The Upside of Doom: Price Signals

I often get accused of being a doom-monger. It’s probably because I kind of am. I mean, I find doomporn fascinating (and clearly, I’m not alone given the popularity of websites like Zerohedge) and I do like to think about — and talk about — what larger trends could mean. I used to have little events called Lunch With a Side of Doom for cryin’ out loud. So I get it.

But I don’t do the predictions of doom just to scare people; I do it because my job as a strategy consultant often means I have to think about how to either (a) avoid the doom, or (b) adjust to the doom. I prefer (b) in the sense of antifragile: withstand disruption, and get better because of it.

I thought I might engage in a bit of the latter in this post, and possibly future posts. It isn’t all doom and gloom. There is an upside, a silver lining to every cloud, and if you’re antifragile or willing to become antifragile, the silver lining is often a big improvement over the status quo.

So this is me hope-mongering. Of course, depending on who you are and what your position is, it might not seem like a lot of hope… but I can’t help that. There wasn’t a whole lot of hope-mongering for buggy whip manufacturers when the automobile came about, but for the rest of us, cars > horse-drawn carts in most respects.

The Disruption: Compensation Go Bye-Bye

The most obvious Sword of Damocles that hangs over the real estate industry today is the end of cooperating compensation — the practice of having sellers pay the buyer agent’s fees via sharing of commissions.

I’ve written about it a ton, including detailed looks at lawsuits, legal motions, the FTC, etc. etc. so I won’t dwell on that here. And you’re starting to see all kinds of brokers and agents and folks on social media wringing their hands about the coming disruption.

According to conventional wisdom, eliminating cooperating compensation is all bad, no good. It will harm consumers who won’t have buyer representation, it will harm the MLS, which will harm sellers, etc. etc.

It is unclear exactly what the negatives of eliminating cooperating compensation will be. We can guess, and I’ve done that, but we won’t know until it happens.

But what is the upside of the disruption?

Price Signals

I’m working my way through an economic treatise (Man, Economy and State if you’re curious) and I ran across a concept that I knew from earlier: the importance of price signals.

Well, the Federal Reserve Bank of St. Louis has an interesting podcast on price signals, which you should listen to. The key section is this:

In a market-based economic system like our own, the market, and not the government, would determine the price of gasoline and the quantity produced and consumed after a natural disaster. Price signals communicate in such a way that prevents massive shortages and surpluses and ensures that consumer wants are largely satisfied. The actual price of the good or service—in this case gasoline—provides an incentive to buyers and sellers.

Because I’m a real estate geek, I immediately thought about how one of the major flaws of our current system is the lack of price signals for brokerage/representation services. I’ve often complained how the compensation structure we have is broken since the top local expert with 30 years of experience costs the same as the brand new agent with 1 week of experience. It also obscures different levels of service between one firm/team and another.

Well, restoring price signals to real estate brokerage services will make things mo betta.

Upside #1: Price Signals Improve Professionalism

The first is that by eliminating cooperating compensation, we restore price signals that tell consumers who are the true experts and who are the less experienced newcomers.

If buyers have to start paying their own agents, it may not necessarily be that we’ll see buyers choose to go unrepresented. After all, it depends on the cost of representation, no?

Perhaps a first-time homebuyer using a FHA loan won’t be able to pay $15K for buyer representation, but maybe they can afford $1,500.

An experienced local agent who really knows everything might not work for $1,500… but a new licensee who needs to build a client base and needs the experience very well might.

The important upside, however, is the information communicated to consumers by the hourly rate. An agent charging $750/hour can do so because her experience is worth it, and there are tons of consumers lined up willing to pay for that level of expertise. Perhaps they have a difficult situation and need a true expert to help, or perhaps they just have enough money to be able to afford the very best; either way, they know that an agent who charges that much is very likely to be a top-tier pro.

That in turn creates real incentives for newer agents, for part-timers, for the less experienced agents to become more professional, more experienced, build up a resume… so they can start charging more money as well.

Because in a free market, you can’t just charge whatever the hell you want; consumers have to be willing to pay your rate. Otherwise, sure, you can charge $750/hour… but if no one is willing to pay you that for what you’re bringing to the table… well, your income is precisely zero. You might want to cut your price some, until you find a market clearing price.

The impact is that varied pricing for professional services creates incentives for more professionalism, whether that’s more education, more training, more certification, or just more real world experience.

Upside #2: Better for Newer Agents, Too

But market-based pricing isn’t just good for the few top tier pros; it’s also good for less experienced agents and for newbies.

With our current system, buyers and sellers have no interest in working with an inexperienced part-timer. Why would they, when working with the #1 agent in the market costs them the same?

With a market-based system, consumers now have an incentive to work with less experienced agents on less complicated deals, because it will cost them less.

If you’re looking to purchase a $10 million working ranch with complicated zoning variances, environmental concerns, and the financing will be cross-border… well, you might want to hire that top tier agent who has seen it all and done cross-border financing deals. But if you’re just trying to buy a run-of-the-mill starter home in a subdivision, without much complexity, maybe you’re happy to save money working with a newer agent.

After we eliminate cooperating compensation, we might actually see more business flowing to the newer, less experienced agents because consumers who feel that they don’t need top-tier expertise are willing to work with less-than-top-tier agents for simpler transactions.

Upside #3: Better for Experts

That means the top experts in a given market will have a bit more breathing room. They won’t be overwhelmed by demand from buyers who really don’t need their knowledge or skills or expertise; they can focus on the complicated deals that actually require their knowledge and expertise.

If those top professionals have a team, they can leverage their less experienced team members to assist clients in most things, except for the truly complicated aspects of the transaction. That means a better lifestyle for the top experts, more interesting work for them, more income for the less experienced, and savings for consumers overall.

I don’t believe that the top experts would actually lose income due to this, since differential market-based pricing should mean that they can charge more per hour or more per unit of work, and potentially make more money overall with fewer hours worked, and work on more interesting stuff.

Upside #4: Better Education and Training

The above leads directly to improved education and training for all agents.

Remember that market-based pricing leads to incentives for less experienced agents to become more experienced, more educated, more expert agents… because they will make more money and charge higher rates.

Which means that instead of the constant drumbeat of “sell, sell, sell” and “leads, leads, leads” that passes for education and training in the industry today, we might actually start to see real education and training on topics as varied as construction methodology, real estate law & finance, local ordinances, local economic growth trends, etc. etc. Perhaps instead of bullshit “classes” like how to use TikTok to do lead-gen, we’d see classes on  how appraisals get done and how that impacts the transaction.

Brokerages can do more to mentor agents in the actual craft of client service, negotiation, product knowledge, and subject matter expertise instead of being the guy that agents call when contracts start blowing up because they didn’t know what the hell they were doing while writing them in the first place.

The end result is a higher quality of agents overall who are subject matter experts, able to really guide a family through an important purchase, not just lead-gen monkeys who are great at getting the representation agreement signed, but then don’t know how to actually do a deal.

Upside #5: A La Carte Services, Greater Certainty

This isn’t precisely about price signals, but having market-based pricing should more easily lead to brokers and agents being able to offer a la carte services, and having greater certainty of income.

It may be that a buyer doesn’t really need a ton of help, except with negotiation. Maybe they’re willing to hire the top expert in the market at a high hourly rate, but only have her help negotiate the deal: the highest value she will bring. The buyer might use some cheaper agent for the routine transaction management piece, but so what? Everybody is happy: the expert got paid for negotiating, the non-expert got paid for managing the transaction, the client got what he wanted at lower overall cost.

Plus, once we move into market-based pricing, we are far more likely to see hourly rates or project-based fees rather than the only-get-paid-on-close system we have today. Agents working with buyers in particular know the risks of spending weekend after weekend with a buyer, writing offer after offer, only to have the buyer change his mind and… they get paid zilch. A better system would be to have some mix of time-and-effort-based fees with incentives for successful closing, and moving away from the cooperating compensation model allows for that to happen.

I think there’s a lot of upside to everybody in that new system.

Not Just Doom And Gloom

I think there are other upsides to disruption, but let’s leave off here for now. I focused mostly on the upsides for agents and brokers in this part. I may look at what the upside of disruption might be for other entities in real estate in the future.

The point is that it’s not all bad news. Sure, disruption sucks for most people; I don’t quite know how disruption will impact my business as an advisor to real estate companies. But I think every crisis brings opportunity, every cloud has a silver lining, and there are upsides to doom.

Consider this: if SMOD should actually hit the earth, ending civilization and life as we know it, well… at least we won’t have to worry about vaccine passports. So there’s that upside.

On a much smaller scale doom-wise, should the various lawsuits and/or the DOJ and FTC eliminate cooperating compensation from American real estate, there will be much disruption and destruction. A lot of companies and individuals will need to pivot, and if they can’t, they’re going out of business. That’s the negative.

But there are upsides to the disruption, and I think those might be pretty cool on balance. Things might actually be better for many agents and brokers after the storm. Don’t feel scared, don’t stop and falter. It might be that if we throw it all away…

-rsh

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