Tech Advances Aren't Lowering the Cost of Real Estate Services

Tech Advances Aren't Lowering the Cost of Real Estate Services
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Over the last decade, a number of technological innovations and new business models in the U.S. residential real estate industry — from instant buying programs to virtual tours and digital closings — have made it easier to match buyers with homes and lowered the cost of housing transactions. However, puzzlingly, these technological advances have not lowered the cost of services by the real estate brokerage industry. In fact, across the country, national average commission fees over the past couple of decades have doubled and outpaced inflation in most years.

Relative to the number of homes for sale, the number of agents has doubled over the last two decades. Theoretically, that should lead to more price competition among agents. Yet, counterintuitively, commission fees have remained persistently high and impervious to competition. Residential brokerage commissions don’t appear to reflect the cost of doing business or the quality or experience of agents.

In new research for the Brookings Institution’s Center on Regulation and Markets, we focused on Boston where the commission rate is 5%. As in the rest of the country, sellers are responsible for paying commission fees to the listing agent and the agent who brings a buyer, a structure that has been in place since the early 1900s and enforced ever since by the National Association of Realtors. Members of the NAR were originally required “to divide the commission equally with any Realtor who can produce a buyer for any client.” In practice, that remains the case today.

A core principle in economics is that prices should reflect the marginal cost of production in a competitive market. When prices are above marginal costs, good profits should encourage more competition. What’s puzzling about the US residential brokerage industry is that this relationship doesn’t hold.

The uniformity of commissions over time, irrespective of competitive conditions, contrasts both with other industries and across global markets. In the U.S. mutual fund industry, for instance, the average 1% commission rate in the early 2000s has been cut by more than half while the cost of trading stocks has fallen by 80%. And among 35 countries, and despite the innovation taking place here, the U.S. remains the third most costly when it comes to buying and selling homes.

As we dug deeper, we found that a few big name brokers tend to be dominant in each market - though those brokers may differ from market to market. These market-dominant brokers are less likely to purchase homes that pay a lower-than-average commission split. What’s more, the commission information isn’t available to consumers or on sites like where they seek information when buying a home.

Properties where brokers get less than the 2.5% norm in Boston, for instance, will have a worse sales outcome. The effect is significant both in terms of days on market and the probability of a sale. We consider alternative angles and conclude that broker “steering” to higher commission properties is a significant factor that limits competition.

This matters because the high transaction costs from commission fees can have a big impact on household savings. In the first quarter of 2019, average home sellers achieved a gain of $57,000 after owning their homes for a little over 8 years, according to ATTOM Research. The average commission they pay a broker is around $13,000-15,000 or about a quarter of their savings from owning real estate. That’s significant when you take into account that the savings of a median household in the U.S. are merely $11,700. 

To put this wealth transfer another way: to sell a house in New York state in 2019, the median household would spend roughly 40% of its annual income on commission, transfer taxes, and other closing fees, with the lion’s share going to commission payments to real estate agents.

So what can be done? A natural policy intervention would be to let the seller and buyer pay independently for the professional service that each obtains, which is the norm in all other consumer service industries. Such a step would eliminate the threat of steering and would allow buyers to shop for the level of service that suits their needs and bargain for its price.

A step short of that would be to require brokers to clearly state the commissions being charged for both sides of the transaction and to encourage rebates. Rebating would require legal change in ten states, but it would be worth it. If buyers knew they were paying the fee and those fees were lower due to competition, research from our colleagues in the U.K. indicates that housing prices are likely to go down by 2-3%

Greater transparency on commissions, more open sharing of information, and regulation that prevents incumbents from excluding outsiders or forcing them to uphold the high commission structure, are all steps that would improve the market in an industry that pulls in over $100 billion of commission revenues and serves six million new and used homes sales annually. With the proliferation of technological innovation in the industry, and the potential of tech to further increase efficiency, consumers in the U.S. should be paying a fraction of the cost they pay today to buy and sell homes, and now is the time to help them do so.

Panle Jia Barwick is associate professor of industrial organization, applied econometrics and applied microeconomics at Cornell University. Maisy Wong is the James T. Riady Associate Professor of the Wharton Real Estate Department at the University of Pennsylvania. They are the authors of "Competition in the real estate brokerage industry: a critical review," published by the Economic Studies at Brookings program.

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