Posted by nithi.vivatrat on August 25, 2009
The paperback edition of Freakonomics went on sale today, and Levitt/Dubner posted on their blog the only new content in this edition, which is a Q&A with the authors derived from the wonderful Freakonomics blog. I thought you would find this excerpt interesting:
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…
Posted by nithi.vivatrat on June 10, 2009
@Rob Hahn, founder of strategy consulting firm 7DS Associates, tweeted this query yesterday:
>>> 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…
Posted by nithi.vivatrat on June 7, 2009
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.
Posted by nithi.vivatrat on May 27, 2009
As I talk to folks about the SmithAdams fee-for-service approach to real estate brokerage, I hear responses ranging from this:
“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?
Posted by nithi.vivatrat on May 18, 2009
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.
Posted by nithi.vivatrat on May 13, 2009
Three little letters every real estate agent spouts. It has been called the “black box” of real estate, was the center of a major antitrust lawsuit from 2005-2008, and may be the key to selling (or buying) your home. What is MLS and why does it matter?
MLS stands for Multiple Listing Service. The singular use of “service” makes it sound like a monolithic system; in reality, there are actually many separate MLS systems across the country, one per region. For instance, the Mid-Atlantic MLS, run by Metropolitan Regional Information Systems, Inc. (MRIS) happens to be the largest real estate database in the country, listing properties in Maryland, Northern Virginia, Washington DC, West Virginia, and Pennsylvania.
An MLS system is a database where licensed real estate professionals list properties they represent for sellers with all the relevant details, such as room dimensions, contact information, tax records, photographs, maps, and of course asking prices. Likewise, MLS is the go-to source for brokers/agents representing buyers to identify prospective properties to show to their clients. WAIT! There is more to read… read on »
Posted by nithi.vivatrat on May 11, 2009
My apologies for my hiatus — lots of activity at SmithAdams keeping me busy, but I hope to get back on the blogging horse starting now.
I hope everyone had a wonderful Mother’s Day weekend. You might have missed Kenneth Harney’s Post article titled “Challenging Brokers’ Add-On Fees.” In it, Mr. Harney explains how U.S. District Judge Virginia Emerson Hopkins ruled against RealtySouth for charging clients an “administrative brokerage commission” (or an “ABC” fee). The court found no evidence that the consumer received any additional service for the fee beyond that which was already covered by the regular commission, violating a federal real estate settlement statutory ban against “unearned” fees.
This is good news for those of us advocating greater transparency and choice for consumers in real estate. Extra fees should not be surreptitiously slipped into an already complicated process. At SmithAdams, we believe that consumers should have total control over what services they choose and pay for. This ruling reinforces that competition, consumer choice, and the laws of supply and demand should determine pricing — not unilateral action by the provider of the service. Hooray!
Posted by nithi.vivatrat on April 13, 2009
When I talk to prospective homebuyers about SmithAdams, I spend much of the time, not surprisingly, explaining how our fee structure works. I thought it would be useful to recap a typical recent conversation:
“How do we get started?”
To get started, SmithAdams presents you with an engagement letter similar to that of an attorney. This letter describes the terms of our relationship, the scope of work, and the fees associated with our services. Our invoicing process is described in detail in this letter as well. Unlike the typical buyer representation agreement, there are no stipulations about exclusivity. By mutually agreeing to the terms of the project as described in the letter, you and SmithAdams are on the same page as to how we will work together.
WAIT! There is more to read… read on »
Posted by nithi.vivatrat on March 17, 2009
On Sunday, the New York Times had this article about the growing use of buyer’s agents on Long Island. The article implied that buyer’s agents are fairly rare there; my feeling is this is less true in the DC area. Regardless, my focus is on this issue: the article cites real estate brokers who now focus exclusively as buyer’s agents to eliminate “the ’smoke and mirrors’ and ‘dual-agency conflict that has caused so much mistrust among consumers and real estate agents.’”
It is true that when there is a documented and disclosed (this is important) relationship between a buyer-client and a real estate broker, then the broker representing the buyer has a fiduciary responsibility to represent the buyer’s interests. This is clearly stated in Article 1 of the NAR Code of Ethics (Standards of Practice 1-1 and 1-13). Classes for agents pursing an Accredited Buyer’s Representative (ABR) designation.
That being said, it is hard to ignore the reality that, in a traditional commission model, the buyer’s representative gets paid a commission amount stipulated by the listing agreement and only at the consummation of a transaction. Sure, this means that buyers don’t have to pay any fees unless a purchase actually occurs. But as I have pointed out in earlier posts, the commission model, even for buyer representation, creates real potential for conflicts of interest that the SmithAdams fee-for-service model avoids. And by the way, most buyer representation agreements keep open the potential for dual-representation, should the buyer agree (I wouldn’t).
So, of course I think it is better for any buyer to have his or her own representative. I just think buyers should be fully educated on dynamics that the NYT piece glossed over.
Posted by nithi.vivatrat on March 10, 2009
When talking to people about SmithAdams, the first question I frequently get is this: “You’re starting a real estate business in this economy? What are you thinking?”
Paul Graham, essayist, partner at Y Combinator, and all-around renaissance man, explains, in much more eloquent language than I can muster, that this is the perfect time to start a new company. This point is especially relevant for SmithAdams:
“That doesn’t mean you can ignore the economy. Both customers and investors will be feeling pinched. It’s not necessarily a problem if customers feel pinched: you may even be able to benefit from it, by making things that save money. Startups often make things cheaper, so in that respect they’re better positioned to prosper in a recession than big companies.”
That’s precisely what I’m setting out to do. SmithAdams fee-for-service model can save consumers money. In this housing market, I think any of us would benefit from real estate transactions being more efficient and less costly.
To this point, I believe potential customers are more likely to be open to new ways of doing business in times like these. During the recent flush years when real estate property values were skyrocketing and homes were sold in a weekend, few questioned the wisdom of paying a 3% (one-sided) commission on property transactions — a commission that often translated into thousands of dollars. With the realty market in disarray, the SmithAdams value proposition has resonated strongly with almost everyone to whom I have spoken about our company.
Now is the time to apply the simplicity and straightforwardness of a fee-for-service model, similar to other professional services industries, to the business of real estate. Despite new technology and other changes in the real estate marketplace, the commission-based fee model has not evolved in decades. The bursting of the housing bubble presents an ideal time to reevaluate current real estate practices. Now is the time to start SmithAdams.
I welcome your comments and feedback.
