Comp Talks: Real Estate Agents (Part 2 of 2)

Last week we discussed real estate agent compensation and looked for parallels within the investment management industry to point to possible clues toward the future. Today we’re circling back to look at different models that exist currently, and what they mean for agents and the clients.

Traditional Brokerage vs Discount Brokerage

 credit: Redfin

credit: Redfin

As opposed to traditional, commission-based brokerages, discount brokers offer rebates to buyers and sellers and/or pay their agents a salary and bonus. While seemingly innocuous to many bystanders, the differences and merits of both are continuing to be debated within the industry.

How and why do firms such as Redfin compensate agents with salaries? What are the motivations for agents to work on commission, knowing it’s potentially feast or famine? What about clients? Should they have a preference, or even a say in how their agent is compensated?

Technology Toolbox: Fact or Myth?

To dig a little deeper into the argument, let’s look at Redfin and compare them to Compass and some other “traditional” brokerages. Redfin’s value prop, as is clearly stated throughout their content marketing, is centered on costs and tools. Basically, it’s cheaper to list or buy with Redfin because the company offers a 1% listing fee and has historically offered a buyer rebate (this of course has changed over the past few years, but for demonstrative purposes we’ll keep it) while for agents, the security of non-commission based income.

Alongside this, Redfin offers superior technology in the form of a great mobile app and desktop site, communicative tools between agent and client, and proprietary management tools for their agents. Compass, interestingly, is heavily focused on developing proprietary technology but retains a commission based compensation model. What does this say about Redfin?

One could argue that Compass clearly values technology, but not discounts. The firm strongly believes that a commission based model correctly incentivizes their agents to be top performers while simultaneously offering a competitive product to Redfin, technologically speaking. Redfin offers a dangerous combo for its competitors: cheaper services and awesome technology. For agents, it also removes the burdens of having to promote yourself, do lead gen, and transactions paper pushing. So why hasn’t Redfin runaway with the market? Is their model actually working?

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Compensation Models: Why Move Away from Commissions?

As you know, real estate agents are compensated via commission as percentage of the sales price. In any sales business, this creates an incentive to work hard to “earn your pay” and results in underperformers exiting the industry. This is a principle of a free market model. The question this begs then is if commission based pay results in creating incentives to work hard, why would clients want agents who are paid salary?

There could be several reasons for this: it creates a better experience for the client and agent, it allows firms to grow faster and earn more market share, and/or it removes conflicts of interests. Let’s tackle these individually.

Better Client Experience
CarMax is a used car company that pays their sales reps a fixed salary. When you go to CarMax, they’re not shy about mentioning in a manner not unlike, “And because we’re not paid based on commission, there’s no pressure at all on you (the client) to take your time and do what’s best for you.” Powerful stuff. In return, CarMax offers no-haggle pricing and can more easily manage their fixed costs. As we previously discussed, a compensation model that is transparent and pre-determined can set aside awkward conversations about commission levels with an agent and allow a client to operate with a clear mind that compensation has no effect on decision making (more on that below) and help agents focus on servicing their clients, as opposed to prioritizing client volume (i.e. shifting to quality over quantity).

 credit: pexels.com

credit: pexels.com

Faster Firm Growth
Firms that have more stable and projectable revenues and expenses often earn a premium valuation among financial analysts. Similarly, brokerages that can more easily attribute revenues and spread costs among their agents (i.e. more evenly distribute among both top performers and underachievers, especially if it’s cyclical) may have an advantage when considering expansion. Knowing your break-even costs can help provide clarity in decision making.

Interestingly, while Redfin, by all accounts, is considered a massive success, financially they’ve been anything but. In the most recent quarter, Redfin reported a net loss of $36 million.

Unfortunately, Compass is a private company so financials are not available, but their latest funding round valued the company at more than two billion dollars, a significant premium to Redfin’s approximately $1.5B company value. This difference of course is not purely due to how these firms pay their agents, but strength of their business model is certainly a factor in valuation.

Removes Conflicts of Interests
Conflicts of interests are always at play whenever compensation is based on commission. The more money the client spends, the more the agent gets paid. In an age where clients are more commonly controlling their home search through the portals, it’s becoming more challenging for agents to clearly prove their value. Could a fee-based or salaried agent use that as a differentiating factor, a la the CarMax model? Or, would a client wonder how much attention they’ll get if the agent is paid no matter what happens?

So Who Is Right?

The answer to that question depends on how you define, “right”. The Redfins, Compasses, Keller Williams and boutiques are successful in their own way. The question should be, “what model provides clients the best experience?” because then, and only then, can we determine what’s right.

Then again, as every agent knows, every client is different. For many clients, saving 4% on their sales price is more important than a high touch agent (not to imply at all that Redfin agents are slouches, but to the point of commission vs salary — truth of the matter is there is no evidence that Redfin agents are inferior). Some clients prefer the Redfin brand name (and knowing that so many home buyers visit Redfin having Redfin bubble your home to the top of the search results is an advantage), while others scoff at the big box retailers. Compensation may not be an issue for one client while it’s everything for another.

It’s harder to look into the crystal ball and guess what the future holds. Will the real estate industry adopt a fee based model? Will Redfin drop its rebates and salary and restructure commissions to align with the rest of the industry? Will a la carte services become more readily available? Will hybrid models emerge?