Negotiation is an essential part of buying or selling a home. But for nearly a century, there’s been one part of the process where haggling doesn’t fly: the 5% to 6% standard commission charged by US realtors.
Now, in a dramatic turn of events, the National Association of Realtors has settled a class-action lawsuit that targeted the practice, agreeing to reforms that could cut commissions.
News outlets have generally described the case as a game-changer that will unleash competitive forces in the industry. And why not? The US standard is far higher than one charged by realtors in countries like Germany (recently 4.5%), Australia (2.5%) and the UK (1.3%).
In reality, though, the history of how these commissions came to be — and how they have persisted, despite legal challenges — suggests that change will come slowly, if at all.
Prior to the early 20th century, real estate brokers had the same sorry reputation as snake oil salesman and carnival barkers, and many people eschewed them entirely. These “curbstone brokers” plied their trade as free agents, displaying a rapacity that earned them a reputation as “land sharks.”
Eager to shed this image, more reputable real estate agents began forming professional associations, usually called boards, in the early 20th century. These new groups established exclusive contracts that bound sellers to a single listing agent for a set period of time. They also set standard commissions, typically a percentage of the total sale that could go to the sellers’ agent — or, when a buyers’ agent played a role, be splitin half.
Brokers had every incentive to join a board. The prime reason had to do with a related innovation: the Multiple Listing Service, or MLS, a system of cross-referenced index cards containing all properties for sale in a given area. Only dues-paying realtors could access these cards – and only if they followed the rules.
For example, real estate boards adopted language stipulating that “brokers should maintain the standard rates of commission adopted by the board and no business should be solicited at lower rates.” This predictability undercut price competition, and also gave brokers an incentive to share their listings. Likewise, buyers’ agents who belonged to the boards knew that they would get a cut of the action if they found a seller with a property worth buying. The system created what one historian of the profession has described as a “perfect market, in which every piece of real estate would be for sale by every real estate broker.”
The Justice Department didn’t see it that way. In 1947, government lawyers hit the National Association of Real Estate Boards with an antitrust suit, arguing that standard commissions amounted to price fixing. The group managed to fend off criminal charges, but a civil suit went all the way to the Supreme Court. In 1950, the justices declared that real estate boards could not, in fact, fix rates.
The National Association of Real Estate Boards dutifully abandoned its formal rate schedules. Instead, it began “recommending” or “suggesting” that local boards adopt the standard 5% or 6% commission. Thanks to this superficial semantic tweak, realtors just reverted to the old standard.
That the ruling did so little to change the status quo underscored the fact that the commissions, far from being a form of covert price fixing, had become woven into the fabric of the real estate industry. When the only way to access real estate listings was to agree to a standard commission – with violators expelled from the MLS – it’s hardly surprising that the practice resisted market forces. It would take much more than a lawsuit to dislodge such a central tenet of the market.
In fact, many of the local boards continued to endorse fixed schedules. In 1960, the California Real Estate Association formally adopted a 6% commission, leading state prosecutors to file a case against the group. Here, too, realtors agreed to abandon formal commissions schedules in favor of recommended rates. Little else changed.
In 1969 and 1970, the Justice Department began filing a new round of suits against real estate boards around the country, again alleging price fixing. After some resistance, boards dutifully agreed to stop recommending rates, leading many observers to predict that the real estate business was ripe for a pricing revolution.
Two years later, though, the Washington Post reported that the 6% commission was alive and well. The paper contacted two dozen of the largest firms in the region and asked about commissions. Every single one of them said they were still charging 6%. Their replies, memorialized by the reporter, offer some sense of why this magic number remains the norm, even today.
“No reputable firm charges less,” one realtor claimed, while another noted that “the rule is six percent.” Several maintained it was the “standard,” and while a handful acknowledged that rates could be negotiated, one realtor threw cold water on the idea: “an agent won’t work as hard on a house for five percent as he will for six percent.”
More antitrust lawsuits followed later in the decade and into the next. Over and over, newspapers reported on these cases, predicting that the long-awaited collapse of the 6% commission was nigh. This was a bit like waiting for Godot: there was much talk about the prospect of lower commissions, but they never arrived.
Given the history, this was understandable: the entire real estate industry had been built to promote cooperation instead of competition, ensuring buyers’ and sellers’ agents work together. This ethos proved remarkably resilient in the 1980s and 1990s; indeed, it has remained alive and well in our own time, despite the advent of the internet, which promised to cut those pesky commissions down to size.
Now we’re being told that the latest, greatest court case truly spells the end of the standard realtor commission. This kind of naïve reporting perpetuates the fiction that the 6% commission is an official rate.
Instead, it’s something far more powerful and persistent: a deeply-held custom nurtured for close to a one hundred years among the members of the nation’s largest trade association. Good luck getting rid of it.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our podcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Stephen Mihm
