Brokerage Models – A Mathematical Analysis, Part 1
By
Rob Hahn
Math is FUN-damental!
One of the more insightful posts on the industry came earlier this week from one of the more insightful people in the industry: Nicolai Kolding, COO of Better Homes & Gardens Real Estate, and former head of M&A for Realogy. This is a man who knows what he’s talking about.
He gave a presentation (PDF) at Inman Connect in San Francisco that I unfortunately missed due to meetings and such but I think his blogpost covers most of his basic points:
– The current business model for real estate brokerage is unsustainable.
– There are four financial factors that drive revenues:
The number of homes sold (with each sale having two “sides”),
The average price of the sales,
The brokerage’s take after the agents’ commission splits (”percent retained”),
The amount (in percentage) received per transaction (”average broker commission rate” or ABCR).
– Three of these four factors have been going in the wrong direction over the past decade or so. The deterioration was covered by rising home prices during the Bubble, but sides, percent retained, and ABCR have all been headed down.
– Even if home prices recover, without changing these fundamental dynamics, the current brokerage model is unsustainable.
– The sustainable model of the future will, in Nicolai’s view, do four things:
Maintain (or increase) ABCR by constantly updating and improving the value proposition to consumers;
Increase average agent productivity;
Increase percent retained through brokerage-generated business;
Generate a far higher output per square foot of office space.
Nicolai recommends a bunch of action items in his presentation. For example, he talks about reducing office space to 50 sq.ft. per agent, restructuring commission plans and compensation plans, consolidating certain functions such as accounting and marketing, and eliminating technology/office items such as printing, copying, extra landlines, etc.
As it happens, I think Nicolai is right on target in many many respects. In the comments to his blogpost, there are some heavy duty thinkers weighing in on how to fix the status quo and structure a business model for brokerage that makes sense going forward.
One of the things I wanted to do — and I’ve asked Nicolai for some help on this, which he was kind enough to supply as he could — was to contextualize the discussion by looking at the numbers involved. A lot of the talk about business models feels to me like a bunch of hot air unless we can start looking at numbers, even if manufactured/fake, just to have some basis for discussion.
Introducing… Simulacra
Virtual Realty: Simulacra
Let me introduce Simulacra, a “traditional” brokerage with some numbers for the purposes of discussion. Here’s the link to a simple spreadsheet.
As you can see, this is a brokerage with 500 agents divided into four quartiles, with varying splits, varying production levels, and the like. The end result is that this brokerage does 3,600 transactions, with 2.5% commission rate per side in a market with the avg. home price of $300K — sort of vanilla really. That means $7,500 is the GCI per transaction.
Again, look at the spreadsheet for some of the analytics, but bottomline is that when the top split is 80% for Tier 1, Simulacra ends up with $7.425M in company dollar against $27M in GCI, or a company dollar % rate of 27.5%. That keeps Simulacra in line with the RealTrends study of a couple of years back showing that the average retained company dollar was about 26.7% among respondents.
With the expenses set at Nicolai Kolding’s estimates of about 5% of GCI for Occupancy (office leasing), 5% for Marketing, 10% for Salary, and 5% for G/A (general overhead), the end result is that Simulacra makes $7.425M in revenues, incurs $6.75M in expenses, for a profit of $675K — a profit margin of 2.5%, which is in line with the reported average of 3% for real estate brokerages.
Now, here’s the thing. From what I’ve heard from realtors and brokers, managers and franchise people, 80% is hardly the top rate for a Tier 1 producer. It’s closer to 90% for the top agents, and in the case of some brokerages (e.g., Keller Williams), there are models offering 100% splits (after a cap, or with transaction fees or some such).
If you reset the splits to reflect 90% as the Tier 1 rate (and cascading down — 80% for Tier 2, 70% for Tier 3, 60% for Tier 4), the results are on Sheet2 in the link above. Bottomline is that our little brokerage, Simulacra, goes from making $675K for a 2.5% profit margin to losing about $2M per year. Could this be what’s going on at brokerages around the country?
Cost-saving measures — such as reducing office space, laying off staff, etc. — have an impact of course. I wanted to see what that was. In Sheet2, you see that I reduce Occupancy costs by 50%, Salary by 25%, and G&A by 50%. Result? Instead of losing $2M a year, Simulacra now breaks even. But think about that: our profit for the year is zero from all those dramatic cost reductions. If you go all-virtual, and simply eliminate the Occupancy cost altogether, then Simulacra will make a profit of $675K — the same anemic 2.5% profit margin of the “Top Split 80%” version.
Implications and Inferences
Let me size this up here...
Let me grant at the outset that the data for Simulacra is entirely made up, although I have tried to keep them “reasonable” and based on what I’ve seen and heard. Nonetheless, the numbers strongly imply that cost-cutting measures simply are not the way forward. Since “expenses” for a brokerage operation apply to Company Dollar, they leave out the single biggest expense line: Cost of Sales. That strikes me as a simply insane way to run a business.
Charging various fees to the agent to try and recapture more dollars don’t strike me as a particularly wise way of going about things if for no other reason than the psychological. Even if it amounts to the same thing, getting paid $1,000 less vs paying the broker a $1,000 fee seem to me to be in two totally different psychological dimensions.
Nonetheless, if the Cost-Cutting scenario above addresses the fourth of Nicolai Kolding’s Four Recommendations (“Generate a far higher output per square foot of office space”), let us address the other three.
Increase ABCR
First up is “Increase Average Broker Commission Rate by constantly updating and improving the value proposition to consumers”.
If you take the second spreadsheet (the “Bad Scenario”) and increase the Commission Rate to 3% per side from 2.5% per side, Simulacra’s losses widen to $2.43M from $2.0M. Part of it is that expenses are tied to GCI as a % of GCI, and increasing ABCR merely increases GCI. Perhaps the real model is to hold expenses steady, rather than as a % of GCI. Doing it that way for Simulacra, what I find is that to increase GCI to a point of break-even — while holding expenses steady at $6.75M — the ABCR has to increase to 3.6% per side: an astronomical 7.2% commission rate for the buyer/seller.
In an environment where consumers think realtors already don’t deserve their 5% (the 6% commission is a historical artifact I think by this point) for the work they do, I can’t imagine a brokerage being able to charge 7.2% in commissions. If anything, rational projections would think that ABCR is headed towards 2% per side.
Increase Productivity
Second up is “Increase average agent productivity”. This one is a bit more challenging to analyze, because the “average agent productivity” is generated by the activity of all of the agents, and which group does more deals impacts revenues.
Simulacra boasts an average agent productivity of 7.2 sides per agent, with Tier 1 agents doing 35 transactions, Tier 2 agents doing 12 transactions, Tier 3 agents doing 3, and Tier 4 agents doing 1 transaction every year. What’s a reasonable increase in productivity? 25%?
Increasing productivity (defined as transactions/agent) by 25% across all four tiers, while holding expenses steady (rather than as % of GCI) results in losing $843K instead of $2M.
So it’s an improvement, but hardly a solution unless there’s some sort of reason to expect that agent productivity would increase dramatically through the application of hitherto unknown techniques. 200% or 300% increases in productivity are irrational to assume absent some sort of major technology change — which requires investment in said major technology, of course.
Increase Percent Retained
The third (and final for us, since we covered the Office Space one above) recommendation is to increase percent of GCI retained through brokerage-generated business. I have heard that brokers often charge between 20 – 30% of the GCI if the lead is originated by the broker (e.g., through the broker website).
Let’s think through how such a scheme would work. Presumably, it would be entirely concentrated on buy-side, since I’m not sure what a “brokerage generated listing” looks like under the traditional model where agents are encouraged to work their individual sphere of influence to get listings.
One of the prevailing wisdoms is that the higher-tier, more productive agents, derive more of their business from listings than they do from buyers. Indeed, the trend towards Agent Teams is the result of the main rainmaker agent wanting to focus on the listings business and hiring a number of buyer agents under him to work with buyers. For our Simulacra model, then we have to assume that the brokerage-generated business will be focused disproportionately on the lower tiers.
For our purposes, then, I’m going to exempt Tier 1 agents entirely from a ‘brokerage-generated business’ deal — they’re busy enough and won’t want to pay the internal referral fee that the broker will charge. So for Simulacra, of the 3600 total sides, 1750 sides simply won’t be affected. That leaves 1850 sides from the Tier 2 – 4 agents. Some % of that 1850 will be listings business, especially from the competent Tier 2 agents. So let’s assume that 50% of Tier 2, 25% of tier 3, and 10% of Tier 4 transactions will be listings. The pool of buyer transactions, then, is (1200 * .5 = 600) + (450 * .75 = 338) + (200 * .9 = 180) = 1,118.
Let us now assume that the brokerage, through increasing its efforts, will drive a large percentage of leads, resulting in some significant percentage of these 1,118 buyer transactions to be “brokerage-generated”. Say that number is 30% — the remaining 70% will come from agent websites, Zillow, etc. — and that Simulacra will collect an additional 25% referral fee from those transactions.
The end result is an additional $628,125 in company dollar, as those referral fees kick in on 335 transactions. That moves the company dollar percentage from 17.5% to 20%. The net of all that is, rather than losing $2m per year, Simulacra will only lose $1.4M.
The Combo
Perhaps the answer is to combine all four approaches, as Nicolai would probably recommend: reduce expenses, increase/maintain ABCR, increase productivity, and increase percent retained through referrals. So let’s combine all four things:
Reduce Occupancy by 50%, Salary by 25%, G/A by 50%
Maintain ABCR at 2.5% per side
Increase agent productivity by 25%
30% of buyer transactions are broker-generated, with 25% referral fee
The net result of all four things is $33.75M in GCI, 20% retained for Company Dollar of $6,626,250 vs. Expenses of $5,906,250 for a net profit of $720K or 2.1% profit margin.
Considering that Bank of America is offering a CD at a fixed rate of 2.50%… I’m not sure that 2.1% profit margins are the future of the industry.
Reducing the Cost of Revenue
What does this button do?
As I see it, if the analysis is not enormously flawed, any new model that will rescue the brokerage industry from its current morass will need to address the single biggest expense item: Cost of Revenue. This is a tricky proposition, of course, since commission splits are being forced upwards, not downwards today — and since those are variable, dependent costs. Until there’s a transaction, the broker has no expense — even if giving away 90% of the revenues to the agent, at least he’s not sinking in money in the absence of revenues.
At the same time, however, the numbers strongly suggest that the single biggest contributor to financial success or failure is the split percentage. At 80% as the top split, Simulacra was making money, even loaded down with huge expenses; at 90% as the top split, Simulacra has to do all kinds of things, make all sorts of changes, in order to make less money (2.1% profit margin vs. 2.5% profit margin). The implication then is that whatever model the future has in store must somehow figure a way to recruit, retain, and make productive agents at lower splits.
Take the original 80% as top split model for Simulacra; if I do nothing else but move my Tier 1 Agents from an 80% split to a 75% split, I double my profits from $675K to $1.33M. Put everyone on 60% splits and Simulacra is now pumping out $4M in profits, a 15% margin — which is more than enough extra money to double the marketing spend and increase Salary by 50% (e.g., add support headcount), and still net more money than the old model.
In a sense, this is truly obvious; it’s so obvious that it oughta be an uninteresting truism. If you keep more of what you make, then your profits are higher. Like, DUH! Yet, this is the sacred cow that can’t be touched in real estate brokerage today. All the talk, all the dancing around issues of value, independent contractor vs. employee, profit sharing, etc. etc. are all attempts not to address the central issue of agent splits.
If, as Nicolai suggested in his original post, the status quo cannot hold… then I dare say that whatever replaces the status quo will be one where the brokerage is able to reduce the cost of revenue: the agent split. In upcoming parts, I hope to examine a couple of those models to see how they work out numerically.
As always, criticism, comments, error correction, and reasoned debate are welcome.
Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.
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29 thoughts on “Brokerage Models – A Mathematical Analysis, Part 1”
Rob,
Pure genius on your analysis of the status quo and why there is no one simple way to return to a “profit model”. From a guy outside looking in your pretty much right on.
The question has always been what will the large brokerages do to convince their top quartile agents to accept manageable splits without loosing them? Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?
For all the risk and expense, most would be best to open that CD at Bank of American, rather than try to build and maintain a big footprint.
I know you think that big brokerage is the future, I think that small brokerages have the edge in these times.
I didn’t see any analysis or comments on the franchise fee that most large brokers charge, typically 5 to 7% of gross commission income (GCI). These are “pass through” fees for the Brokerage, but a big consideration when top agents are considering a move to an independent or own brokerage.
Any thoughts?
Rob,
Pure genius on your analysis of the status quo and why there is no one simple way to return to a “profit model”. From a guy outside looking in your pretty much right on.
The question has always been what will the large brokerages do to convince their top quartile agents to accept manageable splits without loosing them? Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?
For all the risk and expense, most would be best to open that CD at Bank of American, rather than try to build and maintain a big footprint.
I know you think that big brokerage is the future, I think that small brokerages have the edge in these times.
I didn’t see any analysis or comments on the franchise fee that most large brokers charge, typically 5 to 7% of gross commission income (GCI). These are “pass through” fees for the Brokerage, but a big consideration when top agents are considering a move to an independent or own brokerage.
Any thoughts?
Thanks Jeff –
I hadn’t thought about the franchise fee issue, as that would be charged whether small or large. In fact, I rather think that the larger brokers probably are NOT franchised based on the various Top 500 Brokerage reports. E.g., Long & Foster, Weichert, etc. are independents.
As to the main question — what could brokerages do to retain their top agents at a reasonable split — I think it’s a slightly wrong question to ask. As I hope to explore in Part 2 and beyond, the issue, as I see it, is that the whole concept of a “top agent” has to change in order for comp structure to change.
I don’t mean to be mysterious, but I wanted to run the numbers first.
-rsh
Thanks Jeff –
I hadn’t thought about the franchise fee issue, as that would be charged whether small or large. In fact, I rather think that the larger brokers probably are NOT franchised based on the various Top 500 Brokerage reports. E.g., Long & Foster, Weichert, etc. are independents.
As to the main question — what could brokerages do to retain their top agents at a reasonable split — I think it’s a slightly wrong question to ask. As I hope to explore in Part 2 and beyond, the issue, as I see it, is that the whole concept of a “top agent” has to change in order for comp structure to change.
I don’t mean to be mysterious, but I wanted to run the numbers first.
-rsh
Rob – Fair enough, I will look forward to part 2.
Rob – Fair enough, I will look forward to part 2.
Thought provoking post.
I believe it is possible that going forward the “super teams” may have difficulty negotiating the same splits they currently enjoy.
Could we be heading for a scenario where teams need to stand independent as their own brokerage instead of the “business within a business” model we see today?
Thought provoking post.
I believe it is possible that going forward the “super teams” may have difficulty negotiating the same splits they currently enjoy.
Could we be heading for a scenario where teams need to stand independent as their own brokerage instead of the “business within a business” model we see today?
Well that’s really what is happening now, isn’t it? Teams are a brokerage under an umbrella. They ought to take the leap and get the license and go.
I realized quite some time ago that as a producing agent it is useless to work under a broker unless the broker is providing value and helping me increase my business. If they’re not, then why are you paying for the privilege to work?
When you look at the “traditional” business model of real estate brokerage, it’s obvious that you have to have multiple profit centers and/or lower splits to stay in the black. With today’s climate of 100% offices, it will be near-impossible to retain experienced agents for any length of time.
The salaried agent seems to be the way to go for both the brokerage as well as the client … The brokerage has fixed costs and the client doesn’t have to fear that they are being forced into more house than they need just because their agent is trying to pad their paycheck.
Of course, I don’t see that happening overnight, either.
– James
Well that’s really what is happening now, isn’t it? Teams are a brokerage under an umbrella. They ought to take the leap and get the license and go.
I realized quite some time ago that as a producing agent it is useless to work under a broker unless the broker is providing value and helping me increase my business. If they’re not, then why are you paying for the privilege to work?
When you look at the “traditional” business model of real estate brokerage, it’s obvious that you have to have multiple profit centers and/or lower splits to stay in the black. With today’s climate of 100% offices, it will be near-impossible to retain experienced agents for any length of time.
The salaried agent seems to be the way to go for both the brokerage as well as the client … The brokerage has fixed costs and the client doesn’t have to fear that they are being forced into more house than they need just because their agent is trying to pad their paycheck.
Of course, I don’t see that happening overnight, either.
– James
Hey Rob,
I’m a little biased here and can only speak from a tier 1 team leader’s persepctive.
First to answer Jeff’s question “Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?” At KW, buyer agents on teams pay 1/2 cap, and most buyer agents aren’t the lead generators or listers so that’s actually the opposite of what you’re saying. This is revenue the company wouldnt have without the team. Not sure how it works at other companies.
Also, Rob I think with what you’re proposing, these companies will lose the top tier agents since in order to be a top tier agent you have to be a lead generator so the value proposition isnt there for these agents. This is where an independent or KW model works well. And tier 1 agents are strong listers, but they dont necessarily derive more of their business from listings than the buyer side if its done properly. Listings generate buyer leads and if you have the right buyer agents,good leadership, and the right crm system, it should be 2/3 buyer side sales.
An idea from the MREA budget model, http://video.google.com/videosearch?source=ig&hl=en&rlz=1R2RNWN_en&q=mrea%20budget%20model&um=1&ie=UTF-8&sa=N&tab=wv# is to hire showing agents hourly before they can become a full buyer specialist or in the case of the brokerage, a full agent. This really saves alot of money in not having to pay splits, and there are alot of agents out there who dont want to work the hours requred to be successful, so they are thrilled to work hourly.
Regarding increasing production, the systems and technology are just a part of it. Its scripts, education, mentoring, accountability, time blocking and commitment to meeting the goals that will increase the productivity. As we all know, systems are only as good as the agents who use them.
Great post Rob!
Hey Rob,
I’m a little biased here and can only speak from a tier 1 team leader’s persepctive.
First to answer Jeff’s question “Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?” At KW, buyer agents on teams pay 1/2 cap, and most buyer agents aren’t the lead generators or listers so that’s actually the opposite of what you’re saying. This is revenue the company wouldnt have without the team. Not sure how it works at other companies.
Also, Rob I think with what you’re proposing, these companies will lose the top tier agents since in order to be a top tier agent you have to be a lead generator so the value proposition isnt there for these agents. This is where an independent or KW model works well. And tier 1 agents are strong listers, but they dont necessarily derive more of their business from listings than the buyer side if its done properly. Listings generate buyer leads and if you have the right buyer agents,good leadership, and the right crm system, it should be 2/3 buyer side sales.
An idea from the MREA budget model, http://video.google.com/videosearch?source=ig&hl=en&rlz=1R2RNWN_en&q=mrea%20budget%20model&um=1&ie=UTF-8&sa=N&tab=wv# is to hire showing agents hourly before they can become a full buyer specialist or in the case of the brokerage, a full agent. This really saves alot of money in not having to pay splits, and there are alot of agents out there who dont want to work the hours requred to be successful, so they are thrilled to work hourly.
Regarding increasing production, the systems and technology are just a part of it. Its scripts, education, mentoring, accountability, time blocking and commitment to meeting the goals that will increase the productivity. As we all know, systems are only as good as the agents who use them.
Great post Rob!
Sue, your post makes sense. I don’t think major brokerages have much chance to save the top producers unless they adopt a flat rate or capped fee split. Of course they could choose to do this at a drop of the hat.
One way to compete with the logic of the top producer leaving to start their own Company. If attractive enough would keep many from the extra effort and expense of going on their own.
And Rob, I think the Franchise fee consideration is around more than you think for many. And let us not forget the Redfin model.
Sue, your post makes sense. I don’t think major brokerages have much chance to save the top producers unless they adopt a flat rate or capped fee split. Of course they could choose to do this at a drop of the hat.
One way to compete with the logic of the top producer leaving to start their own Company. If attractive enough would keep many from the extra effort and expense of going on their own.
And Rob, I think the Franchise fee consideration is around more than you think for many. And let us not forget the Redfin model.
More to chew on. Thanks.
More to chew on. Thanks.
I promise I’ll put more thought into a response before too long but can’t at the moment – a few quick observations, though:
-first, kudos for tackling a model. I do NOT believe it is fundamentally flawed so the conclusions can therefore stand up and face reasoned debate on their own merits.
-this is a BIG firm in your example. Would be a Real Trends Top 100. FYI – if you want to shoot for middle of RT500 pack, then it would have to be about 1/3 this size.
-I certainly believe that all 4 strategies should be pursued (and then some) rather than going hard after any one. I believe the broker needs incremental changes in several areas.
-I disagree with one aspect of your profit improvement assumptions (or deterioration as was the case with ABCR change): your operating expenses continued to float with the GCI change. I think for a before/after analysis, you need to keep fixed your occupancy, salary, and probably G&A (as your spreadsheet states, you should continue to float marketing as a percentage of revenues – though you could in theory get some economies of scale, let’s just let it float for simplicity sake). If we keep occupancy, salary, and G&A fixed, then the ABCR change (which is now properly isolated), for example, would improve profits by $675k instead of resulting in greater loss. This is a big difference in results.
-a lot of operators will tell you that the “increased productivity” strategy comes down to trying to get “1 more closed transaction” per year per person, particularly in 2nd, 3rd, and 4th quartiles. If we follow that and skip the top quartile, it actually gets us very close to the +25% you put in so I think that stands well.
-splits – as we know, this is VERY regional. Places like CA, WA, and CO, in particular, have very high splits. But brokers in New England, NYC, and (my favorite) Hawaii have much better percent retained, even those with high productivity per agent. Their cost profiles are different, though. So which levers brokers pull will be largely based on region (and I think this then speaks to how the long-term viability of the “traditional” model will be regional, too). As you point out, nothing but nothing can move the needle like managing percent retained. I’ll try to write more on this later.
-for rent, I’ve been using national retail rates of about $20/sf. Assuming a goal of 50sf/agent, that would put our target total of 25,000 sf and $500k annual rent. When you add in other occupancy costs, the total should be no more (maybe slightly less) than your $675k target.
Sorry – I know my comments are a bit disjointed but wanted to get something out and hope it’s not complete nonsense.
I promise I’ll put more thought into a response before too long but can’t at the moment – a few quick observations, though:
-first, kudos for tackling a model. I do NOT believe it is fundamentally flawed so the conclusions can therefore stand up and face reasoned debate on their own merits.
-this is a BIG firm in your example. Would be a Real Trends Top 100. FYI – if you want to shoot for middle of RT500 pack, then it would have to be about 1/3 this size.
-I certainly believe that all 4 strategies should be pursued (and then some) rather than going hard after any one. I believe the broker needs incremental changes in several areas.
-I disagree with one aspect of your profit improvement assumptions (or deterioration as was the case with ABCR change): your operating expenses continued to float with the GCI change. I think for a before/after analysis, you need to keep fixed your occupancy, salary, and probably G&A (as your spreadsheet states, you should continue to float marketing as a percentage of revenues – though you could in theory get some economies of scale, let’s just let it float for simplicity sake). If we keep occupancy, salary, and G&A fixed, then the ABCR change (which is now properly isolated), for example, would improve profits by $675k instead of resulting in greater loss. This is a big difference in results.
-a lot of operators will tell you that the “increased productivity” strategy comes down to trying to get “1 more closed transaction” per year per person, particularly in 2nd, 3rd, and 4th quartiles. If we follow that and skip the top quartile, it actually gets us very close to the +25% you put in so I think that stands well.
-splits – as we know, this is VERY regional. Places like CA, WA, and CO, in particular, have very high splits. But brokers in New England, NYC, and (my favorite) Hawaii have much better percent retained, even those with high productivity per agent. Their cost profiles are different, though. So which levers brokers pull will be largely based on region (and I think this then speaks to how the long-term viability of the “traditional” model will be regional, too). As you point out, nothing but nothing can move the needle like managing percent retained. I’ll try to write more on this later.
-for rent, I’ve been using national retail rates of about $20/sf. Assuming a goal of 50sf/agent, that would put our target total of 25,000 sf and $500k annual rent. When you add in other occupancy costs, the total should be no more (maybe slightly less) than your $675k target.
Sorry – I know my comments are a bit disjointed but wanted to get something out and hope it’s not complete nonsense.
Nicolai, Its probably true that CA, WA, and CO all are way ahead of the east coast in real estate company trends. The east coast has always been the slowest to change. A model like KW is still considered new here in NJ, and is just now taking off, so the traditional offices havent had to compete w/ the Re/Max’s and KW’s for agents like they did in the midwest and western states. However, that is now changing as more and more agents are attracted to this model and leaving their traditional offices.
I think you’re right about working on the one more transaction per agent per year because that entails training and that’s the value proposition for the agents where many traditional offices seem to fall short, but on the other hand, I’d be really happy if this new traditional model reduces commission splits because it will really help our recruiting at KW 🙂
Nicolai, Its probably true that CA, WA, and CO all are way ahead of the east coast in real estate company trends. The east coast has always been the slowest to change. A model like KW is still considered new here in NJ, and is just now taking off, so the traditional offices havent had to compete w/ the Re/Max’s and KW’s for agents like they did in the midwest and western states. However, that is now changing as more and more agents are attracted to this model and leaving their traditional offices.
I think you’re right about working on the one more transaction per agent per year because that entails training and that’s the value proposition for the agents where many traditional offices seem to fall short, but on the other hand, I’d be really happy if this new traditional model reduces commission splits because it will really help our recruiting at KW 🙂
Great discussion but I would like to point out one danger of looking at profits as a % of GC (Gross Commicssions). While a good measure for comparing companies you can not compare profit earned as a percent of GC to savings rate. The average Broker does not have $27M just laying around to invest. Believe me, if they did they would not be in the brokerage business. Keep in mind that a smaller percentage of a bigger number can provide more profits.
Great discussion but I would like to point out one danger of looking at profits as a % of GC (Gross Commicssions). While a good measure for comparing companies you can not compare profit earned as a percent of GC to savings rate. The average Broker does not have $27M just laying around to invest. Believe me, if they did they would not be in the brokerage business. Keep in mind that a smaller percentage of a bigger number can provide more profits.
Hi John – thanks for the note. You’re right on that you can’t compare profitability of brokerage to yields on bonds. 🙂 But I don’t think that impacts whether profit should or should not be calculated as a % of GCI.
What’s really needed is some sort of data on actual expenses compiled from a big enough sample such that we don’t have to go with % of GCI or some such, but can go with actual average costs.
Sadly, that data is nearly impossible to come by… though I know a source *cough*.
-rsh
Hi John – thanks for the note. You’re right on that you can’t compare profitability of brokerage to yields on bonds. 🙂 But I don’t think that impacts whether profit should or should not be calculated as a % of GCI.
What’s really needed is some sort of data on actual expenses compiled from a big enough sample such that we don’t have to go with % of GCI or some such, but can go with actual average costs.
Sadly, that data is nearly impossible to come by… though I know a source *cough*.
-rsh
Great article Rob and very thought proviking. My broker charges a transaction/admin fee of $355 for each side of a file. If my math is correct, based on 3,600 transactions, that is an additional $1.3M to the bottom line. Is that included in your analysis? I apologize upfront if that is something I missed.
No — I didn’t include transaction/admin fees in the model; the next version probably will have to take that into account.
Anyone playing with the spreadsheet can add such fees in of course to see the impact. 🙂
-rsh
Great article Rob and very thought proviking. My broker charges a transaction/admin fee of $355 for each side of a file. If my math is correct, based on 3,600 transactions, that is an additional $1.3M to the bottom line. Is that included in your analysis? I apologize upfront if that is something I missed.
No — I didn’t include transaction/admin fees in the model; the next version probably will have to take that into account.
Anyone playing with the spreadsheet can add such fees in of course to see the impact. 🙂
29 thoughts on “Brokerage Models – A Mathematical Analysis, Part 1”
Rob,
Pure genius on your analysis of the status quo and why there is no one simple way to return to a “profit model”. From a guy outside looking in your pretty much right on.
The question has always been what will the large brokerages do to convince their top quartile agents to accept manageable splits without loosing them? Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?
For all the risk and expense, most would be best to open that CD at Bank of American, rather than try to build and maintain a big footprint.
I know you think that big brokerage is the future, I think that small brokerages have the edge in these times.
I didn’t see any analysis or comments on the franchise fee that most large brokers charge, typically 5 to 7% of gross commission income (GCI). These are “pass through” fees for the Brokerage, but a big consideration when top agents are considering a move to an independent or own brokerage.
Any thoughts?
Rob,
Pure genius on your analysis of the status quo and why there is no one simple way to return to a “profit model”. From a guy outside looking in your pretty much right on.
The question has always been what will the large brokerages do to convince their top quartile agents to accept manageable splits without loosing them? Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?
For all the risk and expense, most would be best to open that CD at Bank of American, rather than try to build and maintain a big footprint.
I know you think that big brokerage is the future, I think that small brokerages have the edge in these times.
I didn’t see any analysis or comments on the franchise fee that most large brokers charge, typically 5 to 7% of gross commission income (GCI). These are “pass through” fees for the Brokerage, but a big consideration when top agents are considering a move to an independent or own brokerage.
Any thoughts?
Thanks Jeff –
I hadn’t thought about the franchise fee issue, as that would be charged whether small or large. In fact, I rather think that the larger brokers probably are NOT franchised based on the various Top 500 Brokerage reports. E.g., Long & Foster, Weichert, etc. are independents.
As to the main question — what could brokerages do to retain their top agents at a reasonable split — I think it’s a slightly wrong question to ask. As I hope to explore in Part 2 and beyond, the issue, as I see it, is that the whole concept of a “top agent” has to change in order for comp structure to change.
I don’t mean to be mysterious, but I wanted to run the numbers first.
-rsh
Thanks Jeff –
I hadn’t thought about the franchise fee issue, as that would be charged whether small or large. In fact, I rather think that the larger brokers probably are NOT franchised based on the various Top 500 Brokerage reports. E.g., Long & Foster, Weichert, etc. are independents.
As to the main question — what could brokerages do to retain their top agents at a reasonable split — I think it’s a slightly wrong question to ask. As I hope to explore in Part 2 and beyond, the issue, as I see it, is that the whole concept of a “top agent” has to change in order for comp structure to change.
I don’t mean to be mysterious, but I wanted to run the numbers first.
-rsh
Rob – Fair enough, I will look forward to part 2.
Rob – Fair enough, I will look forward to part 2.
Thought provoking post.
I believe it is possible that going forward the “super teams” may have difficulty negotiating the same splits they currently enjoy.
Could we be heading for a scenario where teams need to stand independent as their own brokerage instead of the “business within a business” model we see today?
Thought provoking post.
I believe it is possible that going forward the “super teams” may have difficulty negotiating the same splits they currently enjoy.
Could we be heading for a scenario where teams need to stand independent as their own brokerage instead of the “business within a business” model we see today?
Well that’s really what is happening now, isn’t it? Teams are a brokerage under an umbrella. They ought to take the leap and get the license and go.
I realized quite some time ago that as a producing agent it is useless to work under a broker unless the broker is providing value and helping me increase my business. If they’re not, then why are you paying for the privilege to work?
When you look at the “traditional” business model of real estate brokerage, it’s obvious that you have to have multiple profit centers and/or lower splits to stay in the black. With today’s climate of 100% offices, it will be near-impossible to retain experienced agents for any length of time.
The salaried agent seems to be the way to go for both the brokerage as well as the client … The brokerage has fixed costs and the client doesn’t have to fear that they are being forced into more house than they need just because their agent is trying to pad their paycheck.
Of course, I don’t see that happening overnight, either.
– James
Well that’s really what is happening now, isn’t it? Teams are a brokerage under an umbrella. They ought to take the leap and get the license and go.
I realized quite some time ago that as a producing agent it is useless to work under a broker unless the broker is providing value and helping me increase my business. If they’re not, then why are you paying for the privilege to work?
When you look at the “traditional” business model of real estate brokerage, it’s obvious that you have to have multiple profit centers and/or lower splits to stay in the black. With today’s climate of 100% offices, it will be near-impossible to retain experienced agents for any length of time.
The salaried agent seems to be the way to go for both the brokerage as well as the client … The brokerage has fixed costs and the client doesn’t have to fear that they are being forced into more house than they need just because their agent is trying to pad their paycheck.
Of course, I don’t see that happening overnight, either.
– James
Hey Rob,
I’m a little biased here and can only speak from a tier 1 team leader’s persepctive.
First to answer Jeff’s question “Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?” At KW, buyer agents on teams pay 1/2 cap, and most buyer agents aren’t the lead generators or listers so that’s actually the opposite of what you’re saying. This is revenue the company wouldnt have without the team. Not sure how it works at other companies.
Also, Rob I think with what you’re proposing, these companies will lose the top tier agents since in order to be a top tier agent you have to be a lead generator so the value proposition isnt there for these agents. This is where an independent or KW model works well. And tier 1 agents are strong listers, but they dont necessarily derive more of their business from listings than the buyer side if its done properly. Listings generate buyer leads and if you have the right buyer agents,good leadership, and the right crm system, it should be 2/3 buyer side sales.
An idea from the MREA budget model, http://video.google.com/videosearch?source=ig&hl=en&rlz=1R2RNWN_en&q=mrea%20budget%20model&um=1&ie=UTF-8&sa=N&tab=wv# is to hire showing agents hourly before they can become a full buyer specialist or in the case of the brokerage, a full agent. This really saves alot of money in not having to pay splits, and there are alot of agents out there who dont want to work the hours requred to be successful, so they are thrilled to work hourly.
Regarding increasing production, the systems and technology are just a part of it. Its scripts, education, mentoring, accountability, time blocking and commitment to meeting the goals that will increase the productivity. As we all know, systems are only as good as the agents who use them.
Great post Rob!
Hey Rob,
I’m a little biased here and can only speak from a tier 1 team leader’s persepctive.
First to answer Jeff’s question “Will this be the end to the Team, with the lead agent benefiting from the “associate agents” production, while the company looses?” At KW, buyer agents on teams pay 1/2 cap, and most buyer agents aren’t the lead generators or listers so that’s actually the opposite of what you’re saying. This is revenue the company wouldnt have without the team. Not sure how it works at other companies.
Also, Rob I think with what you’re proposing, these companies will lose the top tier agents since in order to be a top tier agent you have to be a lead generator so the value proposition isnt there for these agents. This is where an independent or KW model works well. And tier 1 agents are strong listers, but they dont necessarily derive more of their business from listings than the buyer side if its done properly. Listings generate buyer leads and if you have the right buyer agents,good leadership, and the right crm system, it should be 2/3 buyer side sales.
An idea from the MREA budget model, http://video.google.com/videosearch?source=ig&hl=en&rlz=1R2RNWN_en&q=mrea%20budget%20model&um=1&ie=UTF-8&sa=N&tab=wv# is to hire showing agents hourly before they can become a full buyer specialist or in the case of the brokerage, a full agent. This really saves alot of money in not having to pay splits, and there are alot of agents out there who dont want to work the hours requred to be successful, so they are thrilled to work hourly.
Regarding increasing production, the systems and technology are just a part of it. Its scripts, education, mentoring, accountability, time blocking and commitment to meeting the goals that will increase the productivity. As we all know, systems are only as good as the agents who use them.
Great post Rob!
Sue, your post makes sense. I don’t think major brokerages have much chance to save the top producers unless they adopt a flat rate or capped fee split. Of course they could choose to do this at a drop of the hat.
One way to compete with the logic of the top producer leaving to start their own Company. If attractive enough would keep many from the extra effort and expense of going on their own.
And Rob, I think the Franchise fee consideration is around more than you think for many. And let us not forget the Redfin model.
Sue, your post makes sense. I don’t think major brokerages have much chance to save the top producers unless they adopt a flat rate or capped fee split. Of course they could choose to do this at a drop of the hat.
One way to compete with the logic of the top producer leaving to start their own Company. If attractive enough would keep many from the extra effort and expense of going on their own.
And Rob, I think the Franchise fee consideration is around more than you think for many. And let us not forget the Redfin model.
More to chew on. Thanks.
More to chew on. Thanks.
I promise I’ll put more thought into a response before too long but can’t at the moment – a few quick observations, though:
-first, kudos for tackling a model. I do NOT believe it is fundamentally flawed so the conclusions can therefore stand up and face reasoned debate on their own merits.
-this is a BIG firm in your example. Would be a Real Trends Top 100. FYI – if you want to shoot for middle of RT500 pack, then it would have to be about 1/3 this size.
-I certainly believe that all 4 strategies should be pursued (and then some) rather than going hard after any one. I believe the broker needs incremental changes in several areas.
-I disagree with one aspect of your profit improvement assumptions (or deterioration as was the case with ABCR change): your operating expenses continued to float with the GCI change. I think for a before/after analysis, you need to keep fixed your occupancy, salary, and probably G&A (as your spreadsheet states, you should continue to float marketing as a percentage of revenues – though you could in theory get some economies of scale, let’s just let it float for simplicity sake). If we keep occupancy, salary, and G&A fixed, then the ABCR change (which is now properly isolated), for example, would improve profits by $675k instead of resulting in greater loss. This is a big difference in results.
-a lot of operators will tell you that the “increased productivity” strategy comes down to trying to get “1 more closed transaction” per year per person, particularly in 2nd, 3rd, and 4th quartiles. If we follow that and skip the top quartile, it actually gets us very close to the +25% you put in so I think that stands well.
-splits – as we know, this is VERY regional. Places like CA, WA, and CO, in particular, have very high splits. But brokers in New England, NYC, and (my favorite) Hawaii have much better percent retained, even those with high productivity per agent. Their cost profiles are different, though. So which levers brokers pull will be largely based on region (and I think this then speaks to how the long-term viability of the “traditional” model will be regional, too). As you point out, nothing but nothing can move the needle like managing percent retained. I’ll try to write more on this later.
-for rent, I’ve been using national retail rates of about $20/sf. Assuming a goal of 50sf/agent, that would put our target total of 25,000 sf and $500k annual rent. When you add in other occupancy costs, the total should be no more (maybe slightly less) than your $675k target.
Sorry – I know my comments are a bit disjointed but wanted to get something out and hope it’s not complete nonsense.
I promise I’ll put more thought into a response before too long but can’t at the moment – a few quick observations, though:
-first, kudos for tackling a model. I do NOT believe it is fundamentally flawed so the conclusions can therefore stand up and face reasoned debate on their own merits.
-this is a BIG firm in your example. Would be a Real Trends Top 100. FYI – if you want to shoot for middle of RT500 pack, then it would have to be about 1/3 this size.
-I certainly believe that all 4 strategies should be pursued (and then some) rather than going hard after any one. I believe the broker needs incremental changes in several areas.
-I disagree with one aspect of your profit improvement assumptions (or deterioration as was the case with ABCR change): your operating expenses continued to float with the GCI change. I think for a before/after analysis, you need to keep fixed your occupancy, salary, and probably G&A (as your spreadsheet states, you should continue to float marketing as a percentage of revenues – though you could in theory get some economies of scale, let’s just let it float for simplicity sake). If we keep occupancy, salary, and G&A fixed, then the ABCR change (which is now properly isolated), for example, would improve profits by $675k instead of resulting in greater loss. This is a big difference in results.
-a lot of operators will tell you that the “increased productivity” strategy comes down to trying to get “1 more closed transaction” per year per person, particularly in 2nd, 3rd, and 4th quartiles. If we follow that and skip the top quartile, it actually gets us very close to the +25% you put in so I think that stands well.
-splits – as we know, this is VERY regional. Places like CA, WA, and CO, in particular, have very high splits. But brokers in New England, NYC, and (my favorite) Hawaii have much better percent retained, even those with high productivity per agent. Their cost profiles are different, though. So which levers brokers pull will be largely based on region (and I think this then speaks to how the long-term viability of the “traditional” model will be regional, too). As you point out, nothing but nothing can move the needle like managing percent retained. I’ll try to write more on this later.
-for rent, I’ve been using national retail rates of about $20/sf. Assuming a goal of 50sf/agent, that would put our target total of 25,000 sf and $500k annual rent. When you add in other occupancy costs, the total should be no more (maybe slightly less) than your $675k target.
Sorry – I know my comments are a bit disjointed but wanted to get something out and hope it’s not complete nonsense.
Nicolai, Its probably true that CA, WA, and CO all are way ahead of the east coast in real estate company trends. The east coast has always been the slowest to change. A model like KW is still considered new here in NJ, and is just now taking off, so the traditional offices havent had to compete w/ the Re/Max’s and KW’s for agents like they did in the midwest and western states. However, that is now changing as more and more agents are attracted to this model and leaving their traditional offices.
I think you’re right about working on the one more transaction per agent per year because that entails training and that’s the value proposition for the agents where many traditional offices seem to fall short, but on the other hand, I’d be really happy if this new traditional model reduces commission splits because it will really help our recruiting at KW 🙂
Nicolai, Its probably true that CA, WA, and CO all are way ahead of the east coast in real estate company trends. The east coast has always been the slowest to change. A model like KW is still considered new here in NJ, and is just now taking off, so the traditional offices havent had to compete w/ the Re/Max’s and KW’s for agents like they did in the midwest and western states. However, that is now changing as more and more agents are attracted to this model and leaving their traditional offices.
I think you’re right about working on the one more transaction per agent per year because that entails training and that’s the value proposition for the agents where many traditional offices seem to fall short, but on the other hand, I’d be really happy if this new traditional model reduces commission splits because it will really help our recruiting at KW 🙂
Great discussion but I would like to point out one danger of looking at profits as a % of GC (Gross Commicssions). While a good measure for comparing companies you can not compare profit earned as a percent of GC to savings rate. The average Broker does not have $27M just laying around to invest. Believe me, if they did they would not be in the brokerage business. Keep in mind that a smaller percentage of a bigger number can provide more profits.
Great discussion but I would like to point out one danger of looking at profits as a % of GC (Gross Commicssions). While a good measure for comparing companies you can not compare profit earned as a percent of GC to savings rate. The average Broker does not have $27M just laying around to invest. Believe me, if they did they would not be in the brokerage business. Keep in mind that a smaller percentage of a bigger number can provide more profits.
Hi John – thanks for the note. You’re right on that you can’t compare profitability of brokerage to yields on bonds. 🙂 But I don’t think that impacts whether profit should or should not be calculated as a % of GCI.
What’s really needed is some sort of data on actual expenses compiled from a big enough sample such that we don’t have to go with % of GCI or some such, but can go with actual average costs.
Sadly, that data is nearly impossible to come by… though I know a source *cough*.
-rsh
Hi John – thanks for the note. You’re right on that you can’t compare profitability of brokerage to yields on bonds. 🙂 But I don’t think that impacts whether profit should or should not be calculated as a % of GCI.
What’s really needed is some sort of data on actual expenses compiled from a big enough sample such that we don’t have to go with % of GCI or some such, but can go with actual average costs.
Sadly, that data is nearly impossible to come by… though I know a source *cough*.
-rsh
Great article Rob and very thought proviking. My broker charges a transaction/admin fee of $355 for each side of a file. If my math is correct, based on 3,600 transactions, that is an additional $1.3M to the bottom line. Is that included in your analysis? I apologize upfront if that is something I missed.
No — I didn’t include transaction/admin fees in the model; the next version probably will have to take that into account.
Anyone playing with the spreadsheet can add such fees in of course to see the impact. 🙂
-rsh
Great article Rob and very thought proviking. My broker charges a transaction/admin fee of $355 for each side of a file. If my math is correct, based on 3,600 transactions, that is an additional $1.3M to the bottom line. Is that included in your analysis? I apologize upfront if that is something I missed.
No — I didn’t include transaction/admin fees in the model; the next version probably will have to take that into account.
Anyone playing with the spreadsheet can add such fees in of course to see the impact. 🙂
-rsh
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