Will court case on real estate commissions impact home prices?
Question of the week: Will court ruling on real estate agent commissions impact home prices?
Answer: This is a question being asked across the country, and a main topic of discussions in real estate offices nationwide.
A big Halloween scare shook the real estate industry when the jury in a federal court case awarded plaintiffs in a class-action suit be paid close to $1.8 billion in damages by the National Association of Realtors (NAR) and several of the biggest national real estate brokerages. Under federal antitrust law, the amount could be tripled to over $5.3 billion.
There are some additional law suits in the judicial pipeline that are similar to the above Gibson, et al v. NAR, et al, this is the first to come to a verdict.
The Cliff Notes version of the lawsuit is that home sellers sued because they felt they were being over charged on commissions as half the commission being paid to the listing agents (representing sellers) were paid to the agents representing the buyers (selling agents). Because this arrangement, commission splitting by the agents paid for by the sellers, is standard in NAR contracts, the plaintiffs argued this violates federal antitrust laws.
Members of NAR can use the title of Realtor© in their marketing and promotional materials. The title comes with rules made by NAR that agents must adhere to remain members. These include rules regarding commissions paid to selling agents, selling agents
Most real estate listing contracts have a 5-6% of sales price as the commission paid by the seller for the agent to represent them in their sale process and list the property on the Multiple Listing Service (MLS), as agreeing that a non-negotiable, by the seller, commission, typically half the total commission, will be paid to a selling agent.
The lawsuits contend that because the sellers have to pay commissions to the agents representing buyers, they are paying for more to sell their homes than if the buyers were to pay their agents directly. One other factor, is that since they buyers are not able to negotiate the commissions the agents representing them are getting paid, the contention is they are paying more than they might if they negotiated the commission directly.
So, what does this mean to the real estate market moving forward?
To generalize there are three segments of the market that are impacted the most: buyers, sellers, and agents.
Real estate buyers in the United States are somewhat unique when it comes to real estate agent compensation. Internationally, the United States is pretty much the only market where buyers’ agents are paid by sellers through an agreement with the listing agents. Elsewhere, buyers, contract with an agent prior to working together. Some of the agreements call for a flat fee to be paid for a period of time during which the agent will be diligent in finding a home, negotiating a price, and handling the details required for the sale. Other agreements call for a commission to be paid as a percentage of sales price.
Because the seller is paying the buyer’s agent, both agents’ commissions are part of the sales price. If a seller agrees to a 6% commission with half being paid to each agent, a sales price of $1,000,000 generates a total commission of $60,000. In closing the buyer will fund $1,000,000 into escrow in some combination of cash and loan(s). At closing the seller will net $1,000,000 minus costs, including the commission before paying any mortgages or other liens on the property.
Due this arrangement, the buyer is technically paying the commission for their agent as it increases their sales price by that amount—assuming the market price would not be the same if only the listing agent’s commission was being paid by the seller.
In the example above, a normal transaction is the buyer would purchase the home with 20% down, $200,000, and 80% loan, $800,000.
If the market changes and selling agents are no longer paid through escrow from the seller’s proceeds, buyers will need to pay their agents directly. How does the buyer restructure their contract? If the commission remains 3% to the selling agent, does the buyer continue with 20% down and pay the $30,000 in cash at closing? Or does the buyer only have $200,000 for the transaction, plus other closing costs, put down $170,000 and obtain a loan for $770,000, which because it is higher than 80% loan to value will require mortgage insurance.
Because of either the additional cash to close required, or the higher loan amount, the buyer may no longer be qualified for the home.
If the seller reduces the sales price by 3% because they are no longer paying the selling agent commission, the price of $970,000 still, at 3%, would have a $29,100 commission—still presenting an issue for the buyer as to paying cash, restructuring the loan, or not qualifying.
For sellers, the supposition is that they will net more from the sale of their homes if commissions for selling agents are no longer taken from their proceeds. But this is assuming the market does not make an adjustment to market values due to buyers having to pay agents directly and not finance as part of their purchase price.
In the above example if the sales price is reduced 3% due to the seller not paying the selling agent, the net proceeds of sales price minus commission (3% to listing agent), would be $970,000 less $29,100, $940,900.
In the “traditional” sale with a $1,000,000 sales price and $60,000 commissions being paid, the seller’s net proceeds would be $940,000.
If the market adjusts downward in pricing because of the change in commission structure, the seller may net a bit more in proceeds, depending on the market adjustment. If prices do not adjust due to the commission structure changes, the seller will net considerably more.
What about realtors? How will they be impacted if the federal judgement results in wholesale changes and buyers having to pay their agents directly.
The real estate industry will go through tremendous change. First, commissions paid per transaction will go down. While the listing agent commissions may still remain in the current 2.5% – 3% range for listing agents, buyers not being able to finance selling agent commissions will very likely reduce the amount able to be paid to selling agents.
With buyers negotiating commissions directly with the agents to represent them, and factoring that cost into their ability to qualify for the homes they wish to buy, market forces will result in lower commissions for agents representing buyers.
Currently there are about 1.2 million members of NAR, and approximately two million more licensed agents that are not members. The vast majority of real estate transactions are done by a minority of licensed agents, estimated to be 20-30% of licenses. Consider that in 2021, a very active year with record sales, the average number of sales per real estate license was 12. If there are 3 million licensed agents, that means 1.5 million did less than 12 and 1.5 million did more than 12.
Real estate is one of the few industries where part-time workers can earn significant income; consider a part-time agent who sells two homes for a total value of $1.5 million with 3% commissions will earn $45,000. If those commissions decline by 25%, 30%, 50%…? how many part-time agents will remain active?
Should commissions drop, so will the number of active, full and part-time agents. This reduction of competition, increase in specialization, should result in increased volume for agents to can make up for some, a lot, of the lost income due to reduced commissions.
Buyer behavior will be interesting to see. Due to Zillow and other real estate websites, for the past several years many of the buyers we have worked with are very knowledgeable about what is on the market, prices in certain areas, and often know the home they want to purchase before they engage a realtor. With more sophisticated buyers, will they contract with the traditional realtor to represent them, try to represent themselves, or use other services.
I foresee agencies that specialize in representing for flat fees become part of the real estate market should the commission structure drastically change with large impact on the commissions paid to selling agents.
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Speaking of change in prices, a very small change in prices had a huge impact on mortgage rates this week. Prior to the release of the Consumer Price Index data on Tuesday, the consensus among economists was that the data would show the CPI increased 0.1% in October. They just missed in their estimate as CPI showed no change for the month, the first time in 15-months CPI was flat month to month. The zero growth was primarily due to gas prices dropping 5.3% in the month. Stripping out food and gas for the “core” rate, inflation was 0.2% for the month. The year-over-year rate fell to 3.2% , the lowest increase in two years; the core rate, which is the Fed’s barometer for adjusting rates, was 4%–a level that has not been able to be breached due to fluctuating food and energy costs. Bond and mortgage markets loved the news, sending prices soaring and rates dropping.
Rates for Friday November 17, 2023: Conforming rates have their biggest Friday to Friday drop since July 14th and hit lowest level since September 1st due to the CPI data.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:
30-year conforming 7.00% Down 0.375%
30-year high-balance conforming 7.50% Down 0.125%
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.
Good thing I like routines. Several time a day, pedal machine, leg bent 90 degrees, leg flat 0 degrees, deep vein apparatus, leg lift, leg bend, leg flat, leg squeeze, and icing throughout…surgery rehab is a full-time job. But worth it as working my goal of incrementally better each day. A motto that is not only good for rehab but also for life!
We have much to be grateful for this year, as every year. I hope you and your family are able to spend a happy, and grateful, Thanksgiving together.
Have a great week,
Dennis
Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog
