The Inevitability of Commission Compression

For the past few years, the attention of the industry leadership has been focused on the issue of commission compression. The Moehrl lawsuit was the beginning, but the involvement of the DOJ and now the FTC is raising real concerns about what happens to the 6% real estate commission that has been the default for decades.

A recent report from Consumer Federation of America is reigniting some of those same concerns, so we’re getting the same arguments from the industry we have had for years now. They are, basically, some variation of the following:

• Real estate commission are a product of the free market, because sellers agree with the listing agent. What the listing agent and the buyer’s agent do afterwards is nobody’s business.
• Commissions are trending down anyhow, so the government should back off.
• The rest of the world wants what we have in US and Canada.
• Decoupling commission would harm buyers, because they wouldn’t have their own representation.
• This isn’t a problem, because the banks will just let buyers wrap the commission into the mortgage.

I’ve dealt with all of those in the past in numerous posts talking about this issue. This isn’t a repeat.

Instead, I think it’s worth taking analysis up a level to see why all of the efforts to decouple commissions are happening. That will lead to the inescapable conclusion that commission compression will happen; it’s not a matter of if, but of when and how.

The short answer: commission compression is inevitable because technology is deflationary.

Technology is Deflationary

I think I knew that for years, but it wasn’t until I read The Price of Tomorrow by Jeff Booth that it really sank in.

For years, I’ve been saying that technology doesn’t make you better; it just makes you more efficient. Here’s a slide from a presentation I used to give in 2016:

It was a good laugh line slide, but one that let me make the point. Technology doesn’t make you a better real estate agent; it just makes you more efficient at what you do. So if you’re a great agent, then technology lets you be great more efficiently, which means you can work with more people. If you suck, then you suck faster and in front of more people.

The step I didn’t take back in 2016, but should have, is asking “What is efficiency?” I think this definition from Investopedia is a pretty good one:

The term efficiency refers to the peak level of performance that uses the least amount of inputs to achieve the highest amount of output. Efficiency requires reducing the number of unnecessary resources used to produce a given output, including personal time and energy.

What I should have realized then is that reducing the number or amount of resources, including time, is deflationary. That is, things cost less because of greater efficiency.

In my latest post about blockchain and real estate, I wrote:

I was alive and an adult and working in 2011. I remember what our computers and cellphones looked and felt like. Because it was a slow evolution, we don’t really think about how much technology has changed until we pause and look back a mere ten years.

I remember the iPhone 4S released in 2011 with an astonishing 8 MP camera, 64 GB of storage, and 512 MB of RAM.

The iPhone 13 Pro in my pocket right now has a 12 MP camera (actually three of them, including a telephoto lens), 512 GB of storage (I chose not to go for 1TB), and 6 GB of RAM. But of course, that’s not the full story since the iPhone 13 Pro is many, many times more capable than the iPhone 4S, has 5G, a brighter, sharper screen, shoots 4K video, and so on and so forth.

That was just ten years.

What Jeff Booth points out is that this advance of technology means that things have gotten cheaper. In some cases, things have become free.

I saw this posted on Facebook recently, and it drove the point home:

The photo comes from this Huffington Post article originally written in 2014, then updated in 2017, where the author points out that 13 of the 15 products in this ad are now included in his phone. He wrote:

So here’s the list of what I’ve replaced with my iPhone.

• All weather personal stereo, $11.88. I now use my iPhone with an Otter Box.
• AM/FM clock radio, $13.88. iPhone.
• In-Ear Stereo Phones, $7.88. Came with iPhone.
• Microthin calculator, $4.88. Swipe up on iPhone.
• Tandy 1000 TL/3, $1599. I actually owned a Tandy 1000, and I used it for games and word processing. I now do most of both of those things on my phone.
• VHS Camcorder, $799. iPhone.
• Mobile Cellular Telephone, $199. Obvs.
• Mobile CB, $49.95. Ad says “You’ll never drive ‘alone’ again!” iPhone.
• 20-Memory Speed-Dial phone, $29.95.
• Deluxe Portable CD Player, $159.95. 80 minutes of music, or 80 hours of music? iPhone.
• 10-Channel Desktop Scanner, $99.55. I still have a scanner, but I have a scanner app, too. iPhone.
• Easiest-to-Use Phone Answerer, $49.95. iPhone voicemail.
• Handheld Cassette Tape Recorder, $29.95. I use the Voice Memo app almost daily.
• BONUS REPLACEMENT: It’s not an item for sale, but at the bottom of the ad, you’re instructed to ‘check your phone book for the Radio Shack Store nearest you.’ Do you even know how to use a phone book?

You’d have spent $3,054.82 in 1991 to buy all the stuff in this ad that you can now do with your phone. That amount is roughly equivalent to about $5,100 in 2012 dollars.

Jeff Booth talks about how YouTube, which is entirely free, has replaced TV and movies to a large extent. How research that would have taken specialized systems now can be done for free on Google. How music costs us less today than it ever has. And so on and so forth. If you’re more interested, this is not a bad presentation by Jeff Booth on the core ideas of his book:

Jeff Booth – We are in fold 34: How exponentiality will change our understanding of economics

Video from the 10th International Conference “The Austrian School of Economics in the 21st Century” (November 3 to 5, 2021) The event took place in Vienna (Austria) at the OeNB Headquarters. It was an OFFline physical conference. No livestream or Zoom sessions were scheduled. Networking and social activities were a main part of the conference experience.

Focus on the first 10 minutes or so, before he transitions to talking about central banking and Bitcoin.

Efficiency reduces the cost of the inputs. Competition then results in lowering costs of the outputs — the product or service. Your dollars will buy more and more as time goes on, because technology keeps making things more efficient, which means cheaper.

This is great for you and me as consumers. It’s terrible news for you and me as producers.

Technology, Deflation and Real Estate

We have discussed ad infinitum on these pages and elsewhere how technology has impacted real estate from the very beginning. And this isn’t just about the internet.

We went from printed books in the MLS to client-server to online. In real terms, the cost of MLS has dropped over time because it is far more efficient to update a database to display on a website than it is to print on paper and ship it all over the county.

We went from color printers costing tens of thousands of dollars to a couple hundred dollars. We embraced digital signatures, immediately reducing the cost of getting documents executed. Back when I was working at Coldwell Banker Commercial, we ran one ad talking about how an agent who was a private pilot jumped in his Cessna and flew hundreds of miles to get a closing document signed by his client who was on vacation, showing the depths of commitment to client service. That story just wouldn’t happen today, since signature technology exists.

In every aspect of real estate practice, technology has lowered the costs for agents to provide increasingly higher levels of service to clients. That efficiency, that lowered cost for higher output, has led directly to the domination of the industry by agent teams who no longer had to depend on their brokerages to provide expensive productivity technology. That efficiency has led directly to a concentration of power in the hands of fewer and fewer agents, because they can do more with less, and work with more clients, and make more money.

It simply cannot be debated that it is cheaper today to become a real estate agent than it has ever been. That fact is expressed directly by the commission splits between the broker and the agent. Just ten years ago, the “standard” agent split was 70/30; if you were a top producer, you can look forward to 85/15. Today, there are hundreds of brokerages that start you off at 100% splits, charging just transaction fees… and those transaction fees are headed down.

Incumbent brokerages denigrate these lower-cost brokerages, of course, and talk about “the race to the bottom.” They are correct that there is a race to the bottom, but they misunderstand what is causing it. Greed and stupidity are not what is causing the race to the bottom; technology is.

Technology, Deflation and the Consumer

You can see where this is headed, right?

The problem is that all of this deflationary pressure that has benefited real estate agents has not led to benefit for the consumer. Real estate commissions have proven remarkably resistant to the deflationary pressure of technology.

We see this in numerous academic papers, regulator comments, and even from within the industry. But I think this article in RealClearPolicy is a good layman’s approach because of who the authors are. Panle Jia Barwick and Maisy Wong are two academics who the policymakers, regulators, and think tankers pay attention to. I’ve written about them in the past. And here’s what they say:

Over the last decade, a number of technological innovations and new business models in the U.S. residential real estate industry — from instant buying programs to virtual tours and digital closings — have made it easier to match buyers with homes and lowered the cost of housing transactions. However, puzzlingly, these technological advances have not lowered the cost of services by the real estate brokerage industry. In fact, across the country, national average commission fees over the past couple of decades have doubled and outpaced inflation in most years.

They based this observation on new research they did for Brookings Institution — an enormously influential think tank.

The result of this is the current focus by the DOJ and the FTC on decoupling commissions. Because the policy wonks look at what’s going on and conclude that the high commissions are the result of some kind of collusion, some kind of monopolistic rent-seeking, some kind of anticompetitive behavior and rules within the industry.

Here’s the thing: it doesn’t actually matter what the government does or does not do.

The Inevitability of Commission Compression

My current take is that if the cause of the bitching about high commissions is technology, then it doesn’t matter what the DOJ or FTC does. It doesn’t matter whether Fannie and Freddie allows buyers to capitalize buyer commission costs or not. None of it matters, because technology is deflationary and someone somewhere will figure out how to pass those savings on to consumers. They won’t do that out of the goodness of their hearts, because they are consumer advocates. They will do that because it will make them a fortune.

None of us know precisely the way in which this technology-driven deflation will manifest. But I can make some guesses.

Even if the government does nothing, and commissions remain tightly coupled, continual advances in technology means someone will find a way over and around the industry.

For example, the MLS system is the underpinning infrastructure of the tightly coupled commissions. Well, someone somewhere will find a way to get property information into a database that doesn’t require such coupling, and offer up an assisted FSBO platform with AI assistants. Agents engage in steering based on commissions? Someone somewhere will come up with a smart contract that exposes the steering. Banks wrap commissions into loans? Someone somewhere will engineer a decentralized mortgage product that leaves banks out of the equation.

None of this is reality today, of course, but none of it is outright fantasy either. Why?

Because technology growth is exponential.

It is exceedingly difficult for the human mind, mine included, to even imagine exponential growth and what that means.

This Wikipedia article is the source of the image I used above, and it explains the problem of exponential growth:

With 64 squares on a chessboard, if the number of grains doubles on successive squares, then the sum of grains on all 64 squares is: 1 + 2 + 4 + 8 + … and so forth for the 64 squares. The total number of grains can be shown to be 2⁶⁴-1 or 18,446,744,073,709,551,615 (eighteen quintillion, four hundred forty-six quadrillion, seven hundred forty-four trillion, seventy-three billion, seven hundred nine million, five hundred fifty-one thousand, six hundred and fifteen, over 1.4 trillion metric tons), which is over 2,000 times the annual world production of wheat, which in the period 2020-21 was an estimated 772.64 million metric tones.^[1]

When technology growth is exponential (Moore’s Law, etc.), then we can’t really imagine what is possible a mere ten years from today. Certainly none of us in 1991 thought that our cellphone could replace 13 of 15 electronic products by 2014. And none of us in 2014 foresaw something like YouTube and Twitch. And none of us in 2021 have any idea what the Metaverse or blockchain will actually do by 2030.

But we do know that whatever comes, it will be deflationary. All of us will get more for less as consumers.

On the flipside, all of us will have to do more for less as producers if we are to stay in business at all.

Implications

As I just said, none of us know precisely how things will play out. We know only that technology is deflationary, and that technology growth is exponential. This is profoundly hopeful as consumers, and profoundly troubling as producers. And with exponential technology growth, the speed of change can only accelerate.

That dizzying speed of change is something that thinkers like Heather Heying and Bret Weinstein have discussed in their book A Hunter-Gatherer’s Guide to the 21st Century. And it is something that real estate agents, brokers, MLS executives, technology leaders all recognize in their bones. Being five years late to the party now is fatal. Being one year late with technology is a real problem. It feels like you have no choice but to find out what is the latest and greatest, because things are changing so fast.

I do believe that there are some fundamental principles, however.

First, doing more for less as producers does not merely mean becoming more and more frenetic, trying to keep up with consumer demands. It also means doing higher-order work. It means not trying to keep up with demand for buyer tours at an increasingly hectic pace, at lower and lower pay, but letting buyers do their own tours or virtual tours, and reserving your time for something that technology can’t do yet. Perhaps it means providing wisdom, and analysis, rather than data and facts… because computers can do data and facts better and faster and cheaper than you.

Second, it means spending less time and energy trying to defend the status quo and more time and energy trying to figure out how to adapt to the new technology-driven deflationary world. The status quo isn’t under attack by government, or by interlopers, or by disruptors. It is under attack by technology.

Third, it means that there is nothing riskier than not taking risks. Standing still in the face of exponential technology growth is the surest way to death. Taking months and years to make decisions is the best way to ensure that your decisions will be rendered completely irrelevant by the time you make them. That doesn’t mean that you just throw caution to the wind, of course, and just bet it all on Dogecoin. It does mean that you have to find a way to take real risks, with the risk-reward in mind, because the world is speeding up.

I have spent years focusing on things like MLS governance precisely because of this reason. Conservative, reflective, consensus-driven decision making is great for many things, but the technology-driven world we live in today demands nimbleness and flexibility above all. Experience is invaluable, but it cannot be allowed to stifle taking calculated gambles. That’s how you die in an exponential technology growth world. Ask Kodak.

Fourth, technology and the efficiency it brings has a peculiar tendency to simultaneously drive monopolization and decentralization at the same time. This one requires far more thought, so I’ll reserve that for future treatment. But as of today, I think it means that organizations and companies not just in real estate but in every industry worldwide have to think about getting bigger and bigger while simultaneously becoming more and more decentralized with fewer and fewer barriers and offer ever more freedom to their workers and members.

There is much more to investigate, study, and say on all of these topics. But here’s the start to the conversation.

-rsh

Daft Punk – Harder, Better, Faster, Stronger (Official Video)

Listen, order & watch now: https://bio.to/daftpunk Official Music Video for “Harder, Better, Faster, Stronger”, taken from “Discovery” available on all platforms: https://daftpunk.lnk.to/Discovery Subscribe to the official Daft Punk YouTube channel: https://daftpunk.lnk.to/subscribeonY Watch more videos of Daft Punk: https://daftpunk.lnk.to/essentialsvideos Listen to Daft Punk’s Essentials here: https://daftpunk.lnk.to/essentials Written by Thomas Bangalter, Guy-Manuel