Note: I previously posted an explanation of this reposting of a series of columns I did for Inman News back in 2006. This is the second of three. Read first and third parts.

“Lack of money is the root of all evil.” – George Bernard Shaw (1856-1950)

Real estate brokers surely will not want to see the end of interbroker compensation if it means brokers will not be paid for providing services to buyers. The first order for one envisioning a world without MLS offers of compensation must therefore be making sure brokers get paid for their services. After we propose ways for that to happen, we’ll talk about some of the advantages to the consumer of getting rid of the offer of compensation through MLS.

Interbroker compensation out of MLS
The problems of having interbroker compensation in MLS can be addressed simply by ridding the MLS of the offer of compensation. But some brokers will be unwilling to part with what has become an ingrained tradition. Removing compensation from MLS does not mean that brokers could no longer offer each other compensation. They could do so just as they please, by sending faxes or e-mails to brokers in their markets prior to doing business with them or at the time the cooperating broker asks to show the listing. They could even publish unilateral offers to compensate cooperating brokers on their Web sites.

The MLS offer of compensation arose at a time when e-mail and fax machines were unknown. Communicating an offer to compensate a cooperating broker in writing in those days meant hand delivery or reliance on the Postal Service. Now they can be transmitted nearly instantaneously.
What’s more, the listing broker making the offer of compensation can control its offer in more detail than MLSs allow. Think back to Nifty Builders in part one of this series. They wanted cooperating brokers to do more than just show up at the first meeting with the buyer. Free from the MLS policies that prevent adding any conditions to performance as procuring cause, Nifty could offer other brokers compensation and spell out in clear terms what the cooperating brokers have to do to earn it. [UPDATE 12/2010: On the other hand, they might also offer poorly worded terms that result in compensation disputes later. Although “procuring cause of sale” is not an easy standard to apply for compensation, it is perhaps better understood than some of the terms that might be drafted by “amateur lawyers.”]

Buyer brokers will want to control their compensation
The possibility that listing brokers will want to establish conditions on cooperating brokers’ entitlement to compensation will engender a natural response: cooperating brokers will want to get paid by someone other than the listing broker. This will be just fine with listing brokers, who are likely to say, “Take it or leave it, but if you take it, you need to do the following things. Leave it, and I’ll take care of those things myself.”

But brokers working with buyers can take this further: they can charge what the market will bear for their services. For example, I knew a salesperson years ago who worked in a small, highly desirable neighborhood in St. Paul, Minn. He knew not just the housing stock, but all the residents. He often knew they were going to sell before they did. As a consequence, if you wanted to buy in that neighborhood, you needed to call him and get on his list so you could get a showing and make your offer the same day your dream house was listed (and usually before it ever appeared in MLS). Is that worth more to the buyer than 2.4 percent of the purchase price (the prevailing cooperating compensation in St. Paul at the time)? I suspect the answer is yes, but it was impractical for him to charge more than the prevailing rate because buyer/consumers were aware that the prevailing rate is what listing brokers were paying.

There may be a down side for brokers: I discussed this proposal before a group of brokers, and a very soft-spoken elderly woman commented, “But that will cause price competition for buyer brokers.” Yes, probably it will. Many licensees, who expect the MLS to find homes for their buyers, will not get paid 3 percent (or even 2.4 percent or 2.1 percent) for the assistance they provide. Others, who assist buyers in complex situations, may be entitled to 3.5 percent or even 4 percent, or perhaps a retainer that is not conditional on a sale (e.g., $x to show up to 10 homes; $y to negotiate and close a purchase; etc.). [UPDATE 12/2010: I’m not sure this approach would work out very well; or should I say I’m not sure it did for one prominent online broker.]

The advent of price competition for buyer brokers will no doubt disturb some, but the flexibility afforded to those brokers may pay off in a substantial way. For example, much has been written about limited service listings, where the listing broker puts the listing in the MLS and does nothing else, for a low flat fee. Cooperating brokers express frustration about having to do additional work and assume additional risk, all without additional pay, when working for buyers in these transactions. But the same problem has existed for years with regard to for-sale-by-owner listings. If the buyer’s broker gets paid by the buyer, she can specify varying compensation depending on the nature of the transaction. For example, “Buyer will pay broker a commission equal to 3 percent of the purchase price; but if buyer purchases a property from a seller who does not have brokerage representation during negotiations and closing, buyer will pay broker a commission equal to 4 percent of the purchase price.”

What about this notion of the buyer paying?
It is widely believed that it is impractical or impossible for the buyer to pay her own broker at closing. A report published in spring 2006 discussing the future of MLS considered the idea of buyers paying their own brokers: “It is unlikely that this will happen unless HUD and Fannie Mae allow the buyer to finance the portion of the commission that the buyer would need to compensate their own agent.”

In fact, HUD and Fannie Mae regard a commission paid by buyer to buyer’s broker at closing as a valid closing cost. In other words, to the extent that closing costs can be financed, a buyer broker’s fee can be financed as well. The traditional view is that the buyer borrows money to pay for the purchase price and comes to the closing with the closing costs in cash. Practically speaking now, buyers have the option to come with a piggyback loan ready to cover some of the down payment and closing costs in return for a second lien position on the property. There may even be tax advantages to this approach for the buyer.[UPDATE 12/2010: I suspect the piggyback loan may be a thing of the past. Does this kill my idea?]

Even if you are queasy about the buyer paying, the transaction can still fund the buyer broker’s commission. The buyer merely seeks the necessary amount as a concession from the seller. Note that this is a request from the buyer that the seller cover some of buyer’s closing costs. It is not a request from the buyer for the seller’s broker to pay more than the published cooperating compensation to the buyer’s broker; such a contract clause would likely run afoul of NAR’s Code of Ethics. A seller concession to pay the buyer broker should be perfectly OK from the perspective of mortgage lenders and the secondary market. But the buyer broker had better have a buyer representation agreement first.

Brokers must have buyer representation agreements
In a world without interbroker compensation, the buyer’s broker must look to the buyer for payment. And the only way to ensure the buyer will pay is to have a contract with her. Many states already require this, though the provisions appear to be honored more in the breach than the observance.
In addition to any provisions mandated by statute or rule, a buyer representation agreement should include the following:

  • What the buyer’s broker will be paid, along with circumstances that can cause that payment to be varied (e.g., transaction with an unrepresented seller).
  • What the buyer’s broker will do, stating with particularity what services the broker will offer. Most consumers don’t know, and it will make it easier for the broker to get paid if it’s laid out. Brokers can also take this opportunity to distinguish themselves from competitors.
  • Permission from the buyer to seek payment from the seller, from the listing broker, and from anyone else who might be willing to pay.
  • Clear explanation of how the brokerage firm will handle a dual agency, if one arises (and provided it is legal in the state). Some states mandate agency disclosure language for representation agreements.

If the broker is worried about the buyer saying, “But Fly-by-Nite Real Estate won’t require me to sign this,” the broker can point out that state law requires it, if state law does, and hand over a copy of the statute or rule. The broker can point out that it is important to discuss upfront what services the buyer will receive and how the broker will get paid.

If the broker is worried about the buyer saying, “I don’t want to be tied down/locked in,” the term of the agreement [can] be terminable upon notice by the buyer. An override clause/protective list can ensure the broker is paid if the buyer purchases one of the homes the broker showed her after she terminates the representation agreement.

Once the broker has the buyer’s commitment to compensation and her permission to obtain payment from other parties, it is now perfectly consistent with the broker’s agency duties to seek compensation from the seller or listing broker. Seeking such payment without the buyer’s commitment and permission might be a violation of the broker’s fiduciary duties, because the broker might jeopardize the buyer’s interest to obtain payment. Once the buyer has a financial obligation to the broker, however, the broker’s duty requires it to do its best to obtain that payment in the way most convenient for the buyer.

Solution addresses several problems
Getting rid of interbroker compensation improves the market in several areas:

  1. Buyers and their brokers have more options for structuring their relationships and the compensation that will flow between them.
  2. Buyer broker fees can be commensurate with the skill and experience of the broker and with the buyer’s needs.
  3. Brokers do not have to fuss with the accounting details and conflicts associated with paying each other.
  4. The market benefits from price competition for buyer broker services.
  5. Buyer brokers working in transactions with FSBO or unrepresented sellers can obtain additional compensation for the additional work and risk they assume.
  6. The question of buyer’s brokers “rebating” commissions to the buyers becomes moot. There will be no compensation from the listing broker out of which any rebate could be made.
  7. The dangers of price fixing, and the claims by industry watchdogs that it exists now, will largely be addressed. Brokers will really be unable to tell what their competitors are charging for services, and there will be no incentive for commissions to be “standard.”
  8. Buyer’s brokers can achieve the type of relationship of trust with brokers that supports a claim to being “professionals.” When the buyer knows what she is paying for broker services and what she is getting in return, buyer expectations and broker performance are both likely to be more refined.

Well, assuming the reader is still with me, I still have to address in part three how the MLSs that make up the bulk of my client base will survive this transition.