An Unbiased Analysis of the Recent $1.8 Billion Legal Verdict on the Real Estate Sector
Former JPMorgan Chase Global Chief Economist (Ph.D in Economics) & Current BrightQuery Chief Economist
First and foremost, readers should know that this legal verdict does not suggest that real estate brokers did anything wrong. The industry has long worked under a structure compensating the buying and selling broker between 5-6% for their services. Negotiating these fees, usually downward, has always been available. Estimates suggest that the $100 billion in commissions earned each year by Real Estate Professionals could be reduced by up to 30% to $70 billion due to this legal verdict.
This legal outcome (subject to court approval) imposes a $1.8 billion fine on the industry. The National Association of Realtors (NAR) will pay $418 million without admitting wrongdoing. The NAR hailed the settlement and believed it represented the best possible outcome given the litigation challenge.
Will this Be a Knockout Blow to the Real Estate Industry?
Not at all! Microsoft was sued (1998) by the Justice Department and lost. The legal outcome restricted the company’s ability to earn higher profits and promoted greater competition. Many individuals assumed that Microsoft’s future was doomed. Still, the company successfully pivoted and became one of the S&P 500’s “Magnificent Seven” firms that dominated the gains in the U.S. stock market in 2023 and 2024!
Similarly, the real estate profession will evolve from this legal outcome and become leaner and more efficient. Of course, we may see a contraction in the 1.5 million plus workers that make up today’s real estate professionals, but the industry will survive under a more transparent regime.
Was this Verdict Unfair?
It is unfair to the 1.5 million+ real estate professionals who entered the industry, assuming the prior fee structures would remain in place. This legal outcome reminds me of the taxi drivers in NYC who purchased medallion licenses for up to $1 million and financed them for the privilege of driving a cab in NYC, only to be displaced by Uber and Lyft drivers who didn’t have to pay any driving fees. Did that make cab drivers bad people? No, but it certainly was unfair to them since the economic value of their medallion licenses largely disappeared overnight. At the same time, they had to continue to pay monthly payments on the money they borrowed to purchase these expensive medallion licenses. However, many consumers were delighted with the lower-cost rides from Uber and Lyft, which were made possible because those drivers didn’t have to pay the high cost of obtaining a medallion license before operating a cab service.
The current agreement, which requires formal court approval, will likely result in lower commissions for standard real estate transactions. However, when realtors perform other non-standard services, it may allow them to stop subsidizing those services. Now, they can offer those services on a la carte basis and be adequately compensated for them, resulting in real estate fees that may be the same or higher. Of course, the commission will be lower for those requiring only the essential services.
The greater transparency may allow realtors who provide aerial views of a home for prospective buyers or expert staging for sellers an opportunity to earn extra fees. Other realtors may also be able to charge for specialized neighborhood analysis. They can rank the surrounding parks, the cultural amenities, the type of restaurants, and the quality of schools that a family might enjoy in different neighborhoods. I realize that this type of analysis could go down a slippery slope if the analysis begins to delve into the racial makeup of a neighborhood, but I will trust the profession to steer clear of such a landmine.
Was this Verdict Fair?
Like Uber and Lyft passengers, buyers receiving standard services at a lower commission rate will celebrate this outcome and say the change is fair. Sadly, whether something is fair often depends on its impact on different groups. Those who enjoy lower prices usually claim the change is fair, while those adversely impacted will claim it is unfair. Not surprisingly, real estate professionals forced to exit the industry will label the outcome unfair.
In a free market, “creative destruction,” articulated by the famous Economist Joseph Schumpeter, reveals that markets for goods and services constantly evolve so that newer, more efficient structures replace older business forms. This scenario is reminiscent of globalization, which resulted in outsourcing many U.S. jobs to emerging markets with low-cost labor. The result was the loss of many U.S. jobs and the destruction of various industries. In return, many U.S. consumers could purchase various manufactured goods at a cheaper price, allowing them to enjoy a higher standard of living as they increased their purchasing power.
Was that fair or unfair? It was unfair to those who lost their jobs but a boon to those who could now afford to buy those same products at a lower price, leaving them with extra money to purchase other items.
Summary and Concluding Thoughts
Labeling any outcome as a winning or losing proposition is always tempting. The reality is far more nuanced. This outcome will undoubtedly be unfair to the hard-working Real Estate Professionals who have devoted their careers to serving their clients in exchange for a standard fee they thought they had signed up for.
In contrast, for consumers who operate in a tight inventory market, use few real estate services, and purchase a home quickly, it may seem unfair to pay the same commission as someone who demands lots of time from their realtor and takes a year or longer to purchase a house. In short, the current arrangement frequently offers a standard price in exchange for an all-you-can-consume array of realtor services.
If the latest legal verdict is approved and implemented in July 2024, it would seem logical for Real Estate Professionals to charge either by the hour or offer a package of services. Charging buyers for each house they are shown, e.g., 5 showings for one price and 10 for a higher price with an extra charge if the buyer chooses to purchase the home. A signed agreement should also prevent the buyer from bypassing the realtor and buying the same house to avoid the charge. I could even imagine a seller being charged for each client brought to view a home with a bonus if the house is sold to the buyer. Same deal, if a buyer brought in purchases the home behind the realtor's back, the Realtor should still be able to collect their fee.
These are highly creative suggestions, and many others will undoubtedly arise. Still, the bottom line is that real estate professionals deserve to be paid for their services, just as accountants, doctors, and lawyers are paid for their time. The latest legal verdict will change the compensation structure. Now, it will be left to the marketplace to find an alternative structure that adequately compensates these professionals fairly and equitably!