Fairness and Efficiency in Agent Compensation (Transmission #302)

WRITTEN BY: SPONDON HAZARIKA

The recent slew of lawsuits and settlements between the National Association of Realtors (NAR) and home sellers have intensified scrutiny on the traditional real estate commission structure. This system, while historically convenient for distributing capital during the final sale, does not necessarily reflect the value provided by agents, nor does it always align incentives. 

There have been skeptics of the commission structure in the United States real estate market for decades, including some more popularized examples from Freakonomics. 

Key issues with the traditional model are:

1. Disproportionate Compensation: At the “typical” 3% commission rate, a buyer's agent might earn $12,000 on a $400,000 home and $36,000 on a $1.2 million home. Does the agent really do three times the work for the more expensive home? Not necessarily. The compensation is tied to the home’s value, not the effort or expertise required.
2. Misaligned Incentives: Because the agent's commission is a percentage of the home's purchase price, their incentive is to encourage higher offers. This conflicts with the buyer’s goal of paying the lowest possible price. While agents have fiduciary duties, these are not always strictly enforced, leading to potential distrust from consumers.
3. Equal Pay for Unequal Experience: A newly licensed agent can earn the same commission as an experienced agent. This doesn't account for the significant differences in expertise and service quality that can exist between agents.

What if there were a better compensation model? One designed to more closely align agent incentives with the interests of home buyers. Let’s explore what that might look like.

ALIGNING THE MISALIGNED
To address these issues, it stands to reason that we must first look at the drivers of value.

These could be simplified to four key dimensions: