Real estate marketplace inefficient, but works

Every morning in the tiny fishing village of Pichidangui on the central coast of Chile, local residents line up and await the arrival of the morning catch. The boats dock; the fish are cleaned, sold and wrapped in newspaper. Within an hour, the small crowd dissipates.

The value chain in Pichidangui is simple–fishermen distribute fish to residents–an efficient and cost-effective marketplace with no middlemen or intermediary costs. Far more complex, the U.S. real estate value chain is also more expensive–10 percent or so of every sale.

Nevertheless, sticking to the same analogy, imagine Google, MSN, Yahoo!, AOL and newspapers being the sea, packed with home buyers. Trolling every day to net the catch are the big boats of Cendant, RE/MAX, Homestore, HomeGain, Service Magic, Agent Connect, Prudential and few others who haul the fish to dock, selling them to real estate brokers and agents, who select the right buyers, then take them to a local restaurant where they sell them a house.

A gaggle of other intermediaries get in the middle–inspectors, lenders and insurance agents clean, scrub and qualify the fish for market.

Real estate is an inefficient transaction, but an efficient marketplace. The inefficiencies come from the number of middlemen touching the transaction and the legal requirements necessary to consummate a sale.

The MLS can be thanked for the efficient market place, which enables a ready buyer to find 90 percent of the available inventory within hours, if not minutes, which has been greatly enhanced by the MLS going live on the Web.

But the real estate marketplace worked fairly well long before the Internet, thanks to the MLS, which was conceived 100 years ago in San Diego when a group of brokers reached what turned out to be a powerful agreement for selling lots of real estate effectively. They agreed to share listings and their display and to share commissions. This system worked because it made home shopping risk free without any direct costs for the home buyer and it created a viable marketplace for sellers to peddle their homes at top dollar. The business model was brilliant.

Most important, the MLS exposes almost all listings to almost all serious buyers, reaching the threshold of comprehensiveness that makes for a true marketplace. This is where the expense come in: the real estate marketplace depends on the Realtor who officially places a home on the MLS and it also depends on broker cooperation, which keeps commissions high. As long as the agent who brings the buyer must get paid, commissions will never reach a steep discount.

This MLS maze is what hundreds of discount brokerage companies and Internet firms have failed to crack. Without the MLS, the home seller does not get exhaustive exposure. Without sellers, there are no listings, so an alternative marketplace is impossible.

The Web represented the greatest promise to change the game. But 10 years later, the essential structure of the marketplace has not changed. Instead of the Internet redefining real estate, traditional industry practices have defined the role of the Web. Underlying the power of the real estate market is marketing. Marketing of homes through the online publication of the MLS became the most viable business model on the Internet with real estate agents paying the bill in the form of buying leads, Web pages, technology and content.

The marketing power obviously inspired innovation at Weichert, Realtors, which is aggressively getting into the online lead business and Prudential’s acquisition of e-Realty, which is also going to be sending its boats to sea to troll for home buyers.

However, in most cases, brokers and franchises haven’t subsidized this marketing explosion, except in a few instances. Instead, agents have paid the bill.

One game-changing trend is how the Web has minimized the role of agents who help buyers. Home shoppers now pan for listings online, calculate property values, learn about the process of buying and figure out the legal loopholes. The Internet has become the de facto buyer’s agent.

The Web is already bringing more buyers directly to the listing agent, and that has already ignited new thinking around the old commission model.

New Jersey-based Foxtons has created its own marketplace of buyers and sellers from an aggressive commission discounting home seller ad campaign that is attracting both sellers and buyers, making the internal sale possible without the MLS.

A real estate sale is a lumbering, emotional and legal-ridden transaction that the public does only a few times in a lifetime. Therefore, it’s expensive and the friction is tolerated. Moreover, people tend to fret less about transaction costs when their asset has appreciated wildly.