Q: Of the examples discussed in the book, which have gained the greatest traction in the popular/political discussion? — Rick Groves
A: There has been a lot of talk about the relationship between legalized abortion and the crime rate. And some governments have cited the low wages of street-level drug dealers as an incentive to young people to go legit. But on a day-to-day level, the part of the book that’s probably spurred the most change is our discussion of real-estate agents. The standard fixed-commission, full-service Realtor model is gradually melting away [emphasis added]. Even the White House weighed in, with the Real Estate Settlement Procedures Act, which is meant to increase transparency between Realtors and their customers.
In my posts, I have never claimed that the commission model will disappear (though it doesn’t hurt when the Freakonomics guys say so). I do, however, believe that the commission-free, fee-for-service model will be a popular option for an increasingly large segment of consumers. To each their own, as the saying goes…
Among the various types of consumers with whom I speak about SmithAdams, one segment immediately and intuitively gets it: professionals. By professionals, I mean specialized service providers such as lawyers, accountants, consultants, and doctors.
None of these professional groups charge a commission for their services. Accountants don’t charge their clients a percentage of their taxable income to do their taxes. M&A lawyers don’t calculate their fees as a percentage of the deal size. Consultants don’t charge their clients a percentage of profits. Yet the commission model is the traditional way we pay for real estate brokerage services.
Looking at my customer base, I can see that professionals — specifically lawyers — are among the early adopters of the SmithAdams model. More than one told me, “I’ve been waiting for something like this to come along!”
What is it about SmithAdams that appeals to professionals? Is it that they can pick and choose what services to use and pay for? Or is it that the potential for conflicts of interest inherent in the commission model is avoided? Or is it our focus on establishing a culture of service and client advocacy, versus a culture of sales and transactions? Probably a little bit of all of the above.
To me, this is key validation of our approach. If the SmithAdams fee-for-service model was the WRONG choice for a consumer, who would know better than professionals who use the same model in their work life? Fortunately for us, lawyers, consultants, and other professionals are opting to choose the SmithAdams model over the commission alternative. Great news for SmithAdams!
Pay a broker per hour; maybe pay for services that don’t lead to a purchase or a sale.
Pay a broker by commission; pay nothing unless the purchase or sale happens. (There are some hybrid models that give rebates on commissions, but you are still paying commissions.)
And
The fee-for-service model is perfect for a consumer who is self-motivated and interested in doing a lot of his/her own footwork and research.
I made this comment — hopefully it will be approved soon:
Down in the metro DC area, SmithAdams (http://www.smithadams.com) offers consumers a fee-for-service alternative to the commission mode of real estate. Your statement that “The fee-for-service model is perfect for a consumer who is self-motivated and interested in doing a lot of his/her own footwork and research” is spot-on — that is exactly our sweet spot, as is a growing segment of consumers who are uncomfortable with certain aspects of the commission model (such as the potential for conflicts of interest).
You are right that many consumers fear paying hourly — but more and more of them are doing the math and making individual risk/reward calculations that lean towards choosing a fee-for-service model. In a world where the information advantage of the broker over the consumer has eroded significantly, many consumers just want to pay a broker to help them through the transaction — and pay the same way they would pay a lawyer — by the hour, even on a non-contingent basis.
You put it perfectly — the fee-for-service model is just one option that consumers should have — and each consumer can make the choice right for him or her. The commission model will always be a choice for many consumers, but the fee-for-service option should be there for others. Bill Wendel is definitely a pioneer in this area, to the great benefit of Boston area consumers. Thanks for your post!
I hope everybody had a wonderful weekend! On Saturday, the Washington Post had this article with a compelling lead-in:
At what point does the real estate industry’s penchant for boosterism — and the sunny outlook that comes naturally to any good salesman — get in the way of buyers and sellers looking for guidance they can trust?
I will make this one comment: regardless if abuse is prevalent or not, it cannot be disputed that there is an unavoidable conflict of interest here — a direct result of the traditional commission fee model. When your adviser is compensated based on whether or not you take a certain course of action, there is a conflict. I discussed this in my very first post titled “The Problem with Real Estate Commissions”.
The SmithAdams approach avoids this conflict of interest. To that point, we will shortly be enabling you to self-subscribe to detailed market updates for your zip code or area. Click the thumbnail to the right to see a sample report (PDF format) for condos in select Arlington zip codes. If you don’t want to wait until the self-subscribe function is set up, just let me know (1) what area you are interested in and (2) condo/townhouse or single-family home, and I’ll email it to you.
Speaking of Arlington, if you somehow still haven’t seen the Arlington rap on Youtube, here it is:
>>> Would you pay 8% commission rate to sell your house, if you knew that the brokerage was donating 40% of profits to charity of your choice?
Interesting question though I thought the answer was obvious. But hey, Rob sent it, so I figured there’s something to this and perhaps I should do the math.
This ended up being an even more interesting theoretical exercise that I had initially thought. As is the case with many situations, it depends what metrics you decide are important. If your cost of doing a real estate transaction is your only metric, then obviously paying a higher commission rate would be silly. On the other hand, if maximizing proceeds to charity is also important to you, then you might decide something else. With both constraints, you should look at total net after-tax costs.
Rob’s tweet said “40% of profits”, but for fun let’s assume this imaginary brokerage would give 40% of the commission income of each transaction to a charity of your choice. I’ve attached a screenshot of the math below (which I did quickly — please alert me of any issues) for 5 scenarios assuming a $300,000 sale price and a marginal tax rate of 35%. The scenarios are as follows:
A: 8% commission ($24,000), brokerage gives $9600 (40% of $24,000) to charity of your choice
B1: 5% commission, and you make a separate $9600 charitable contribution
B2: 5% commission, and you make the appropriate contribution to have net after-tax costs of $24,000 (to match the cost of Scenario A)
C1: 6% commission, and you make a separate $9600 charitable contribution
C2: 6% commission, and you make the appropriate contribution to have net after-tax costs of $24,000 (to match the cost of Scenario A)
D1: 7% commission, and you make a separate $9600 charitable contribution
D2: 7% commission, and you make the appropriate contribution to have net after-tax costs of $24,000 (to match the cost of Scenario A)
(click to enlarge)
The key factor is the prevailing seller commission rate (the cost of your alternative to the 8% brokerage). At a prevailing seller commission rate of 5%, your charity gets much more bang for your same buck if you choose a 5% brokerage and make a separate charitable contribution, assuming you can take the whole deduction (compare Scenarios B1 and B2 against Scenario A). At 6%, you’re roughly indifferent (compare Scenarios C1 and C2 against A). At 7%, on the other hand, your charity would get more proceeds by choosing the 8% brokerage (compare Scenarios D1 and D2 against A).
The marginal tax rate is also factor — the higher the margin tax rate, the more it favors the scenario where you make a separate contribution and get a tax deduction.
So, conclusion: not as wacky an idea as I originally thought. It would be interesting to see if any consumers would go for this idea. Of course, the truly best scenario is to go with SmithAdams’ commission-free a la carte services, and then donate your savings to charity
DISCLAIMER: I am not a professional tax adviser, you should consult with your adviser for real guidance. In fact, I really wouldn’t listen to anything I have to say…
As I talk to people about the unbundled, fee-for-service model governing SmithAdams, I am occasionally asked, “Are you a discount brokerage?” The simple answer is NO. SmithAdams differs from a discount brokerage in a couple primary ways:
Discount brokerages provide a reduced set of services for a lower commission rate. In contrast, SmithAdams doesn’t charge commissions at all. Our fee model is similar to that of an attorney, accountant, or consultant. Your accountant’s fees to do your taxes are based on how much work is performed, not a percentage of your net worth. The SmithAdams fee model works the same way – we charge based on the amount of work we do.
While discount brokerages offer a reduced set of services, SmithAdams provides our clients with the full range of services (if not more) than traditional full-service brokerages – but on an a la carte basis.
The SmithAdams approach is very different than the norm in the real estate industry. We believe this approach achieves two important goals for our clients:
First, SmithAdams is able to customize each engagement (and the associated fees) based on the particular needs of each client. We don’t spend (or bill) time putting together home tours for homebuyers who have already performed their own market research and already know the property they want to buy. We might, however, spend time staging the home of a seller if that is critical to achieving the client’s goals. In any case, our work and our fees are tailored to the particular needs of each project.
Second, our model removes the conflicts of interest inherent in a commission model (even a discount commission). As I have written before in previous posts, a conflict of interest exists when your advisor (from whom you expect to receive objective guidance) gets paid based on whether or not you close a deal. I’m not saying this conflict of interest by definition causes poor behavior, but it is nevertheless a conflicted situation with which one may be uncomfortable (I know I am).
Notice that these two points above did NOT include “saving you money.” Sure, many people can save thousands of dollars with the SmithAdams model. But the primary goals of the SmithAdams approach are to align our services with our clients’ individual needs and to raise the quality of service to consumers. Cost is an important factor, of course, but it is not the only thing. More important, we think, are the quality of the client outcome and the overall customer experience.
Our clients do not choose SmithAdams purely for the chance of saving money. In fact, our clients pay our non-contingent fees on a monthly basis. Rather, our clients work with SmithAdams because they believe that we make their real estate experience better, and that SmithAdams will zealously advocate for their interests. Our clients are confident that they receive value from every hour we spend working on their behalf, and they are happy to pay for it.
And that is why SmithAdams is not a discount brokerage.
“Way to go! It’s time to get rid of the commission model!”
to this:
“I don’t know – do you really think fee-for-service will replace commissions?”
To both, let me say this: hold your horses. We have no expectation that the fee-for-service model will completely replace the traditional commission model.
Why should there be only one way? You can hire an attorney on retainer or on contingency. We believe the same options should exist for real estate brokerage. No single way will be the right fit for everybody, so consumers should have choices.
That’s what SmithAdams is really about: giving consumers choice in real estate brokerage. No two consumers are identical — each person’s needs and wants are different. Consumers should be able to choose what services they need and are willing to pay for. If a consumer wants to pay based on a commission fee model, so be it. Likewise, if a consumer prefers a fee-for-service, pay-as-you-go model, that should be available too.
Here’s my long-term vision of a world of peaceful coexistence and competition between the two fee models. As more and more consumers opt for a fee-for-service approach, there will be more scrutiny of fees by consumers as well as demands for transparency. Commission-paid agents will need to better link their value-add to their fees. The good ones will have no difficulty doing so and will continue to thrive in this environment. The ones who cannot will eventually leave the profession. Over the long run, the overall quality of service to consumers should rise — whichever fee model an individual consumer chooses. Sounds like a good outcome to me. What do you think?
It is not uncommon these days for people planning on selling their homes to consider doing it as For Sale By Owner (FSBO). The lure of not having to pay a commission to a listing agent is powerful. Likewise, the proliferation of online real estate resources is making it increasingly easier for individuals to successfully market their properties without the assistance of an agent; this is especially true as a growing proportion of buyers find homes to purchase via the internet versus using an agent.
SmithAdams meld the savings and control of the FSBO route with the benefits of a full-service brokerage. Using our flat-fee, a la carte seller services, sellers can choose what services they need and are willing to pay for.
With SmithAdams, a DIY seller is still in control. We’re there when and if you need us, and there’s no commission for you to worry about. If you’re thinking about FSBO (and if you’re selling a home, you should), then please consider adding SmithAdams to your team.
These days, it is not uncommon for folks shopping for homes to do a lot of the tasks traditionally associated with a real estate agent: surveying neighborhoods, identifying listings, touring properties (via open houses), analyzing comparables, even contacting homeowners. The DIY home buyer has been greatly empowered by the proliferation of online real estate information resources such as Zillow, Trulia, and Hotpads that have eroded the information advantage of brokers. The most difficult part of the process for a non-professional, not surprisingly, starts after that: actually making an offer, negotiating the best deal possible, and working through the process to get to a successful close. This is where a real estate professional can add the most value. It is also, in my opinion, where the commission model makes the least sense.
Enter SmithAdams. Using our flat-fee, a la carte buyer services, the DIY home buyer can have the best of both worlds: no commissions but access to a real estate professional on an as-needed basis. Similarly to the way one would consult a lawyer, accountant, architect, or other professional on a fee-for-service basis, one can use a SmithAdams consultant – and pay only for the time used.
Given how much of the discussion on this blog revolves around comparing the commission fee model to the SmithAdams fee-for-service model, I thought you might be interested in this lively discussion about brokerage commissions at ThinkOOB.com. It’s great to see that we are not the only ones actively thinking about this issue. I hope my contribution added to the dialogue.
ThinkOOB.com was created by Al Lewis, founder and president of Disease Management Purchasing Consortium International (DMPC) as well as all-around big thinker, to be a “community blog that rewards lay people for coming up with solutions to society’s problems.” To this end, ThinkOOB.com is offering a million-dollar prize to the first idea originated there that becomes policy at the state or federal level. There are some great discussions going on at that site.
In the context of government economic policy, Al coined a phrase that I love: the “methadone economy,” equating the new federal stimulus programs to a substitute — but still very addictive — for the “heroin” of the bubble economy. Great turn of phrase.
First, SmithAdams is able to customize each engagement (and the associated fees) based on the particular needs of each client. We don’t spend (or bill) time putting together home tours for homebuyers who have already performed their own market research and already know the property they want to buy. We might, however, spend time staging the home of a seller if that is critical to achieving the client’s goals. In any case, our work and our fees are tailored to the particular needs of each project.
Notice that these two points above did NOT include “saving you money.” Sure, many people can save thousands of dollars with the SmithAdams model. But the primary goals of the SmithAdams approach are to align our services with our clients’ individual needs and to raise the quality of service to consumers. Cost is an important factor, of course, but it is not the only thing. More important, we think, are the quality of the client outcome and the overall customer experience.