Real Estate Brokerage – The Greatest Consumer Scam of All Time?
How Realtor Accounting Gimmicks Drive Up Prices
Real Estate Brokerage – The Greatest Consumer Scam of All Time?
A Missouri federal court jury recently delivered a devastating blow to the National Association of Realtors (Realtors). Not only did the jury find the Realtors and their co-defendants guilty of violating the Sherman Anti-Trust Act, but they also hit them with damages that could balloon to over $5.0 billion.
At issue is something called the “buyer broker commission rule,” where sellers of property are effectively compelled to pay the buyer’s broker’s commission. For more background on the commission rule, see our note “MLS Blinks.”
Not surprisingly, the Realtors and real estate brokers are now facing an avalanche of similar lawsuits throughout the country. It’s our hope that these lawsuits will usher in much needed comprehensive commission reform and level the playing field for consumers.
The harm inflicted on the consumer by the Realtor’s commission shenanigans extends well beyond the buyer broker commission rule. In our opinion, both lack of transparency and accounting gimmicks have artificially elevated real estate values. Most residential real estate price appreciation can be chalked up to the Realtor commission shell game.
National Association of Realtors – The Fox Guarding the Hen House
With 1.5 million members made up of real estate brokers and their sales agents, the Realtors are the largest private trade association in the United States. Through their ownership or control of most of the Multiple Listing Services in the United States, the Realtors effectively control the residential real estate market.
Labeling the organization a “cartel,” the Wall Street Journal Editorial Board recently noted that, “as powerful lobbies go, few have more clout than the Realtors.” Correctly speculating that the Realtors would lose the Missouri case, the Journal noted that, “The Realtors may own the U.S. Congress, but perhaps independent courts won’t be so intimidated.”
The National Association of Realtors is considered a self-regulatory organization (SRO). Unlike financial services SROs (e.g., FINRA, the New York Stock Exchange) which operate under the direct supervision of the Securities and Exchange Commission, the Realtors don’t operate under the direct supervision or oversight of any government entity. It’s the classic fox guarding the hen house.
Commission Shell Game – The Greatest Consumer Scam of All Time?
Residential real estate sales are simple agency transactions, where a broker represents their client in the marketplace in exchange for a fee or commission. The true sale price of a property is the net price received by the seller after deducting transaction expenses, i.e., sales commissions.
In our market, the average price for a 2-bedroom condominium in Boston’s Back Bay is about $2.0 million and sales commissions are generally 5%. In the real world the math works like this:
Not surprisingly, the Realtors have a unique definition of “net price.” Most Multiple Listing Services define the net price as:
Net Sales Price – Shall mean the full or gross selling price of a Listed Property…
Huh? According to Realtor math, the net price equals the gross price. So when a residential property sells, the reported price includes the commission expense. In essence, commission expenses (which generally run between 5% - 6%) become embedded into the asset value of the underlying property, and ultimately into the broader market price structure. In our example, the $1.9 million net sale (the value of the property) gets artificially marked up to $2.0 million.
Just to be clear, expenses aren’t assets. In the case of residential real estate commissions, these expenses provide no future benefit beyond the transaction closing. Paying Realtor fees is no different than paying homeowners insurance or property taxes - they’re expenses, and they absolutely do not increase the value of the property.
Commission Compounding - the Ultimate Momentum Market
Realtors value property based on comparable sales data (“comps”), often referred to as a broker’s opinion of value. In a nutshell, they take the values of similar properties that have recently sold and extrapolate those values to the next property being offered for sale. Since Realtors use artificially inflated prices, by default the comps are overstated by 5% - 6%.
This is well illustrated when a property turns over several times in a short period – we call them mulligans. Take unit 7/8 at 142 Chestnut Street in Boston’s Beacon Hill (note, there were no meaningful improvements to the property in between sales).
The property sold in November of 2022 for a net price of $2.612 million. Just eight months later a buyer paid $2.899 million (gross price) – an 11% premium over the first actual net sale price. While the second buyer clearly paid an ill-advised price, the real harm is that these transactions artificially inflate the comps.
Rising Tide Lifts All Boats
Sticking with our Chestnut Street example, sellers of similar properties in that area will price their properties off these artificially inflated values. Inevitably, sellers pad their asking prices by the amount of their commission expense – plus a little wiggle room to negotiate. The next seller of a similar property in that neighborhood will likely ask $3.1 million. This compounding repeats itself over and over.
The compounding effect of improperly including commission expenses in property values is the likely source for most, if not all the value gains in residential real estate. The Case Shiller Home Price Index for Boston has increased on average 3.79% a year over the trailing 20 years. If you strip out the embedded compounded commission expenses, you’d likely be in negative territory.
What the Seller Is Willing to Accept, Not What the Buyer Is Willing to Pay
Realtors are quick to claim that the gross price (including the fees) represents what a buyer is willing to pay for the property and therefore that’s the fair market value. This is completely false. One-time expenses, including real estate commissions, are deducted from the gross selling price at closing and commissions are paid out to brokers.
Inappropriately embedding expenses in the asking price may be an effective way to trick buyers into paying the seller’s commission, but expenses do not increase the property value. The fair market value is what the seller is willing to accept for the property net after transaction costs - this is the clearing price.
Mortgaging Commission Expenses = Financial Poison
Another common argument Realtors make in favor of including commission expenses in the asset value is that it allows buyers to mortgage the commission expense. While this is true, it’s akin to peddling financial poison.
Using the example of the average $2.0 million Back Bay 2-bedroom condominium, if a buyer finances the purchase with a mortgage, they’re effectively financing the $100,000 commission expense. Let’s assume that they put down 50% and took a $1.0 million 30-year mortgage.
10% of their monthly mortgage payment, or roughly $720 a month, will service the commission expense. That’s over $8,600 a year – for thirty years. At the end of the thirty years, total principal and interest on that $100,000 expense will add up to well over $250,000 – they don’t tell you that at the closing.
Comprehensive Reform Needed
Realtors are terrified that their game is changing and are fear mongering that buyers won’t be able to afford representation in the marketplace. What they fail to recognize is that their business model is ridiculously expensive, inefficient, and antiquated.
Real estate brokers should take a page out of Wall Street’s play book. Stockbrokers, who executed securities transactions on behalf of clients, went extinct when their commission rates plummeted. Today consumers are far better served by investment advisors and wealth managers.
We applaud the Missouri jury decision - they got it right. Realtors have been protecting their fiefdom at the expense of consumers for decades, and they broke the law in the process. It’s time for the buyer broker commission rule to be outright banned.
Comprehensive commission reform is needed to protect consumers. In our opinion, burying fees in listing agreements, property sale prices, and ultimately into buyer’s mortgages is akin to a street corner shell game – it’s an intentional deception on the consumer by the Realtors.
The residential real estate market is rigged. The cost of housing has skyrocketed, and, in our view, Realtors and their accounting gimmicks have played a part in driving up prices. Buyers of real estate need to approach the negotiating table with a clear upfront understanding of what they are paying for. How much is the house? And how much has the seller agreed to pay their broker? Negotiate the price of the house and let the seller pay their own commission.
About Batterymarch Group LLC – Batterymarch Group is an independent full service real estate brokerage and advisory firm focused on the downtown Boston high-end residential market. We represent both sellers and buyers with a sharp focus on valuation. We also offer sub-advisory and owner’s representation services to financial institutions, family offices, and trustees.
About Andrew Haigney – A 25-year Wall Street veteran, Andrew held senior positions at leading global investment banking institutions where he routinely valued and negotiated complex securities transactions on behalf of institutional clients. Andrew has been an outspoken advocate of a universal fiduciary standard. In founding Batterymarch Group, Andrew brings that same discipline and passion to real estate brokerage.