Editor’s note: This is part one of a three-part series discussing important issues organized real estate is facing and possible strategies for resolving them. The author argues that interbroker compensation should be done away with and in part one explains why this should be done right away. Part two will discuss how the world will work without interbroker compensation, and part three will look at the future of the MLS in that world.

Editor’s note: This is part one of a three-part series discussing important issues organized real estate is facing and possible strategies for resolving them. The author argues that interbroker compensation should be done away with and in part one explains why this should be done right away. Part two will discuss how the world will work without interbroker compensation, and part three will look at the future of the MLS in that world. (Read Part 2 and Part 3.)

“It’s the end of the world as we know it, and I feel fine.” – R.E.M.

The real estate industry now operates multiple listing services that not only draw attacks for suppressing competition, but also have at their core a service that is obsolete and inefficient: the communication of interbroker compensation offers.

The essence of the MLS for more than 30 years has been the offer of cooperation and compensation. The National Association of Realtors includes the offer of compensation in its definition of MLS, considering services without compensation mere “exchanges.” Even broker-owned MLSs not affiliated with NAR generally require that listings input in the system must have offers of compensation.

I’ve argued for five or six years that interbroker compensation should go the way of the MLS book and broker subagency. Recent events persuade me that the industry is ripe for this change now.

Core purpose of MLS — A 35-year-old model

The MLS model of the 1960s and ’70s made sense because at the time, nearly all brokers involved in transactions represented the seller either as the seller’s agent or as the subagent of the listing broker. Listing brokers got paid by sellers; listing brokers could therefore compensate brokers working with buyers.

This all changed in the late ’80s and early ’90s because of the arrival of exclusive buyer agents, who represent the buyer in the transaction rather than the seller or seller’s broker. Also, listing brokers became more concerned about vicarious liability, a legal theory that says that the listing broker is legally responsible for misdeeds of cooperating brokers who are subagents. And under pressure from Realtor organizations, state legislatures began fashioning non-agency forms of representation; depending on state law, these “facilitators” and “transaction brokers” do not owe traditional agency duties to buyers or sellers.

NAR kept up with the times. It clarified, first, that MLSs had to allow exclusive buyer agents (EBAs) to participate — sometimes over the objections of incumbent listing brokers, who complained EBAs “came to the potluck with a fork but no dish to pass.” Later, NAR clarified that the offer of compensation through MLS could extend to cooperating brokers representing buyer brokers and cooperating brokers “acting in a non-agency capacity defined by law.” In light of these changes, most listing brokers moved away from subagency, preferring to compensate other brokers as buyers’ agents and non-agents.

As a result, the vast majority of listing brokers no longer offer subagency to other brokers. With the demise of subagency, there is little reason to keep interbroker compensation. There are also affirmative reasons to get rid of it.

Seller pays but does not receive service

It does not make sense for listing brokers to pay buyers’ brokers for the services the latter provide to buyers. This is a bit like the lawyers working for one side in a transaction paying the lawyers working for the other side. It may happen, but it would not be anyone’s first choice. In fact, there are rather complicated rules about what happens when a lawyer working as the fiduciary of one person is being paid by another person who is not his client.

Faced with the prospect of creating a real estate market from scratch, who would embrace this model? In fact, there are real estate markets being created from scratch, throughout the former eastern block and Soviet Union. By and large, the brokers there do not embrace interbroker compensation. One acquaintance of mine, a frequent advisor to real estate organizations in those developing economies, put it this way: “(Interbroker compensation) is the toughest concept to get across — they just don’t get it.” I know my friend is a good teacher — so I conclude that what my friend is trying to teach does not make sense to folks who did not grow up with sub-agency.

Constraining the nature of broker relationships

Interbroker compensation through MLS imposes unnecessary constraints on the relationships that buyers’ brokers can form with buyers. Here are examples of how that’s true:

First, imagine that Stirling Realty has a great reputation for providing excellent buyer representation. It believes that its services to the buyer are worth 3 percent of the sale price on most residential transactions. The prevailing cooperating compensation offered in the MLS where Stirling participates, however, is only 2.1 percent. (I use the term “prevailing” here to mean the average or market-rate compensation, acknowledging that neither brokers nor MLSs can establish a standard commission.) If Stirling sells another broker’s listing, Stirling will have to arrange for additional compensation to be paid separately, either by the buyer or by the seller. This separate compensation will not be subject to Realtor arbitration if not paid; if there is a dispute about compensation in the transaction, Stirling might have to bring separate actions against the listing broker (through Realtor arbitration) and against the buyer. This is unnecessarily complicated.

Second, imagine that Buyer First Realty has developed a model for working with buyers that costs a flat $3,000, regardless of the purchase price of the home. Buyer First helps its buyer find a home, which the buyer purchases for $500,000 and on which the listing broker has offered a 2.4 percent cooperating commission (the prevailing rate in that MLS). Buyer First is entitled under the MLS offer of compensation to a payment of $12,000 from the listing broker. At closing, Buyer First wants to give $9,000 of that back to the buyer. Because the money comes to Buyer First at closing, Buyer First now has to comply with RESPA regulations to pay the rebate to the buyer; in some states, the rebate itself would be considered illegal. In the absence of interbroker compensation, Buyer First would just not charge the $12,000.

Third, imagine that Nifty Builders, a residential construction firm, has a wholly owned subsidiary brokerage firm, Nifty Brokers, that markets its listings. Nifty Brokers would rather not pay cooperating brokers at all but is willing to offer 2.1 percent cooperating compensation to other brokers, the prevailing rate in the MLS where it operates. In return it wants cooperating brokers to be present with the buyers to advise them during the process of selecting finishes, developing a budget for options, etc. Nifty is tired of agents showing up for the first appointment at the construction sales center and then never showing up until closing. Under NAR MLS policy, Nifty cannot condition the compensation it offers other brokers on them performing specific tasks; all that matters in interbroker compensation is whether the cooperating broker was the procuring cause of the sale. There is a way around this for Nifty (which I’ll save for another column), but it can be confusing for everyone involved.

Discouraging buyer rep agreements

Interbroker compensation discourages buyer brokers from entering into buyer representation agreements with their buyers. I have recently given lectures to brokers in three states where I asked the brokers present to indicate by show of hands whether they require buyer representation agreements with all or nearly all buyers before they begin showing them homes. In each case, fewer than a third of the brokers present raised their hands.

A good buyer representation agreement provides numerous protections and advantages to the buyer’s broker: It offers some remedies for problems associated with working with unrepresented sellers (we’ll save the details for later). It permits the buyer’s broker to spell out the boundaries of her representation of the buyer. And it can be critical in ensuring that the buyer’s broker gets paid if there is a dispute about procuring cause. In some states, without a buyer rep agreement, the broker may not be entitled to receive compensation — from buyer, seller or listing broker — at all.

Buyer brokers get away with not having buyer representation agreements — even in states where the law requires them — because they are assured payment by the listing broker through the MLS.

Danger of price fixing

Normally, antitrust regulators frown on competitors publishing their prices to each other, because it makes price fixing easy. Assume, for example, that a large broker in Midtown MLS, where the prevailing cooperating compensation is 2.4 percent, has decided it wants to pay cooperating brokers less. It starts putting its listings into MLS at 2.1 percent cooperating compensation; it waits a few weeks to see if other market-leading brokers follow suit in lowering their compensation. If they do, great, the change sticks. If not, the large broker can raise its compensation back to the market rate. In this way, a few market-leading brokers can establish the market-rate cooperating compensation without ever speaking directly to each other. They can just watch what happens on MLS.

Thanks to the MLS offer of compensation, listing brokers effectively are able to fix service prices of buyers’ brokers; many buyers’ brokers are loathe to collect more than what is offered in MLS, even if the broker has a written agreement with the buyer providing for a higher payment.

Criticism from outside

Just because folks don’t agree with us on some issues does not mean that everything they say is wrong.

The first of a recent round of criticisms came from the Government Accountability Office report of August 2005. Some of the GAO’s comments echo what I have said here. For example:

“While MLSs provide important benefits to consumers by aggregating data on homes for sale and facilitating brokers’ efforts to bring buyers and sellers together, the cooperative nature of the MLS system can also in effect discourage brokers from competing with one another on price…. As previously noted, MLSs facilitate cooperation in part by enabling brokers to share information on the portion of the commission that sellers’ brokers are offering to buyers’ brokers…. When choosing among comparable homes for sale, brokers have a greater incentive — all else being equal — to first show prospective buyers homes that offer other brokers the prevailing commission rate than homes that offer a lower rate. Therefore, even without formal policies to maintain uniform rates, individual brokers’ reliance on the cooperation of other brokers to bring buyers to listed properties may help maintain a standard commission rate within a local area, at least for buyers’ brokers.”

The GAO report also notes:

“Further, some states prohibit brokers from giving clients rebates on commissions, and some states require or are considering proposals to require brokers to provide consumers with a minimum level of service. Although such laws may offer some consumer protections, DOJ and FTC have argued that they can potentially prevent price competition or reduce consumers’ choice of brokerage services.”

An AEI-Brookings report, authored by Bob Litan and others, appeared in November 2005 and was the subject of a New York Times editorial by Litan in June 2006. The Brookings report notes:

“First, we believe that the involvement of multiple parties and the unique splitting arrangements make it difficult for buyers and sellers to pay for services according to their needs. Second, the commonality of the structure across firms and its persistence over time suggest the possibility that alternative models have not had a fair chance to compete.”

The Brookings report further noted:

“Commission rigidity results in a socially wasteful oversupply of underproductive agents in high-priced cities, compared to lower-priced ones.”

The Consumer Federation of America released a very unflattering report called “How The Real Estate Cartel Harms Consumers And How Consumers Can Protect Themselves” in June 2006. Many of the assertions in the document were entirely unsupported by documentary evidence. Some of their comments were nonetheless provocative. For example: “If sellers and buyers each separately negotiated compensation with their brokers, uniform 5-6 percent commissions would quickly disappear.”

The CFA continued: “Traditional brokers not only continue to oppose separate buyer and seller compensation but also have vigorously promoted state anti-rebate laws which prevent brokers working with buyers from rebating a portion of the… commission split to their clients.” It is true that organized real estate has championed anti-rebate regulations in some states. But I do not believe that traditional brokers “continue to oppose separate buyer and seller compensation.” In fact few brokers have discussed the issue, and the ones with whom I’ve discussed it would happily get rid of interbroker compensation tomorrow.

Brokers don’t like it

I gave a presentation to a large national brokerage concern last year. Before my talk, I heard the participants discussing the problems they experienced with paying out and collecting interbroker compensation: disputes about the amount of compensation due; complaints about the time between closing and payment of the compensation; tracking payments to be made and received; and even arguments about whether any compensation was due at all. Before I began my talk, which was on a different topic, I asked them whether their lives would be easier if there were no interbroker compensation. Every one of them said “yes.”

Consider this: Every broker being paid through the MLS by another broker has to track amounts due and follow up on payments. Doesn’t it make much more sense for buyer’s broker and seller’s broker to be able to walk away from the closing table with the money due them?

Conclusion to Part I

Interbroker compensation is an anachronism, and for the reasons I’ve noted above it should be eliminated. Getting rid of it means ceasing to be MLSs, at least from NAR’s perspective. But if indeed this would be the end of MLS as we know it, how do we survive the end?

Brian N. Larson is an attorney practicing in Minneapolis. The views expressed in this column are not intended as legal advice and do not necessarily represent the views of Larson’s firm, his clients, or their affiliates. Larson can be reached at fls@larsonlegal.com. He will aggregate and analyze responses to this series and present them in an article in the coming weeks.

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