The Wall Street Journal had an opinion piece this week about real estate commissions, with the point that they needed to be revamped, and possibly lowered. In the article, there was a discussion of the fact that buyers, although sellers pay the commission, are mortgaging their share, by including it in the price of the property. Since the amount a buyer can borrow is linked to the value of the property, a higher sales price would mean that more can be borrowed. This is a well-known issue in residential sales in particular, and has led to some questionable practices, not just with commissions.
Because that's where the money is
My father used to love the vignette about why Willie Sutton, a famous outlaw, robbed banks: "Because that's where the money is", he allegedly said. Sellers have traditionally paid commissions, because they are the ones receiving the cash. Buyers are often stretched for a purchase, and cannot manage extra costs and fees. This also has come to factor into negotiations where sellers pay closing costs. Some mortgage programs specifically allow this, and even put a cap on what can be paid that way to the buyers at closing. This is far more convoluted than the commission issue. Why would sellers be paying closing costs? Why wouldn't the price of the property just come down, to reflect what the seller is truly getting?
The answer is in the financing.
The buyer can mortgage on the recorded price, and therefore wants that to be a higher number. This means that appraisers cannot always tell what the true exchange was for, and that may influence appraised values on other properties. Why this hasn't been a focus for regulation is something I cannot explain. It also affects commissions, since the seller will often complain that the commission should only be paid on the net amount actually received for the property. Listing agreements now commonly state that the listing commission will be paid on the recorded price. When the seller objects, the listing agency is in a tough position. They have published a buyer broker commission, and are required to stand behind that amount. If the seller negotiates the commission downward, and the buyer broker commission must be honored, then the listing broker, whom the WSJ article agreed had a great deal of work and cost in most cases, gets squeezed, and may receive less than the buyer's agent.
None of this would make sense to someone who was creating a commission system from scratch. However, it is not the only part of the real estate transaction where costs are shifted. The lawyer handling the mortgage usually works for the bank, but is paid by the buyer. In commercial, this is an open discussion of a loan. In residential, it is in the paperwork, but it's not clear how many buyers really understand that. If buyers should pay their own agents, shouldn't banks pay their own lawyers?
The future of commissions
The WSJ goes on to suggest that commissions should be unbundled, with different costs for differing parts of the process. This is a reasonable suggestion, but there would have to be other changes. Since brokers are not allowed to charge for giving a seller anything that would be considered an "appraisal", there has to be a listing agreement for those discussions to be valid. The article's proposal that proceeds above a certain number be shared is prohibited directly by real estate law in most places. The biggest problem, though, is that everyone would have to shift to the new system, and agents would need to be paid for their time. Right now, all monies are generally paid at the closing. Only about two-thirds of listings close in a year, and a lower percent of buyers purchase in that time frame, so agents would not survive unless people paid for their time, even if no property changed hands. Also, agents get paid for their knowledge, built up over time, of the market and the industry, and that has to be reflected in their time's value. There is much food for thought in the opinion piece, but it overlooked many of the legal and practical considerations. Maybe it's time to redo the system, but it needs to be a fair one for everyone.