumers.
If homeowners could market their properties online, the thinking went, more sellers would list with limited service brokers offering a menu of services including "MLS only" listings. And if buyers could go online to find their ideal home, why pay a Realtor full commission to chauffeur them around town?
Internet-based brokerages sprang up offering commission rebates to buyers willing to do some of their own legwork.
Flat-fee and limited service brokers offered sellers a menu of services on an a la carte basis, including "MLS only" listing packages, so that clients could choose to pay only for the services they wanted.
During the housing boom, discount and limited-service brokers attracted the notice of the news media and consumers alike. Statistics show the companies also grew their market share, and commission rates charged by traditional full-service brokers declined.
Redfin expanded out of its home base of Seattle, ruffling feathers in the industry by plugging its commission rebates and discounts in high-profile forums like "60 Minutes."
ZipRealty Inc., a full-service brokerage that rebates part of its sales commission to buyers and offers reduced commissions on listings, made an initial public offering in 2004, five years after launch, and climbed into the ranks of the nation's top 10 brokers.
Although the percentage-based commission rates charged by real estate brokers declined during the boom, they didn't come down as fast as home prices went up -- meaning the total commission revenue generated by each sale still increased sharply.
From 2002-06, the average commission rate earned by brokerages owned and operated by Realogy Corp. subsidiary NRT, the nation's largest brokerage, fell from 2.63 percent to 2.48 percent per transaction side, according to the company's annual reports to investors.
During the same period, the average home-sale price in transactions involving NRT brokerages climbed more than 56 percent, to $492,669.
As a result, the average commission revenue generated by each transaction side involving NRT brokerages climbed nearly 49 percent from 2002-06, to $12,691 per transaction side, even as the average commission rate declined by nearly 6 percent.
After adjusting for inflation, the increase in average commission revenue per transaction side at NRT brokerages from 2002 to 2006 was nearly 33 percent.
(A "transaction side" refers to each instance in which a brokerage represents either a buyer or seller in a sale. The total commission rate on a sale is equal to twice the commission rate per transaction side, if the brokers representing the buyer and seller split the commission paid by the seller equally.)
NRT has 750 offices in 35 markets, staffed by 44,000 sales associates operating under the Coldwell Banker, ERA, Corcoran Group and Sotheby's International Realty brands.
Although NRT brokerages tend to represent high-end properties, median commission fees for the industry as a whole grew an inflation-adjusted 20 percent from 2002-06, to an average of $12,458 per transaction, according to the U.S. Department of Justice's "Competition and Real Estate" website.
"Unless broker costs were also rising sharply during this period of time, competition among brokers should have held commissions in check even as home prices were rising," the DOJ observed.
Representatives for Realogy and NRT declined to be interviewed for this story. Before it was taken private by private equity firm Apollo Management in 2007, NRT parent company Realogy was publicly traded, and Realogy continues to file detailed reports to investors that provide valuable insight into commission practices.
Realogy also provides franchise services to independently owned brokerages operating under the Century 21, Coldwell Banker, ERA, Sotheby's International Realty, Coldwell Banker Commercial and Better Homes and Gardens Real Estate brand names.
Industry leaders maintain that competition between real estate brokers is intense -- ZipRealty, citing figures compiled by Real Trends, noted in its most recent annual report to investors that in 2009 the 10 largest brokerage firms handled less than 6 percent of residential real estate transactions.
There's evidence that average commission revenue is cyclical, dropping off in a downturn. John C. Weicher, Director of the Hudson Institute's Center for Housing and Financial Markets, concluded in a 2006 paper that inflation-adjusted commission fees per home sale declined by approximately 7 percent from 1991-98.
But Weicher, who served as assistant secretary for housing in the Bush administration from 2001-05, also noted the widespread perception that commission rates are "sticky" on the way down -- even though technology has supposedly reduced brokers' costs. Much of his paper addressed the difficulty of ascertaining the truth of such perceptions.
Economist Chang-Tai Hsieh has theorized that during a boom, rising home prices and commissions attracts more people to the industry, but that increased competition between agents doesn't benefit consumers or individual agents.
The most recent real estate boom nearly doubled NAR membership, from 700,000 in 1996 to a peak of 1.37 million in October 2006 (NAR membership has since declined to 1 million and falling).
Instead of offering reduced commission rates, Hsieh's research suggests agents in competitive markets spend more time prospecting for clients, and close fewer deals. Hsieh concludes that in high-priced markets with intense competition between agents, consumers end up paying higher commissions but individual agents are no better off.
While discount and limited-service brokers made inroads during the boom, some of the downward pressure on commission rates was undoubtedly due to rising home prices.
Realtors often say that all commissions are negotiable. Sellers are aware of the fact that rising home prices meant bigger commission checks for Realtors.
There was a widespread belief during the boom that, with loans easy to come by based on market conditions -- just about any home could essentially "sell itself," even without the marketing expertise of a skilled, experienced agent.
A 2008 survey by Consumer Reports, based on responses from 3,753 readers who sold or tried to sell a home, 4,029 who bought one, and 7,368 who did both within the past few years, found that about 46 percent of sellers attempted to negotiate for a lower commission rate, with a 71 percent success rate among those who tried.
"Sellers who paid commission rates 3 percent or lower were just as satisfied with their brokers' performance as those who paid 6 percent or more, suggesting that haggling can't hurt," and there were no statistically meaningful differences among the report's rated companies in customer satisfaction, Consumer Reports found.
The Consumer Reports survey also revealed that "paying an agent a lower commission rarely had any effect on the sales price."
When the bottom fell out of home prices, median commission fees came tumbling back down, to $9,733 per transaction in 2009 -- about where they'd been a decade ago, according to DOJ figures.
But as home prices dived, commission rates rebounded, demonstrating brokerages' resolve to stanch the bleed in commission revenue -- and a willingness on the behalf of sellers to pay full commissions to agents with proven marketing abilities.
At Realogy's NRT brokerages, the commission rate bounced back 3 basis points, to 2.51 percent per side in 2009, before retreating to 2.48 percent in 2010. Independently owned brokerages affiliated with Realogy's franchise brands boosted commission rates from 2.47 percent in 2006 to 2.54 percent in 2010.
But because home prices were falling, the average gross commission income per side at NRT brokerages dropped 24 percent from an all-time high of $13,806 in 2007 to $10,519 in 2009. During that time, the average home-sale price in transactions involving NRT brokerages dropped nearly 27 percent, from $534,056 in 2007 to $390,688 in 2009.
While commission rates at NRT brokerages slipped in 2010, gross commission per side increased to $11,571, boosted by a rise in the average home-sale price to $435,500.
Franchisor Keller Williams Realty's studies also show overall commission rates rebounded from 5.09 percent in 2007 to 5.59 percent in 2009, before softening slightly to 5.42 percent in 2010.
"Right now, the consumer is having to really value the agent," said Mary Tennant, Keller Williams' president and CEO. "(Consumers) can't achieve the results without the agent."
Austin, Texas-based Keller Williams is one of the largest franchisors in the U.S. Brokerages affiliated with the company operate 700 offices with 80,000 agents in the U.S. and Canada.
"In 2005, some of our agents may have elected to be more flexible than they are in 2011," Tennant said. "Fees are not one-size-fits-all -- we teach our agents to be responsive to their market."
If full-service brokerages were more willing to negotiate commission rates during the boom because rising home prices more than offset any concessions they made, they also faced growing competition from limited-service and discount brokers.
An analysis by Keller Williams revealed that the share of listings represented by limited-service brokers surged by 7 percent in 2006. After that, limited-service and discount brokers saw their market share plummet by 34 percent in 2007 and 18 percent in 2008.
The analysis looked at the top five limited-service and the top five full-service brokers in each of several markets.
"I don't think 'worry' is the best way to describe our mindset," Tennant said of the inroads made by limited-service brokers during the boom. "We were very aware of the dynamics coming our way."
When housing markets cooled, many brokerages and franchises -- traditional and discount alike -- found the going tough.
One of the earliest and most prominent casualties among discount brokerage was Foxtons, which operated in New Jersey, New York and Connecticut before filing for bankruptcy in the fall of 2007. Foxtons made waves by offering to list homes for a total commission of 3 percent, and offering only one-third of that to agents representing buyers.
In fall 2008, the Help-U-Sell Real Estate franchise company filed a petition for Chapter 11 bankruptcy, with company officials blaming the housing downturn. Although Help-U-Sell lives on under another owner, Infinium Realty Group Inc., the flat-fee brokerages affiliated with the franchisor now operate 117 offices, down from nearly 820 in 2006.
ZipRealty charged into 16 new markets in 2006 and 2007, only to post a $13.3 million loss in 2008 -- even as the company's 2,800 agents handled 17,156 transaction sides, a 23 percent increase from 2007.
With losses continuing to mount -- the brokerage posted a $15.5 million loss in 2010 -- ZipRealty kicked off 2011 by announcing in January it was closing offices in 11 markets. That move reduced the agent count in the company's remaining 23 markets to 2,500, down from 3,403 at year-end.
In fall 2008, Redfin announced it was laying off 20 percent of its workforce. CEO Glenn Kelman said at the time that the downsizing, which left the company with 75 to 80 employees, had more to do with the downturn in housing markets than the company's business model.
The following month, the company announced a new pricing structure that provided more services but reduced buyer rebates and discounts on listing fees.
In his 2008 book, "SHIFT: How Top Real Estate Agents Tackle Tough Times," Keller Williams co-founder and chairman Gary Keller predicted that agents who mastered markets like short sales, foreclosures and bank-owned homes would prosper. The book detailed techniques for agents to overcome buyer reluctance, manage expenses, generate leads, and utilize creative financing.
Short sales and real-estate owned REO properties have accounted for more than half of sales in many distressed markets in California, Florida, Nevada and Arizona.
"We felt that if our agents were the best educated going into this, they would stand the best odds of prevailing" during the downturn, Tennant said.
Derek Eisenberg, broker-owner of Hackensack, N.J.-based limited-service brokerage Continental Real Estate Group Inc., said that listing with a flat-fee service provider can help sellers recoup equity they've lost in their home.
And while large lenders and their asset managers don't seem to have realized it yet, "If anything, REO (listings are) the best situation to be using an a la carte broker," Eisenberg said. Cleanout services can ready REO properties for sale, and asset managers can handle negotiations for the seller, he said.
"I'm not seeing it with the Chases and the Bank of Americas, but I'm definitely seeing it with small, midsize lenders," Eisenberg said. "Most of them are putting combination lockboxes on the door and letting people go unaccompanied to see the house."
Tennant said Keller Williams looked at a la carte pricing models nearly 20 years ago.
"We don't inhibit our agents in any way. They can operate in any way they choose," Tennant said, adding, "We believe the market validates our view that more people are looking for full-service agents who are knowledgeable about the entire process. Right now that's what we're hanging our hat on."
Keller Williams' studies show the market share of listings claimed by top limited-service brokers rebounded by 16 percent in 2010, but those brokers still represented less than 3 percent of for-sale listings. The top limited-service brokers in markets analyzed by Keller Williams included Assist-to-Sell, Housepad.com, ZipRealty, Help-U-Sell, and SellSmart.
The latest trends
In a recent Inman News survey conducted in February and March 2011, 1,054 agents, brokers and sales managers shed light on the commission and compensation practices at their firms.
Although 94.3 percent of agents and brokers surveyed said they charge clients a percentage-based commission, 12.3 percent said they offer services on a flat-fee basis, indicating some overlap between the two models.
In addition, 6.5 percent of those surveyed said they offer cash rebates or other rebate incentives, and 4.4 percent provide services based on a fixed hourly rate.
One Oregon broker-owner who's a sole practitioner reported charging clients $125 an hour, up to a maximum of 4.5 percent of a home's sale price.
A broker in Nevada reported typically charging a percentage-based commission of 6 to 6.5 percent, but also offers consulting service packages that include a choice of hourly or task-based compensation.
A brokerage in New Hampshire reportedly offers clients different marketing plans, with commissions ranging from 6 to 10 percent. Most choose the marketing plan with a 6 percent commission, but about one in five sellers choose plans with commissions of 7 to 8 percent, reported an agent who works for the brokerage.
Most of those surveyed -- 58.7 percent -- said sellers were not more likely to negotiate commissions in 2010 than they were in 2009. But 45.6 percent said they believed sellers are more likely to negotiate commissions this year than they were in 2010.
Nevertheless, only 5.4 percent said seller negotiations related to compensation had the biggest impact on their income in 2010. An even smaller number -- 3.4 percent -- said competition from low-cost brokers had the most impact.
An earlier Inman News survey, released in September 2006 and based on responses from more than 1,000 real estate professionals, revealed that 20.3 percent of respondents reported that seller negotiations related to commission had the most impact to their bottom line. In that 2006 survey, about 27 percent of respondents said their broker limits their freedom to negotiate listing commissions.
The latest Inman News compensation survey, conducted this year, found that Local and national economic conditions (44 percent), distressed properties (17 percent) and business from past clients (13.1 percent) were identified most often as the factors having the biggest impact on income.
When asked to identify typical compensation per transaction side for listing agents in their market area, 85 percent gave responses in the range of 2.5 to 3 percent. Nearly 91 percent put typical compensation for buyer's agents in their market in the 2.5 to 3 percent range.
Half of those surveyed said their broker required a minimum total commission in order to list a home. Most often, the minimum total commission was between 5 and 6 percent (20.2 percent of responses), followed by 2 to 3 percent minimum commission (11.2 percent of responses), 6 to 7 percent minimum commission (7 percent of responses), and 4 to 5 percent minimum commission (6.3 percent).
Fewer than 1 percent said their minimum commission was either less than 2 percent or more than 7 percent.
"Normally we get 6 percent, but this market has taken us to some 5 percent listings," said one Oregon-based broker associate. "They state in our manuals: 7 percent."
"We work to have a 7 percent commission on listings under $300,000 and a sliding scale above that but nothing is set in stone," reported an agent in Indianapolis, Ind.
An agent in Pennsylvania said that for listings under $60,000, the minimum commission charted is $4,000 (about 6.7 percent or higher). The minimum commission for homes priced above $60,000 is 6 percent, while commissions can be as low as 5 percent for homes priced over $500,000.
"Anything under $1 million is listed at 6 percent" commission, said a New York broker associate.
"Below 5 percent, you need to discuss with (the) broker," said a Florida agent.
"We start at 7 percent and settle for no less than 5 percent," said an agent based in Las Vegas.
The percentage of agents and brokers who responded that percentage-based commissions would become more popular in the next five years (43.6 percent) exceeded the percentage of agents who responded that flat-fee services would be more widely embraced (35.8 percent).
About 13.1 percent of those surveyed responded that cash rebates and other rebate incentives would become more popular in the next five years.
Next week: Part 2 in the series will explore the history of competitive issues and antitrust actions related to low-fee real estate business models.
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