The Realtor Commission Settlement.

The Good, Bad, and Ugly.

Most of you probably saw the splashy headlines last week that the National Association of Realtors (NAR) trade group has proposed a settlement to the class-action lawsuit that was brought upon them in the state of Missouri, but has effects that reach far beyond the state lines.

For those of you not familiar with the details, the class-action lawsuit that was filed accused NAR and local brokerages of conspiring to fix real estate commissions and make them non-negotiable off of the set 6% (again, this was just in Missouri). Like we do here in California, part of that commission goes to the listing brokerage, and the other part goes to the brokerage representing the buyer. Now, commission-fixing of was truly taking place (much debate still rages about the validity of this claim), then shame on NAR for letting this go on for so long. By definition, that is price fixing and worthy of an anti-trust lawsuit. NAR ultimately lost this court case, much to their surprise, and the damages were set at $1.8B with the potential for treble damages of over $5B since it is an anti-trust case.

Rather than sticking to what everyone felt was strong basis for an appeal, the NAR caved last week and proposed a settlement that will change how homes are sold all across the US. While some good things will certainly come out of this settlement, I'm never a fan of “one-size-fits-all” regulations, especially in an industry where the practice varies so widely from state to state.

Missouri is not California, and we practice real estate far differently than the methods they were accused of employing, which is why net effect of the proposed sweeping changes is akin to solving a problem that doesn't really exist.

A prime example? On the very first page of the standard California listing agreement this statement has been their in large boldface type for years:

COMPENSATION TO BROKER:
Notice: The amount or rate of real estate commissions is not fixed by law. They are set by each Broker individually and may be negotiable between Seller and Broker (real estate commissions include all compensation and fees to Broker).

— California Association of Realtors

So where is the collusion and price fixing in our local market that needs to be fixed?

The Terms.

There are a lot of issues to digest in the 108-page proposed settlement, which still needs to be approved by the court and the plaintiff. But here are the two key points that impact home buyers and sellers the most:

1. Sellers can no longer offer compensation to the buyer's broker though the MLS. Up until this point, a seller would pay the listing brokerage a commission, which the listing brokerage would then use part of to pay the brokerage that represented the buyer, as mentioned above. This is known as “cooperating compensation”. In other words, the seller paid the commission for both sides of the transaction. This change will eliminate that from the listing agreement. Sellers are still able to compensate the buyer's brokerage if they wish, but it must be done by a separate agreement outside of the MLS. This is their solution to the perceived “commission fixing”. Even if the sellers continue to pay for the buyer's agents commission, that can no longer be communicated through the MLS. More on that below.
2. Buyers agents will be required to sign a binding contract with any buyer that they intend to represent, prior to showing them any properties. This contract outlines the responsibilities of the buyer's agent, and also how the agent is to be paid. This will likely be the thing that will be the most disruptive and confusing should this settlement become a reality.

Let's break this down further to better understand how it's going to impact you as either a buyer or seller of real estate here in San Carlos.

Buyers: You May Have to Pay Your Own Way.

One of the byproducts of de-coupling the listing commission from the buyers commission is that sellers can opt to offer little or no compensation to the buyer's brokerage. That means if a buyer is going to employ an agent to help them purchase that home, the buyer may now be responsible for paying all or part of the services that their buyer's agent provides. That payment, whether it's a flat fee, a percentage of the sale, or an hourly rate, is outlined in the binding contract referenced above, which is also referred to as a Buyer-Broker Agreement.

One of the most obvious downsides of forcing the buyer to pay their own agent that it's simply going to eliminate some buyers from the market. I know that when I purchased my first home back in 1991, I had to shake every piggy bank empty just to come up with the down payment for the house. If I also had to pay the buy-side commission, I would have never purchased that particular house. Fast forward to the present with down payments starting at over $400,000, the same thing is going to happen. Buyers who are stretched to the max of their budget to get into the market are simply going to instruct their agents to pass over any house where they would be responsible for paying the buy-side commission. And that's an important differentiation — it's perfectly OK for a buyer to “steer” their agent away from a house for that reason, but it's not legal the other way around.

Now you might think that the buyers can just roll their agent's commission through their home loan, but that's not allowed under the current lending guidelines, and it will likely take years to change that rule knowing how regulated the banking guidelines are in this country. An no, the the banks also won't let a buyer take a credit from the seller at the close to pay for their agent either.

Even worse? Military personnel who qualify for a Veteran's Administration (VA) loan are not allowed to pay their agent per the terms of the VA loan, period. VA loans provide great terms for veterans and in many cases it's the only loan option they can qualify for. So they are essentially blocked from purchasing a home where the seller is not offering cooperating compensation.

This example is not as relevant here in the high-priced bay area, but it just again shows how a one-size-fits-all settlement can have unintended negative consequences, and how this settlement was simply not well thought out.

Sellers: Lower Cost of Sale?

The apparent benefit to the home seller is that they would only responsible to pay the listing broker, and paying the buyer's brokerage would be optional. By not offering a cooperating compensation, they are indeed lowering their cost of sale. But does that mean they'll net more for the sale of their home? I don't think that's crystal clear, and here's why…

I've been selling San Carlos real estate for 17 years, and with only a few minor exceptions, it has been a hands-down sellers market for that entire period of time, and there's no sign of that changing any time soon (can you say no inventory??) So in a market like this, what is the key factor that enables sellers to get the best and highest price for their home? Leverage.

Leverage is simply the ability to get the highest number of willing and able buyers to see your home when it's for sale. The more potential buyers you have competing for your home, the more leverage you have. That's just the nature of an imbalanced market.

We just witnessed what happened when another event — high interest rates — pulled buyers out of the market and stripped the sellers of some of that leverage. The market stalled and homes sat for a long time before they sold, if they sold at all.

So if a listing loses potential buyers because the buyers can't pay for their agent, that will impact a seller's leverage.

It's hard to say what the true effect will be on the seller's net profit. In one of my most recent listings, we received well over a dozen offers and I was able to negotiate an additional $120,000 (above the top offers already received) because I had the leverage of so many offers. That upside that I negotiated, by the way, easily paid for both commissions. Looking at the strength of some of these offers, I believe I would have lost a full 1/3 of them if the seller had not offered cooperating compensation. Would I have been able to deliver the same outcome to my sellers with a third fewer offers?

I'm glad I didn't have to find out.

The Buyer-Broker Agreement.

If there is a clear-cut positive outcome of the settlement, it's that agents must execute a written agreement with their buyers before showing them properties. Not only does this outline who pays for what, but more important, it will also clearly states what the agent's responsibilities are (and are not) which helps eliminate misunderstandings down the road.

For too long, buyer's agents have been engaging in representing a buyer with no contract in place to dictate the process, yet a listing agreement has always been mandatory in order for a listing agent to sell a home. This correction is long overdue, and I believe it benefits and protects both the buyer and their agent.

The Bottom Line.

If this settlement is accepted, NAR has stated that the changes will take place as early as July of this year. Some local brokerages have already jumped the gun and are encouraging their sellers to offer low, flat fees to the buyer's broker (while they can still do so on the MLS). Only time will tell if this gamble will prove to be a smart one. Look for their to be a lot of confusion and misinformation until the dust settles on this.

The attorneys for the plaintiffs have claimed that this lawsuit and accompanying settlement will lower the cost of housing for everyone. For the local market, that's a big leap. There are a LOT more prominent and significant reasons why home prices are so high in the bay area — namely, there are far too few homes for sale for the number of buyers looking.

If the Department of Justice and the ambulance-chasing class-action attorneys really want to solve the housing shortage here in California, how about we work more aggressively to lower interest rates so that sellers will be motivated to sell? And we're long overdue for an increase to the capital gains exemption. Those two reasons alone are the biggest impediment that's keeping home owners from becoming home sellers in this market, which is why inventory will remain low and prices will generally remain high.

Sorry for the long read, but this is one of the most significant changes in the real estate market in many decades, and there will many more posts about this subject in the future.

Got more questions? Don't hesitate to reach out!