The Department of Justice has recently weighed in on the real estate agent commission debate, and researchers at the Federal Reserve have also added to the discussion.
In a working paper published in late February and written by Borys Grochulski and Zhu Wang of the Federal Reserve Bank of Richmond, the authors concluded that the current real estate agent compensation structure “may lead to elevated home prices, overused agent services, and prolonged home searches.”
They also argued that high commissions “impose financial burdens on households, and may induce significant lock-in effects that limit household mobility.”
Grochulski and Wang reached this conclusion after creating and analyzing a mathematical model of home searches and purchases in the U.S. housing market.
Legal experts told HousingWire that it is rare to see the Fed offer an opinion about an ongoing legal debate, as it typically does not want viewed as an influence on court decisions. The paper includes a disclaimer that “the views expressed are solely those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Richmond or the Federal Reserve System.”
In the paper, the authors note the ongoing legal battle between the DOJ and the National Association of Realtors (NAR) over commissions, as well as the myriad of lawsuits and the jury verdict in the Sitzer/Burnett suit, in which the real estate industry was found liable for colluding to artificially inflate agent commissions.
Similar to the arguments made by the plaintiffs and their attorneys in the commission lawsuits, the authors of the paper argue that despite technological advances, agents still take a “high percentage commission.” They noted that in the Houston metro area, between 1997 and 2019, 2.58 million houses were listed for sale, with 95.6% of them including an offer to pay 3% of the sales price to the buyer’s agent.
The authors attribute the consistency of the 3% commission rate to steering, as sellers “are concerned that buyer agents would steer clients away from their properties if they do not offer the prevailing buyer agent commission rate.” Because of this, the authors believe buyer agents are then able to “command commission above cost.”
The paper also highlights commission levels in foreign housing markets, just as the plaintiff’s attorney did in the Sitzer/Burnett trial. Grochulski and Wang noted that in the United Kingdom, Ireland, the Netherlands, Singapore, Sweden and Norway, the typical amount paid by the seller for a commission is 2% of the sale price, and the buyer typically pays for their own agent, if they chose to use one.
Based on these comparisons and their own model, the authors concluded that the current U.S. buyer’s agent compensation structure deviates from its cost basis in two ways.
“One is the agents’ extra profits, which push up buyers’ transaction costs of purchasing a home,” the paper states. “As a result, buyers have to be pickier in their home search to justify the purchase. Another distortion comes from the free house showings offered by buyer agents, which lower buyers’ marginal cost of home search and induce homebuyers to search too much.
“Together, the two distortions may lead to elevated home prices, overused agent services, and prolonged home searches.”
Based on a quantitative analysis of their model, Grochulski and Wang believe that the agent compensation structure in the U.S. needs to change.
“Switching to a cost-based commission model, in which buyer agents do not earn extra profits and buyers pay for each house showing, may increase U.S. homebuyers’ welfare by more than $30 billion a year,” the authors wrote.
But while the authors feel the compensation structure needs to change, they note that they are not necessarily advocating for a world where policymakers directly regulate commission fee levels.
“Rather, we propose shifting to an a la carte compensation model. This model requires that sellers and buyers each pay their agents directly to mitigate the threat of steering by buyer agents,” the paper states.
“Also, buyers should be able to pay their agents for each task separately, independent of the final price of the purchased home. This would allow buyers to shop for each service they need and bargain for the price. Under such a system, competition among agents would likely align agent compensation with cost, and buyers would not overuse agent services.”
The paper also notes that while a uniform commission cap would generally increase consumer welfare, it would also potentially harm buyers shopping for lower-priced homes, “as buyer agents would find it unprofitable to serve that market segment.”
Due to this, the authors believe a commission floor to support buyers of lower-priced homes would be a better option.
