Fixed Pricing: Why Most Real Estate Agents Charge 3%
The Federal Trade Commission, defines fixed pricing as “an agreement among competitors that raises, lowers, or stabilizes prices or competitive terms.” Sound familiar?
While price fixing may be extremely lucrative (thanks Dave Chappelle), it’s also very illegal. But if that's the case, why does it seem like most real estate agents charge the same price? In this post, I'll do my best to answer this question.
Section 1: Do Agents Actually Fix Their Prices?
Before I answer this question, I'd like to provide a quick lesson on how real estate agents are paid.
Let's pretend for a minute you want to sell your home for $300k. If you sign hire an agent, the typical commission is 6% (in this case $18k). This commission will be deducted from your total sale proceeds at closing, and split between your agent (AKA the listing agent) and the agent representing the buyers (AKA the buyer's agent). So in this scenario, each side gets $9,000. Make sense?
Sometimes listing agents discount their commission, which is why you may have heard about 5% listing fees. In this scenario, the listing agent receives 2% and the buyer's agent receives 3%.
On rare occasions, the aforementioned discount is reversed so that the listing agent receives 3% and the buyer's agent receives 2%. Situations like this are rare, however, because the buyer's agent portion is advertised as a "finders fee" (AKA a co-op amount). While dissuading a buyer from viewing a home with a lower commission is illegal, it does happen. Studies show that sellers (or listing agents) offering less than 3% can have adverse effects on how quickly a home sells.
So with that in mind, here's what we know based on national commission data:
The average commission in 2015 was 5.26%.
Listing agents collected a 3% commission in approximately 60% of transactions.
Buyer's agents collected a 3% commission in approximately 98% of transactions.
So it's clear that most agents charge the same fees, but is this price fixing? Not necessarily. Perhaps 6% is simply the market price dictated by supply and demand.
In 2003, Chang-Tai Hsieh of Princeton University and Enrico Moretti of UCLA set out to determine just that. They looked at average commission rates across 282 US cities. Real estate is a local business, so surely commissions can't be the same nationwide. But the results of the study were eye-opening to say the least. Not only are commissions fixed from city to city, but Hsieh and Moretti also found a strong correlation between home prices and the number of agents per capita. They write:
"Consider, for example, two cities - Boston and Minneapolis - that are similar in most dimensions except in the cost of housing. In 1990, the price of a typical house in Boston was roughly twice that in Minneapolis...the brokerage fee from selling a typical house in Boston was therefore twice that of a similar transaction in Minneapolis. If this is all there is to the story, real estate agents in Boston would simply earn twice as much as their counterparts in Minneapolis...However, because there is relatively free entry into the real estate business, the average real estate agent in Boston does not earn twice as much as an agent in Minneapolis. Because the commission from selling a typical house is twice as high in Boston as it is in Minneapolis, there are more real estate agents in Boston seeking these high commissions, although the total number of homes sold each year is actually larger in Minneapolis. Consequently, the average real estate agent in Minneapolis,is is much more productive than a typical agent in Boston, selling 6.6 houses each year in Minneapolis as compared to an average 3.3 houses a year in Boston."
My apologies for the long-winded quote, but I think this sums up the real estate market nicely. If supply and demand actually determined commissions, then fees, in theory, would vary across different markets. But the exact opposite is true. In fact, the supply of agents is dictated by the commission. Higher home prices lead to more agents, which lead to less productivity (more on productivity in The Real Estate Paradox blog post).
So are real estate prices fixed? It appears so…
Section 2: How Do Agents Fix Their Prices?
The answer’s simple really. In the 1940’s, the National Association of Realtors (NAR) decided to set all fees at 6%. At the time, no one really cared about price fixing. After all, the U.S. had bigger problems to deal with (i.e. The Great Depression, Japanese attacks on Pearl Harbor, Hitler, etc.). But shortly after the end of WWII, people started to notice.
In 1950, the US Supreme Court presided of over United States vs. The National Association of Realtors. The court ruled in favor of the United States (#murica), thus ending official nationwide price fixing. But unfortunately it didn't end price fixing altogether. It continues on to this day in 3 main capacities:
Local Board Policies
When the NAR was forced to repeal the 6% commission policy, state and local boards began implementing similar rules. Though most of these policies have since been overturned, their influence still lives on. Fixed pricing is now more of an unwritten tradition rather than an official mandate in many local boards.
Brokerages are the large real estate firms that agents work, including companies like Remax, Keller Williams, and HER. As privately owned companies, the courts have very little influence over their policies, and therefore cannot prevent them from fixing their agent's fees. While not all firms do this, a couple key players do, thus fixing the price for a large percentage of agents nationwide.
Dual agency is the practice of having 2 agents involved in each transaction – a buyer’s agent and a listing agent. Agents who deviate from the standard 3% fee are often looked down upon. While most “traditional” agents won’t outright blacklist “non-traditional” agents such as myself, there’s certainly a ton of peer pressure to fall in line with the status-quo.
So how are prices fixed? As you can see, it's a bit complicated. While the days of official price fixing are over, it's still baked into the real estate culture and remains on the policy books (albeit legally) of many large brokerage firms.
Section 3: How Do Agents Get Away With Fixed Pricing?
So if real estate agents have fixed prices and if price fixing is illegal, then what gives? How do they get away with this?
As always, the answer is money and power. According to OpenSecrets.org, a non-partisan watchgroup, the NAR and their state affiliates spent $64.8 million on lobbying in 2016 alone, making them the 2nd most powerful Political Action Committee in America.
It is because of these intense lobbying efforts that the real estate industry is able to fix their prices without retribution. But there is hope in sight! In recent years, there have been multiple antitrust lawsuits filed against the NAR. The most famous of these involved their attempt to block agents from lowering their fees. Here's how the story goes...
It all started when some tech-savvy agent in Chicago figured out a way to use technology to make the home selling process cheaper and more efficient. Rather than pocketing all of the savings, he passed much of his profit on to his clients via lower fees. Seems innocent, right? I certainly think so, but it made the NAR go ape-shit.
Needless to say, all of the ruckus caught the attention of US Department of Justice, who eventually settled the whole debacle. Here’s what the USDJ had to say:
“In September 2005, the Department’s Antitrust Division filed a civil antitrust lawsuit in U.S. District Court in Chicago, against NAR challenging policies and related rules that obstructed real estate brokers who use innovative Internet-based tools to offer better services and lower costs to consumers. The Department said that the policies prevented consumers from receiving the full benefits of competition, discouraged discounting, and threatened to lock in outmoded business models.”
In the end, the NAR was forced to revise policies that promoted price fixing, but the battle still continues. Unlike gas stations or airlines, who’s prices change constantly, real estate fees have remained fixed for decades. This is so deeply ingrained in our culture that it’s nearly impossible to find any written evidence of wrongdoing. And thanks to continued lobbying efforts, the battle rages on.
Thanks to an epic study by Hsieh and Moretti, we know that prices are fixed. And thanks to some epic lobbying efforts in Washington, price fixing continues to this day. But things are changing...
This is the generation of Amazon, Uber, and AirBNB. We support companies that challenge the status quo to improve our lives. We look forward into the future, not backwards into the past.
The world is changing exponentially faster than ever before, and the real estate industry is bound to do the same too.