The Real Estate Brokerage Industry is Broken
The residential real estate services industry is in freefall. Not a day goes by without news of another mass layoff, a public company announcing a record quarterly loss, or a company permanently shutting their doors. It’s not just the real estate brokerages that are getting crushed. The pain has permeated throughout the entire residential ecosystem and its effects are being felt by mortgage companies, appraisers, home inspectors, real estate attorneys, title companies, moving companies, and just about anyone that touches the home buying/selling process. Within the past few weeks, Opendoor announced a quarterly loss of nearly $1B, Zillow laid off 300 employees, and both Realogy and Compass announced major downsizings. This is on top of the thousands of people who have recently been let go across many of the largest mortgage companies in the country. Some market segments are holding strong on home prices, and other markets are experiencing sharp pricing declines, but home prices aren’t the metric that drives the health of the real estate services industry. The residential brokerage industry, and many of the ancillary services that support it, is measured by volume of transactions.
Most brokerages charge commission based on a percentage of the sale price of a home, so theoretically higher pricing should drive higher commissions. And while this is true, the amount that an agent earns on a transaction is not significantly affected by even a 10% increase or decrease in home prices. The median price for homes sold so far in the US in 2022 is $428,700. Assuming a brokerage charges a 5% commission, and the listing agent is on a 60/40 split, the difference in the amount of money that the agent would take home (on an average priced home) if the home sold at a 10% discount would amount to $643. That’s not to say that $643 isn’t a lot of money, but the point is that price increases and decreases don’t have a massive impact on an agent’s earnings (the median earning for a real estate agent in the US was $48,700 in 2021). The way that agents significantly increase their earnings is by selling more homes. Granted if an agent transitions from selling average priced homes to ultra-luxury homes, their earnings will also increase, but moderate price changes in the market do not not have a huge impact. There is an excellent chapter in the book Freakonomics that delves into this topic deeper. It’s worth noting that I have a very different view on the value of real estate agents compared to the views of the authors of Freakonomics. As I covered in a prior article, Are Residential Real Estate Agents Really Needed, the value that a knowledgeable real estate professional can add to a transaction is hard to overstate.
For as long as I have been in the real estate industry, companies have tried to disrupt the residential brokerage model. The primary lever that disruptors usually defaulted to was a commission discounting model. Time after time, every disrupter that built a model on commission discounting either went out of business or pivoted to more of a traditional model. The discount commission graveyard is filled with companies that were once very well funded (Purple Bricks, Foxtons, REX). New discount brokerages continue to enter the industry, but history has taught me that discount models are not sustainable in the US (other countries have found a way to make this work).
As devastating as the pandemic was, one silver-lining that it spurred was massive innovation in the real estate industry. Record amounts of venture capital flooded into the space, and new breeds of disruptive business models were launched. They include companies that offered different ways to buy & sell homes, Fintech companies that changed the way deals were financed, title companies that stream-lined the settlement services process, and virtual tour providers that made it possible to buy a home without ever setting foot in it. Many of these companies made huge strides in modernizing the brokerage industry, but unfortunately the sharp decline in transactions hit before most of these companies matured and became profitable. The disrupters were not immune to the downturn, and due to the fact that most of them had not achieved profitability, they were often the ones hit hardest by the change in the market dynamics. But I am confident that all is not lost, and the innovations that many of them pioneered will be the basis for the future of the industry. And this then brings me back to the topic of real estate agents.
When a homeowner is looking to sell their home, it is common that they invite multiple agents to pitch their service before the winner is selected. Each agent has their own unique pitch about how they are going to market the listing, the pricing strategy that they use, and the services that they will provide, but the goals of every pitch is the same: sign listing agreement and list the home on the MLS. The only decisions that the homeowner needed to make were selecting an agent, and agreeing to the list price. If the industry continues down this same path, then I fear that all of the innovation from the past few years will be lost. The brokerages of the future need to change their pitch in order to survive and thrive.
Some of the innovative models that were launched over the past few years included iBuyers, online Auctions Sites, Power Brokers, and Fractional Ownership. However, most of the companies that offer home services only specialize in a single offering. For example, a client who is looking to sell their home through a traditional process would go to a company like Coldwell Banker, Re/Max, or Compass. A client looking to enter into an iBuyer transaction would reach out to a company like Opendoor or Offerpad. This has created a fractured industry where clients get bombarded by many different companies offering their own unique services, typically leading to confusion and uncertainty from the client.
The successful brokerages of the future will need to offer a menu of services to their seller clients. To make this work, a professional advisor is needed to detail all of the options available to a seller, and guide them through the process to help them make an informed decision based on their goals. This is where the agents come in.
Real Estate professionals who work in the industry are typically aware of the many different options that a client can choose to buy/sell a home because they keep up-to-date with industry trends. But the average client has limited knowledge of available options and alternatives outside of a traditional sale. I have detailed some of the options below that should be included in the menu of services that can be offered during the listing process.
While the sale of homes has come to an abrupt halt, the rental market is stronger than ever. In addition to listing a home for sale, renting out the home can be a great option for the owner to generate a consistent revenue stream while retaining ownership in the asset. In fact, the rental business has been so strong that many of the largest investment firms in the world have started acquiring enormous portfolios of single family homes to rent out for their Single-Family-Rental (SFR) division. Blackstone recently acquired SRF focused Home Partners of America for $6B which added 17,000 units to their portfolio. Invitation Homes has grown their portfolio to include 80,000 SFRs, and other large players are following suit. The reason why so much institutional money is flowing into the SFR space is because demand from renters is outpacing supply. And this trend should continue as the population grows and rising interest rates price many buyers out of the market and into rentals. In addition to a traditional rental, homeowners can also look to monetize their property through short term rentals via companies like Airbnb and Vrbo.
iBuyers are a fairly new breed of companies that offer sellers a low hassle option to quickly sell their home. The concept is fairly straightforward. If a customer is interested in getting an offer from an iBuyer, all that they need to do is provide the company with their address. iBuyers such as Opendoor and Offerpad use proprietary algorithms that leverage many data points on the house and the local market to generate a valuation for the home. If the client decides to accept the offer from the iBuyer, all that they need to do is sign the paperwork, and the sale proceeds. The iBuyer typically completes some touchup work on the property, and then puts it back on the market at a higher price with the hopes of selling it quickly and pocketing the difference. I had written an article in the past that provided a detailed overview of this model and the current leaders in this space.
Traditional wisdom would suggest that the price that an iBuyer offers is slightly below what the seller could get on the open market, but there are significant benefits to selling to an iBuyer. The seller doesn’t need to worry about keeping the house in immaculate condition to have it ready to show at a moment’s notice. They also do not need to worry about making any repairs to home. Lastly, iBuyers offer a level of certainty to the seller that doesn’t typically come with a traditional sale. Opendoor for example, promises an offer within minutes, the ability to close within days, and since they pay cash, there is no risk of the mortgage falling through at the last minute.
But even amongst the leading companies that offer iBuying services, there are different versions available to meet the unique needs of every customer. For example, companies like EasyKnock offer their Stay & Sell program where they will buy your house from you, and then rent it back to you for up to 5 years. Flyhomes offers a solution called Buy-Before-You-Sell. They provide sellers with cash upfront to purchase their new home before they even list your current home. Then, when you list your home for sale, if it doesn’t sell within 180 days, Flyhomes will purchase your home at a pre-agreed price.
Another option which many home sellers are unaware of are online auctions. A benefit of using an auction site is that the seller gets instant access to a pool of pre-approved buyers that are ready, willing, and able to move quickly to purchase a home. These companies promise that the competitive nature of an auction increases the likelihood that a home will sell at or above fair market value. And unlike a traditional sale where a stale listing that lingers on the market for too long (and inevitably leads to price reduction after price reduction) loses its appeal, the auction has a predetermined start and end date. Buyers will not be hesitant to make an offer on a house because it has languished on the market for months with a dozen price reductions during that time.
Home Auction companies are not new, and they have been a primary vehicle to sell foreclosures, but they have traditionally only been offered by stand alone Auction companies. Since these services had rarely been offered as an option by a traditional real estate agent, most sellers never even considered an auction as a viable option to sell their home. Over the past few years, home auction companies have started to work more closely with traditional agents. And in November of 2021, luxury powerhouse Sotheby’s International Realty acquired a majority stake in the leading high-end home auction company Concierge Auctions. This move armed Sotheby’s army of over 25,000 agents with the ability to offer a home auction as an additional option to their sellers across the world.
Purchasing a vacation home is out of reach for the millions of families that barely earn enough to cover the expenses of their primary residence. And by definition, a vacation home is typically only occupied for a few months (or even weeks) throughout the year. Innovative companies like Pacaso looked at the challenge of affordability of vacation homes, and when paired with the fact that these homes are vacant more than they are occupied, they saw an opportunity to significantly increase the pool of buyers for these types of assets. Pacaso created a platform that allows customers to sell and purchase a fraction of a home (as little as ⅛). They pool together multiple buyers (no more than 8 per property) and create an entity that entitles each buyer to the percentage of ownership that they agreed to. Pacaso then layers on a tech stack that allows each owner to access the home during the weeks that work best for their schedule. Pacaso takes care of property management responsibilities which includes cleaning, maintenance, and repairs. Pacaso can work with clients to sell their entire home, or fractional percentages of their home.
This may sound like a traditional timeshare, but fractional ownership is a completely different model. Unlike a timeshare where customers book weeks at different properties in different cities, Pacaso customers actually own a percentage of the underlying asset. As the home appreciates over time, the value of the investment increases as well. If a customer decides to sell their stake in the property, they can either offer it on the open market, or Pacaso will purchase the stake back from them.
Companies that offer the business models referenced above gained significant traction during the past few years, but they are getting crushed in the current economic climate. Access to new capital for startups has become much more elusive, which will eventually lead to consolidation in the market. But I do not foresee a future where each of these different models are operated as a standalone company, each competing with each other and against the brokerage community. Some of these companies may get acquired by traditional brokerages (similar to Concierge Auction with Sotheby’s), but the majority of them will become service providers that leverage existing brokerages as a sales channel. Instead of agents pitching clients solely on a traditional listing agreement, agents will need to take on a much more consultative role.
Here is how I see this playing out. A customer who is interested in selling their home will contact a Real Estate agent to hear their listing pitch. After a tour of the property, the agent will sit down with the customer to discuss options. The agent will pull out a menu of services to review with the client. They can discuss the pros and cons of a traditional listing agreement. The agent can then discuss the benefits of working with an iBuyer, and as part of the process the agent can submit the property to various iBuyers to generate multiple offers that the seller can review. Next, they can present options for renting out the property, both long term and short-term. They can then provide pros and cons for other services such as Auction and Fractional Ownership. The value of the agent shouldn’t just be limited to acting as a single source of information for the various options that are available. Their value needs to extend to providing the seller with guidance on the different options and help them decide which one (or combination of options) is best for them. The role of agents will continue to evolve. The more options that are available to sellers, the more complicated the decision becomes. And since the sale of a home is likely the single largest transaction that most people deal with during their lifetime, the need for a trusted professional in the field will only increase.