Why are Realtors so Expensive? (And Disruption in Real Estate)
It’s been a month since my last blog and I must apologize for the gap! The Spring market sprung fast this year. Between that and a previously planned trip to visit family on the other side of the country, I’ve been remiss with my blogging.
Since I haven’t blogged in a little while, I decided to pick a controversial topic and write a ridiculously long article full of fun details and info. There’s quite a bit of insider information here. Enjoy!
CHOICES
One of the big reasons that the cost of hiring a Realtor is suddenly a relevant and controversial topic is that there are several new market “disruptors” that are offering alternative options to buying and/or selling a home.
In the past, the choices were simple, either use a Realtor or go it alone. Now, the options are confusing and (often) misleading, which can make a complicated process even more stressful for potential buyers and sellers.
Have you heard any of these terms lately: iBuyer, wholesaling, Rex Real Estate, Open Door, Redfin Direct, Zillow Offers? These are just a few concepts and businesses attempting to disrupt the “traditional” real estate industry.
So, in addition to talking about how Realtors make money and why we charge what we do, we’ll also dive into a few other questions:
Are what these alternative companies offering drastically different from “traditional” Realtors?
In what way are they disrupting the industry?
How do they make money, and do they charge more or less than Realtors?
Do they do a better or worse job than Realtors?
So many questions… and the answers require understanding what Realtors do, how it all works, how it came to be this way, and what the future might look like.
First we need to define what Realtors and “traditional” real estate means. Then we can figure out what alternative companies are offering that may or may not be different.
Disclaimer: Please know that I am a licensed real estate broker in the state of Oregon. Anything I say below is from that perspective. Other states and municipalities may operate under different rules, regulations, and standards of practice.
“TRADITIONAL” REAL ESTATE
Sometimes, when a homeowner wants to sell a house, they decide to employ what we refer to as a listing agent (also referred to as a seller’s agent). This agent, usually a Realtor, has several responsibilities, including:
discussing the process with the seller so that they are free to ask questions and become familiar with how the process works BEFORE listing the home for sale (because once it’s on the market, you won’t want to make the process any more stressful with a lack of knowledge!)
understanding the seller’s motivations and priorities
formulating a strategy to sell the home at the maximum price in a time frame that works for the seller
marketing the home (which includes a long list of responsibilities, including: researching the property and providing repair and staging recommendations well before listing, creating all the marketing materials to list the home on various websites and other media, listing the home and updating the listing with relevant information, holding and marketing open houses, broker opens, etc.)
providing pricing recommendations and comparable property reports
coordinating showings
procuring showing feedback (sometimes a tough part of the job!)
finding and vetting buyers
vetting buyer agents
assisting with negotiation recommendations throughout the process at several stages
driving communication with the buyer/buyer’s agent
protecting the seller’s interests
problem solving when issues arise
drawing up paperwork and writing contract language (that protects the seller)
reviewing paperwork and contract language from the buyer (to make sure the seller’s interests are protected)
providing lots of advice and oftentimes employing excellent listening skills to help the seller through the tough parts of the transaction
assisting with locating and scheduling contractors for bids and repairs when needed (with a focus on finding reputable contractors that can do the job for a reasonable, lower than average cost and in a tight timeframe)
coordinating and attending the appraisal
serving as a project manager with a team of people that are involved with the home sale, including the buyer/buyer’s agent, title and escrow company, lender, etc.
managing the process through to closing (and sometimes beyond)
And much more…
Sometimes, when a person is thinking about purchasing a home, they decide to employ a buyer’s agent. This agent, usually a Realtor, has several responsibilities, including:
discussing the process with the buyer so that they are free to ask questions and become familiar with how buying a home works BEFORE the search begins (because once you start looking at homes, the last thing you’ll want to think about is appraisals, inspections, permits, etc.)
assisting with locating a lender for pre-approval, if suggestions are needed (I always provide more than one recommendation and always suggest that the buyers look into their local bank/credit union along with asking for other recommendations and doing research online. The more options for a buyer, the better!)
becoming very familiar with the buyer’s list of needs and wants, in order to facilitate the search
setting up an automated search on one or more online portals (in most cases, but sometimes buyers prefer to use their own search sites and send listings of interest directly to the agent themselves)
consistently and actively looking through other channels for homes that match the buyer’s needs, such as through private real estate groups, coming soon listings, off-market properties, auction properties, FSBO (for sale by owner) properties, and more
coordinating and scheduling showings, from 1-20 in a day (yes, I’ve shown that many in a day!)
researching listings of interest to provide as much insight as possible BEFORE placing an offer
providing guidance during the showing, particularly pointing out areas of concern (I’m definitely no Vanna White; when showing a property, I tend to focus my time on finding flaws and potential problems, since that’s more important to be aware of when formulating an offer strategy and during negotiations :)
running a comparable property analysis BEFORE placing offers and providing offer guidance (which is a lot more than just about the offer price!)
providing offer recommendations and employing strategies that give the buyer the best chance of getting an accepted offer, especially when in competition
problem solving when issues arise (and they almost always do on the buy side!)
recommending inspectors and contractors when needed
scheduling and attending all inspections
providing expertise regarding inspection negotiations
serving as a project manager with a team of people that are involved with the home sale, including the seller/seller’s agent, title and escrow company, lender, etc.
managing the process through to closing (and sometimes beyond)
HOW ARE “TRADITIONAL” REALTORS COMPENSATED?
While not all transactions involve an agent on both sides, most of them do, so it’s important to understand how commissions work.
The method that Realtors (on both sides) are compensated is decided upon between the listing agent and the seller before the property is listed for sale.
When a seller decides to employ a listing agent, they sign a listing agreement which stipulates the amount of commission that will be paid to the listing agent. This is most often a percentage of the final sales price, though not always.
The vast majority of listing agents then offer a portion of that total commission to a buyer’s agent, assuming that agent brings a buyer and represents that buyer.
It’s important to note here that there is really only one commission - the amount the listing agent negotiates with the seller. If the listing agent brings a buyer, and the state/locality allows dual representation, then the listing agent will earn the full commission (unless the listing agreement stipulates that the commission will be different if the agent represents both parties).
FYI, dual agency (representing both the buyer and seller) is controversial just on its own. Not all agents will do it and not all buyers and sellers are okay with it. For it to happen, all parties must agree.
Check out my blog about Dual Agency for a lot more information about this.
The absolute vast majority of listing agents know how important buyer’s agents are. They are usually very happy to pay a portion of the commission to the buyer’s agent. Even the majority of FSBOs (for sale by owner) are willing to pay a buyer’s agent’s commission.
Both agents are paid after closing directly by the escrow company (the checks actually go to their brokerage) so that all funds are distributed properly.
It is also important to note that THERE IS NO STANDARD COMMISSION. I see companies like Opendoor throwing around a 6-7% figure as though that’s some kind of set norm in real estate. It definitely isn’t!
Average and median commission amounts vary pretty widely from market to market. Also, different agents may offer different commission amounts for varying levels of service, experience, and situations.
For instance, an agent that is paying to get the home ready for market, cleaning, staging, professional photography, drone shots, video walk through, digital floorplan, social media marketing, etc. may charge a higher fee than a Realtor that takes pictures with their cell phone and just plugs the home into the MLS and requires buyers to contact the seller directly for showings and info.
Of course, remember that you don’t always get what you pay for. A high rate doesn’t mean you’re getting the best agent. A reasonable rate doesn’t mean you’re getting a mediocre agent…
Insider tip: Realtors are salespeople that have a hard time saying “no” to potential clients, even when they have too much business to reasonably take on more clients. Realtors are always worried about “down times” and try to take advantage of every opportunity they get.
It’s very important to try to determine whether or not the Realtor you’re considering really has enough time for you. And I mean THAT Realtor, NOT their extended team. You’re paying commission to work with an expert, not spend all of your time with people that just got their license, are missing vital skill sets, and assistants that are out of the communication loop half the time!
SO, YOU’RE SAYING THAT THE BUYER’S AGENT IS PAID FOR BY THE LISTING AGENT?
Sort of, yes. The listing agent earns a commission and offers part of that to the buyer’s agent (the amount is stipulated on the listing in the MLS). So, buyer’s agents are aware of the amount of commission offered on each listing.
But, even though the commission technically comes from the listing agent/seller, the buyer’s agent owes 100% fiduciary duty to their buyer. All other parties to the transaction are to be treated honestly but the buyer’s agent always represents the buyer’s interests.
Is this a perfect system? No! Realtors debate this all the time.
Unfortunately, I have yet to hear an alternative that makes as much sense. From the outside, it might seem to be more equitable for the buyer to pay for their own agent and the seller to pay for their listing agent.
But, not many buyers have the liquid funds available to pay for their agent along with a hefty down payment and closing costs. And yet, they absolutely need professional representation (scroll down a few sections to the history of real estate to learn why).
Rolling the full commission into the listing side and allowing the listing agent and seller to decide how much of the commission to offer to a buyer’s agent is the next best alternative. Since the vast majority of homes are sold with Realtors on both sides of the transaction, the cost of these commissions is already factored into the value of the home.
Of course, a seller can always decide not to use a listing agent and they can always require buyers to go unrepresented. This makes selling a home extraordinarily difficult as most buyers don’t want to go it alone due to the risks involved.
COULD A BUYER AND SELLER JUST USE AN ATTORNEY INSTEAD OF A REALTOR?
Yes, they certainly can. I have seen this work well, especially if the buyer and seller know each other (such as close family members), or the various parties are very experienced.
In any other case, an attorney alone may not be a good option. An attorney does NOT replace all of the things that a Realtor does. They can review contract documents, but unlike Realtors, they don’t help people buy and sell homes on a daily basis.
Here’s an anecdote: I helped buyers purchase a FSBO home where the seller utilized an attorney to review the documents. The attorney charged her a few hours for their services and suggested one change to the sale agreement (which actually slightly benefited the buyers over the seller, but it was a minor point).
All of the other aspects of selling the property had to be handled by the seller. By the end of the process she confessed to me that she would NEVER sell a home again without a Realtor. (True story!)
According to her, the attorney was no help at all during negotiations, repairs, scheduling, marketing, etc. She had issues understanding what to ask for during the different stages of negotiation and didn’t have the knowledge to know how to protect her own interests at several points, which could have been disastrous for her. She said that the entire process was so stressful, she could not imagine trying to do it again. (She did end up using a Realtor to help her with the purchase of another home.)
It wasn’t a bad attorney, they simply don’t sell real estate professionally and aren’t equipped to handle the process.
BTW - I am NOT saying to forgo hiring an attorney if you feel that you need one (some states require them to close). I AM saying that while an attorney may be useful, they do not replace a Realtor.
HOW LONG HAS REAL ESTATE WORKED THIS WAY?
Not really very long!
Buyer’s agents in particular have only been commonly used since around the late 1990s. And if anyone reading this is now thinking that the 1990s is a super-long time ago, you better not say that to my Gen X face!!!
The fact that real estate is constantly evolving is a good thing and an important point as we work up to talking about Realtor alternatives.
BRIEF HISTORY OF REAL ESTATE
Around 1900 or so in the United States, real estate brokers began representing houses for sale. Unfortunately, anyone could call themselves a real estate agent. Competing brokers would stick their signs into the yard of one specific home for sale, leaving potential buyers confused about who to contact. Homeowners would allow whoever came up with a buyer to sell their home, and didn’t contract with a specific real estate broker.
Even though the broker would often find the buyer, that broker still represented the seller, not the buyer.
Within a couple decades, professional certifications and licensing started to emerge. Listing agents began to cultivate relationships with home sellers, developing a portfolio of clientele and exclusive listings.
Multiple Listing Services also began. This allowed real estate brokers to share their exclusive listings which enabled buyers a wider range of homes to choose from (even though they still purchased homes without representation).
By the 1930s, open houses started to become a good way to try to sell a home, which in turn led to real estate agents broadening their networks. Buyers could go to an open house and the real estate agent could show them a portfolio of other homes they had available, in case the open house didn’t work for them.
Within the next couple of decades the term “Realtor” started to become common and associations became more organized.
During these early times, all Realtors represented sellers, not buyers. Even when a secondary agent worked “with” the buyers, it was as a sub-agent of the listing broker, so the buyers were actually unrepresented.
While homeownership became more and more common, so did bad deals for buyers.
MODERN TIMES AND BUYER’S AGENCY
In 1983, the FTC (Federal Trade Commission) conducted a study that showed that more than 72 percent of home buyers thought that the agent showing them homes were representing their interests.
This led to laws being passed requiring agents to disclose who they were representing. It also called into question the decades-long practice of subagency, which allowed Realtors to collect commissions for bringing a buyer to a listing agent, without actually owing any fiduciary duties to that buyer.
Things got messy for awhile, (here’s a good article about it) but eventually exclusive buyer agency relationships became commonplace around the late-1990s.
HOW DO DISRUPTORS FIT IN ON THE BUY SIDE?
We now know that what so many people call “traditional” real estate has only been around since the late 1990s.
We also know that buyer’s agents became common because of a very pressing need for buyers to have their own representation. Purchasing a home can be a risky, complicated process. Buyer’s agents are necessary to protect the buyer’s interests and help facilitate the transaction.
Notice that buyer’s agents became common around the late 1990’s, which is also when the internet started to really pickup steam.
The need for a buyer’s agent did not arise because buyers needed help finding a home. It became necessary because buyers needed an expert in their corner.
Some “disruptors” are trying to cut out the buyer’s agent. These include REX and Redfin Direct.
People have been cutting out listing agents for as long as home sales have been around (we’ll talk about that more in a second). That’s really nothing new (hello, FSBOs).
But, trying to cut out the buyer’s agent, and claiming that buyer’s agents aren’t needed anymore because a home buyer can find the house themselves online is… well, ridiculous.
Even the most experienced of investors that will FSBO their homes still use a buyer’s agent to purchase a property. As I mentioned above, the buyer’s commission is paid by the listing agent/seller, not by the home buyer. So, a buyer has next to nothing to lose and a lot to gain in using an agent to represent their interests (as long as they carefully choose a good agent!)
Cutting out the buyer’s agent isn’t “disruptive”. It’s trying to turn real estate back several decades to when home buyers had no professional assistance in the home purchase process. These particular disruptors are wanting to make a profit off of people that don’t understand what a substantial risk it is that they’re taking.
Many disruptors say that buyers don’t need the buyer’s agent because they can provide the paperwork or “assign” an agent to the transaction.
I can’t even begin to stress how dangerous this is. Buying a home is probably the most expensive, risky thing a person will ever do. Handing that process over to an unknown person who may or may not be actually representing you, with a dubious amount of expertise, is playing Russian roulette with a large chunk of your savings and livelihood.
A good buyer’s agent is seriously worth their weight in gold.
HOW DO DISRUPTORS FIT IN ON THE LISTING SIDE?
Most of the “disruptors” that are targeting listings are called iBuyers. This includes Opendoor, Zillow Instant Offers, and Redfin Now.
(I’m going to pick on Opendoor a little here because the other options are just barely getting off the ground in Oregon.)
Again, the term “disruptor” is fairly misleading. What these companies are doing is very close to what’s called “wholesaling” and definitely can be considered “flipping”.
Wholesalers find homes either off market or on market, and do no repairs or minimal, cheap repairs before selling the home to another party, sometimes before they even close on the purchase of the property themselves!
iBuyers are looking to buy relatively newer properties (usually 1990 or newer) that need fairly easy and inexpensive repairs which they either have the seller do or complete quickly after closing. They then re-list the home and sell it to (try to) make a profit.
Wholesaling and flipping have been around a long time. The difference is that often local home flippers will find truly ugly ducklings and take a few months to turn them into a beautiful home.
Check out this gorgeous 1909 Portland bungalow that was flipped by some people that I know. This project took over 6 months and a lot of blood, sweat, and tears. I held an open house on it and about 30 neighbors came through, all of which were extraordinarily happy with the outcome of the project. Some very happy buyers are living there now.
And yet, iBuyers would almost certainly never even consider a project like this. They look for properties that were built more recently and in need of only basic repairs/updates. What they really want is the same thing wholesalers do: people that need to sell their home ultra-fast and/or people that don’t realize what their home is actually worth.
What’s different about iBuyers compared to wholesalers or flippers is the fees they charge. Opendoor in particular often charges upwards of a 7% fee. This isn’t a broker’s commission since no broker is involved. It’s just a fee they tack on to buy your home, and they will even ask for sellers to complete or pay for repairs, too!
That fee is a built-in way for the company to make money or at least break even. They know that a super-fast, basic flip will be unlikely to make enough profit (if any) to make the transaction worth it. So, they end up charging the SELLER a big chunk of change.
(I’ll give Opendoor some credit, though: they are NOT seeking to cutout buyer’s agents. Once the basic repairs are complete, they list the home on the MLS and offer a buyer’s agent commission.)
The thing is, wholesaling and flipping has been around for decades. You’ve probably seen one of those flimsy “Want to sell fast? Dial 1-800-sell-now!” signs.
These are wholesalers looking to do exactly what Opendoor and the other “disruptors” are doing. They’re just doing it on a much smaller, local level.
Most people that sell to Opendoor or a wholesaler will turn a (significantly) lower profit than they would have had they used a “traditional” real estate agent or even a local flipper.
Now, don’t get me wrong. This is not always the case. If you need to sell your home VERY fast, then Opendoor might be a decent option. I have heard a couple anecdotes of Opendoor sellers that were satisfied with the process. Generally, they knew they would net less money, but needed to sell for a specific, compelling reason.
However, I can almost guarantee you that there is a local real estate agent (like me) that has a portfolio of investors that would be happy to consider purchasing your home quickly with cash (especially in today’s market!). And, you will likely net more money than you would at Opendoor.
Of course, the best way to protect your interests as a seller is to hire a good, experienced Realtor. I tend to hammer on that point because a disaster in real estate can be bankruptcy-inducing.
YOU HAVEN’T YET SAID WHY REALTORS ARE SO EXPENSIVE. ISN’T THAT THE TITLE OF THIS BLOG?
You got me! It’s tough to explain why Realtors make the money they do without diving into a lot of detail. Even with this blog growing ever-lengthier, I feel like I’ve barely scratched the surface of explaining all the things Realtors do and why trying to replace them with an app will probably not work on a large scale.
I think I need to write a blog with nothing but anecdotes just to give a small glimpse into the ways Realtors facilitate transactions, protect their clients, and keep things together.
The reality is that Realtors most frequently earn a percentage of the sale of the home. From the outside, this can seem disproportionate to the amount of work they do, especially for pricier homes or when a deal seems to go very smoothly (rare).
I can’t necessarily argue with the disproportionality but it’s another imperfect solution to a difficult problem.
I frequently talk about real estate as project management. Every one of my clients I help is a project that I’ve taken on. They tell me their goals and I figure out how to make it happen.
Unfortunately, unlike most projects, there is no way for me to know if a client will end up taking 40 hours of my time or 400 hours. I have spent 100-200+ hours on clients that ended up never buying anything. I doubt they’d be willing to pay me an hourly wage for my services.
The current commission structure exists to compensate agents for the tremendous amount of work that they do. Alternatives are flat-fee structures and hourly structures similar to how attorneys are paid. For several reasons, a couple of which I’ve stated above, this is unlikely to ever work for most transactions.
Another reason: the last thing buyers and sellers want is an agent that only works when the meter is running. There are simply too many points in the process that are extremely time sensitive, so most (successful) agents are willing to work any day of the week and any time of the day.
There are simply so many balls to juggle in this profession and the amount of knowledge and intelligence needed to successfully broker deals that leave your clients happy is sometimes staggering.
So my answer is: Realtors are expensive because the good ones are 100% worth it.
Realtors have to be a jack-of-all-trades but know when to call in experts. More than most professions, we have to KNOW what we don’t know.
Good Realtors are detail-oriented, organized, creative problem solvers, data-driven, analytical, high-energy, always available, near-psychic, great listeners, patient, aggressive when necessary, cooperative, focused, and often flat-out crazy.
HOW DO I KNOW WHAT OPTION IS RIGHT FOR ME?
Technology is (finally) starting to catch up in the real estate profession and there are a lot of startups funded by BIG money, all of which are trying to carve out a piece of the real estate pie.
If you’ve read anything about me or my blog, you probably know that I’m a big proponent of technology. I have no issues at all with companies trying to make a buck off of real estate with (sometimes) unique concepts. ESPECIALLY if they provide a valuable service to home buyers and/or sellers.
I DO, however, have a problem with deceptive business practices that seek to make a profit from people that don’t have a firm grasp of the options. Little regulation exists regarding how many of these new companies can advertise their services (unlike with Realtors, who are inundated with rules and regs).
So, as always, the best way to figure out what is right for you is to read about the options, ask effective questions, and find people that you can trust. Talk to Realtors, talk to lenders, talk to your friends, look into things like Opendoor and Rex… but be objective.
Here’s a blog I wrote about commissions and hiring a listing agent.
Here’s another blog about preparing to buy a home and what to look for in a buyer’s agent.
Don’t get bogged down by the options. Find an expert that you trust and discuss your goals then go from there!
