January 19th, 2010 by Al Lewis (alewis)

President Obama has often said that it would be a shame to waste this economic crisis.  Nowhere is that more true than in real estate, where federal homebuyer tax credits up to $8,000 are barely denting the mortgage foreclosure rate.   Instead, let’s use this crisis to try a new approach:   slashing the 6 percent real estate brokerage commissions still prevalent in most markets.

How? By replacing that $8,000 automatic credit with a $2,000 incentive credit, the difference being that this credit goes only to homebuyers whose purchase prices include a total commission of 3 percent or less (or no commission at all).  Because prevailing commissions average 6 percent today, the selling brokers will naturally complain:  “We can’t afford to split a 3 percent commission with the buyer’s broker.  That’s how much we need to make ourselves.  So buyers will have to make their own arrangements.” 

And that is exactly the point:  Today’s 6 percent commissions include two payouts—3 per cent each to the seller’s broker and the buyer’s broker.   Instead of requiring  this fixed buyer’s broker commission requirement in the sales price, this tax incentive encourages  homebuyers to pay openly for whatever level of assistance they want, if any, from whomever they want. Given those other options and the chance to collect $2,000, few buyers would opt to pay a 3 percent out-of-pocket commission (about $6,000 on a median-priced house). 

But buyers don’t have multiple options today – that is why the hidden, fixed buyer’s brokerage commission survives.  Writing the check themselves to keep the total commission low enough to earn the credit, most buyers would want advice only, perhaps by the hour, and/or perhaps only a few times during the homebuying process.   

Financially, a buyer paying a small sum for advice with no built-in buyer’s brokerage commission will be about as well off as a buyer collecting today’s much larger homebuyer tax credit while also paying much larger hidden commissions.  The big difference:  far lower taxpayer expense ($2,000 per house instead of $8,000).   Anyone could still opt to pay the traditional commission at closing — but paying a full-service buy-side broker by commission would become a choice instead of a requirement.

This hidden buyer’s brokerage fee requirement survives only because real estate brokerage is a cartel, as a few market observations clearly demonstrate.    While middleman costs on everything else from stocks to cars to travel to insurance have plummeted, real estate commissions have remained close to 1970 levels in percentage terms and have climbed dramatically since then in dollar terms…and are often curiously identical within a market. 

Forty years ago you needed one broker to buy a stock or a house, while today you need none to buy a stock, but two to buy most houses.    In law and medicine fee-splitting is illegal.  In real estate, it is required.  Finally, while a few discount brokers charge less than the “standard” fee in a market, no broker anywhere charges more by claiming that their service is better.

Even a temporary $2,000 credit could permanently alter the structure of real estate brokerage, because there will be no going back once the credit expires — there has never been an industry where high commissions have replaced low commissions.  And just as happened when stock commissions were allowed to decline, much lower transaction costs will create more transactions and hence more liquidity.  Liquid markets will allow people to sell houses more easily before they go “underwater,” thus reducing foreclosures.  

Of course the real estate brokerage industry, which has strongly endorsed homebuyer tax credits, will oppose this particular tax credit.  .  Fortunately, an equally powerful coalition of builders, bankers, mortgage brokers and consumer advocates will be lined up against them.   

Much lower transaction costs would not just reduce foreclosures by facilitating transactions, but would also increase people’s net equity in their existing homes, thus making all homeowners better off – a perfect example of not wasting an economic crisis.

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  1. Joel Stern Says:

    Excellent proposals, which make sense from an economic and consumer benefit point of view.

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