Thoughts on the Incoming Class Action Lawsuit Filed Against Realtors

First of all, if you haven’t been watching Hot Ones on YouTube, you really should. I have been a late adopter but it’s been my go-to time-killer the last month or so. With that in mind, I’d like to break down the implications of the recently (and very fiery) filed class action lawsuit within the United States District Court in the Northern District of Illinois (hello, Chicago!) on Wednesday, March 6th, 2019 by generating some potential outcomes on a scale of mild to armageddon. 

But First, The Case Brief

The class action lawsuit names the plaintiffs as “all persons who paid a broker commission since March 6, 2015 in connection with the sale of residential real estate listed on one of the Covered MLSs” — which refer to essentially the players make up the vast majority of broker-members and transactions across the country (think The BrightMLS and almost all major cities across the South, Southeast, Mountain and Midwest regions). 

The defendants named include National Association of REALTORS, Realogy, HomeServices of America, Re/Max and Keller Williams and I should note it appears this is a fluid list, so expect more large players to be named.

Here’s what the suit alleges: the rule that is implemented and adopted by NAR that requires all broker-members to market ‘blanket, non-negotiable offer of buyer compensation’ when listing a property on the MLS is anti-competitive.

Due to the fact that brokerages are required to be participants in the MLS  — which is controlled by local associations that must comply with NAR rules  — the competitive environment that would normally dictate commissions does not exist, hence why brokers are able to charge 5–6% commissions with little or no (market) pressure — i.e. buyers and sellers are handcuffed and have no purchasing power, which is bad optics. 

For now I’ll skip the potential dollar implications of this mostly because it’s early and I have no ability to gauge how this will play out, but suffice to say something along the lines of $X/transaction/person ends up being a LOT of money — one that no defendant could reasonably cough up and even settlement figures could be shockingly high.

Should this stop you in your tracks as a NAR leader, MLS associate, broker, or software vendor? Not yet. Should it perk up your ears? You bet.

The Potential Implications

Here let me remind everyone I am not a lawyer, and these are purely my own thoughts and ideas. Let’s try to break the problem down to it’s core:

Why was the lawsuit filed? Because the real estate industry is rigged.

Why? Because commissions are enforced in a monopoly-like way.

Why? Because brokers are required, as members of an association in which they must adhere, they structure compensation in such a way that the seller foots the bill for both agents.

Why? Because buying a home is expensive and both sides *should* use an agent and it’s important we incentivize agents to work hard through a commission (sub-text: and those commissions get expensive fast and become challenging for consumers to pay out-of-pocket).

There is a lot to unpack here — the necessity of agents, the commission model, the requirements of member participation — and little of it is straightforward. This is why I abandoned LSAT studying and went into Finance out of college.

Mild: Improved Disclosures Required for Buyer’s and Later-Stage Compensation Agreements

A key issue is the buyer’s understanding of how agents are paid, how commissions are split, and what a buyer’s agreement is all about. At a minimum, requiring more thorough discussions and ensuring that buyer’s know that they’re signing up for could go a long way in making, on the surface, the current compensation model more fair. 

Instead of an agreement between the seller and seller’s agent and the latter and the buyer’s agent, an agreement between the buyer (made at the time of offer) and the seller (conditional in acceptance) as to what the agent’s compensation is could provide consumer purchasing power in a more fair way. Yes — this means that agents are less certain of their pay until the end, but this may make compensation more fair. 

Would you agree to the tip percentage for your restaurant server before you were seated? Why do we do this in the real estate industry?

Medium: Agents Do Not Have to Be Members of MLS, NAR

Another issue is the requirements of membership into the MLS association. Besides the “I pay you money for membership in exchange for access to the MLS, tools, training, and more” trade-off, the “I pay you because I have to” rubs a lot of Adam Smith’s the wrong way. 

It’s 7:30am on a Saturday so my ability to dive deeply into what it means to have optional membership into the MLS is challenged, because it is an enormously complex topic, but consumers across lots of areas choose professionals who are not members of MLS-type associations. Financials advisors are often bifurcated by those who have earned the Certified Financial Planner (“CFP”) designation (through tests and membership association dues) and those who have not (note: there are still securities exams that are required at a minimum). Those who carry the CFP designation are afforded more tools, trainings, research, and other benefits but are not required to do so in order to advise clients. So your agent wants to let you use Zillow to find homes and work with an attorney and skirt the membership part, leaving them more flexibility to get creative with compensation that aligns better with clients — why not?

Medium: Commissions As Compensation Change

This is on the upper-echelon of medium spice. Car-Max is a car dealer where its agents work on salaries, as opposed to commissions. This affords the company the ability to not have pushy sales people in order to attract buyers who feel that there is no incentive for the sales person to try to upsell them in order to make more money. This is at the very heart of why consumers hate the commission model in real estate. 

The “what have you done for me lately” attitude has created fee compression for hedge fund and asset managers, and without the unilateral agreements in place between both agents (who, at an extreme case, one could argue flirts with collusion) it’s very likely commissions would be lower for real estate agents. I do not believe a flat fee best incentivizes agents and should be the standard in the industry, but a baseline salary with incentives could be a solution. 

At this time of year, when the baseball season is nearing, free agents who are coming off down or injury-plagued years or are simply not premier targets agree to sign incentive-laden contracts. These combine a base salary and other performance-based incentives. Could a base salary (or base commission of 1%) plus agreed-upon performance incentives (based on final sale price, quality of experience, etc) level the playing field and reduce the power the brokers have in compensation?

Hot: Buyer’s Must Pay Out of Pocket for Buyer’s Agent

Now we’re wading into deeper waters. This could completely change the industry as it operates today. Not only would overall pay decline, we are swapping from finding ways of helping the consumer have more say and power to potentially harming the consumer. 

Let’s assume the average purchase price is $300k — of which 3% is $9,000. What buyers are going to willingly go out-of-pocket to pay that amount, especially in the post-Zillow era? Therefore, a few things have to happen: buyer’s agents compensation goes way down or buyers simply do it on their own (and buyer’s agents roles effectively go away). 

The reason these agreements exist in the first place is not so much to monopolize compensation for brokers, but to provide the ability for buyers to work with an agent throughout an emotional, complex, and incredibly financially important process. 

If the world is willing to put full purchasing power in the hands of the buyer, it must be done so that it does not create an insurmountable barrier to buyer’s ability to seek advice and guidance from an agent. For this to happen, it means, again, buyer agent’s compensation has to change, payment structures have to get creative, or something else. Like I said, this is a hot topic.

Armageddon: NAR and The MLS are Screwed

Time for the final dab: rehashing an earlier point, if membership becomes optional, what’s stopping all agents from abandoning the MLS and NAR and simply going “open-source” with all things real estate? The tools to complete a transaction all exist, but one advantage of MLS is compiling these tools and subsidizing the cost of many to member agents (sort of — agents still pay indirectly through dues), but if agents are not paying dues and are free to use that capital to invest in other tools, consolidate brokerages to save money, go virtual, whatever — all of a sudden the value-add of NAR and the MLS declines steeply and quickly. 

There is so much more out there on this topic that falls out of scope of this diatribe at the moment, but from a top-down perspective, NAR and the MLS have a lot at stake with this lawsuit. 

So what do you think? What’s the threat level here?