THE PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES: A REVIEW OF THE EVIDENCE, SUCH AS IT IS

Transcription

1 THE PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES: A REVIEW OF THE EVIDENCE, SUCH AS IT IS JOHN C. WEICHER* Introduction This paper discusses the available information on the cost of real estate brokerage to consumers. Economists, at least, are particularly interested in the question of whether the brokerage market is competitive, a question that has become especially important in the context of the Department of Justice anti-trust suit against the National Association of Realtors (NAR), concerning internet access to Multiple Listing Service (MLS) databases. 1 There is a fairly widespread view that brokerage is not a competitive industry, a view shared by publications as diverse as the Wall Street Journal and the New Republic. 2 This opinion is based on several perceptions: commission rates are too high for the work involved, and are sticky downward even as technology reduces the * John C. Weicher is Director of Hudson Institute s Center for Housing and Financial Markets. Dr. Weicher would like to thank Xiuyue Zhu for research assistance; Jesse Gurman, Norman Hawker, Austin Kelly, and Thomas G. Thibodeau for providing copies of various studies; and Peter F. Colwell for helpful comments on the literature. 1 U.S. Department of Justice (2005). 2 See for example Wall Street Journal (2005), Murray (2005), Hagerty (2005), and Risen (2005). Evans (2005) lists several other publications, including USA Today, Computer World, the Washington Post, Time Magazine, and Forbes, and also The Tonight Show and The Today Show on NBC. 119

2 120 REAL ESTATE LAW JOURNAL [VOL. 35: ] broker s cost; 3 commission rates are higher in the U.S. than other countries; NAR and state Realtor associations lobby vigorously for state laws to restrict competition, for example by setting minimum commission rates and by requiring that brokers provide full service; NAR has successfully lobbied Congress to prohibit banks from entering the real estate brokerage business; and NAR restricts access to the MLS by discount and internet brokers. 4 In response, industry advocates argue that: commission rates are highly variable and have been declining for over a decade; the number of real estate brokers and agents is increasing, and entry to the industry is easy; brokerage practices and state regulations are hardly limiting the market, since existing home sales are at record volumes; 5 real estate brokers bear substantial marketing costs with no guarantee of a sale; bank entry into brokerage will bene t the banks and the Federal treasury, but not consumers; and homes are unique while other goods sold over the internet, such as stocks and airline tickets, are a commodity where one share or ticket is the same as the next. 6 A number of these issues are being addressed by other papers at this conference. Hahn and Litan describe a number of state laws and regulations and industry practices that appear too many economists and antitrust lawyers to be anticompetitive trade restraints, and have analyzed their impact. 7 Delcoure and Miller compare brokerage costs in the United States with other developed countries. 8 Lande and Marvel address an important question that must occur to any economist (and has been studied by several): how a cartel can be effective with free entry into the industry. 9 This paper therefore excludes these subjects, although the review of the literature necessarily impinges on several of them. My focus is empirical. A number of economists have created formal models of brokerage to illuminate various aspects of the brokerage market. Some have concluded that brokerage commis- 3 Murray (2005); Bahney (2005). 4 Hagerty (2005). 5 Lereah (2005). 6 Evans (2005). 7 Hahn and Litan (2005). 8 Delcoure and Miller (2000). 9 Lande and Marvel (2000).

3 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 121 sions are well above the competitive market equilibrium. 10 Others have argued that there is a simple economic rationale for the observation that real estate commission rates seem to exhibit remarkable rigidity, in that higher commissions may result in greater e ort by the broker or agent to sell the house. 11 To my knowledge, neither of these models, nor any of a variety of others, has been empirically tested; nor am I in a position to test them in this paper. It is my belief that a model should be tested empirically, even if the formal analysis yields insights that correspond to market behavior in a qualitative sense, but that has simply not been possible in most cases. The paper is essentially a review of the limited empirical evidence. It rst reports the available time-series data on brokerage commissions, with some attempt to interpret the data despite its shortcomings. It then discusses the cross-sectional, primarily academic literature on commissions in various markets. There is not much. The data are usually proprietary and not readily available to the public or to academic analysts. This is undoubtedly the main reason for the overwhelming preponderance of theoretical studies. To quote one economist who attempted to obtain commission rate data in order to test his model, It s been one stonewall after another. 12 Time-Series Data: The REAL Trends Survey Apparently the only source of information over time on real estate commissions is a survey conducted annually by the industry publication and communications company, REAL Trends. Unfortunately, this survey is not publicly available. The data are compiled from the larger real estate brokerage rms, which consider the information proprietary and will not allow it to be published. REAL Trends has historically made some information public, but changed its policy in 2004, according to Steve Murray, co-founder and co-editor, and will no longer disclose it publicly: Based on new privacy policies we put in place last year for our entire range of publications we cannot use the commission information publicly any further. So although we still collect the data for all of these rms we cannot and will not use it in any other fashion than for verifying the inputs from 10 See for example Anglin and Arnott (1999). 11 Bruce and Santore (2004, p.10). 12 Roberts and Mara, quoting Bruce (2005).

4 122 REAL ESTATE LAW JOURNAL [VOL. 35: ] brokerage rms. 13 Commission rates are available only from secondary sources, which report average commission rates for one or two years and identify REAL Trends as the source of the information. I have compiled these reports primarily from the internet; the data that I have been able to locate appear in Table 1, with the secondary source identi ed. Table 1 indicates that there has been a downward trend in the average commission rate between 1991 and Roughly speaking, the average commission was about six percent or a little more in 1991, and also about six percent in 1995; it declined to about 5.5 percent by 2000; then it dropped sharply to slightly above ve percent in 2001 and has remained at that level since then. There are several limitations to these data, and some reasons to question the accuracy of the information as reported. REAL Trends surveys the largest brokers, the Top 500, including ties. (The actual number of rms in the Top 500 was 532 in 1998 and 541 in 2003, according to GAO.) These Top 500 rms accounted for 27.6 percent of all new and resale home transactions in 2001, according to REAL Trends. It is not necessarily true that the largest rms are typical of the industry. Besides the Top 500, REAL Trends collects information from an additional group of Up-and-Comers, ranking in size just below the Top 500. The number of Up-and-Comers seems to be variable; it was 335 in The average home sales price reported by REAL Trends is high relative to the market. In both years, the REAL Trends average was about 13 percent above the average for existing homes sold, as reported by NAR, and about 0.5 percent above the average for new homes sold, reported by the Census Bureau. The REAL Trends gure was about 11 percent above the weighted average for new and existing homes combined in 2002, and about 9 percent in (See Table 2.) A possible partial explanation is that the NAR series is limited to single-family homes, while REAL Trends apparently includes condominiums, but this is hardly enough to account for the di erence. It appears that the REAL Trends survey is weighted toward more expensive homes as well as large brokers. Besides the inherent limitations in the survey itself, there are some discrepancies in the reported data. Although the survey results 13 Roberts and Mara (2005). 14 The survey apparently began in 1988, but the rst year for which I have found any data is 1991.

5 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 123 are proprietary and REAL Trends does not make them public, there is nonetheless a web page posted by REAL Trends reporting some summary information for 2002 and 2003, apparently taken from the May 2004 issue of the REAL Trends monthly newsletter. 15 These data include average commission rates by rm size and by region. They are shown in Table 3. Although various published secondary sources report an average commission of about 5.1 percent for both years, the actual average commission is below 5.1 percent only for the top 100. It is well above 5.1 percent for the remaining 400 rms in the Top 500, and also for the Up-and-Comers. The average commission rounds to 5.1 percent only if the top 100 and the remaining 400 have about equal shares, or the top 100 accounts for more than half of the transactions for the entire group. 16 Some further reason to question the 5.1 percent also appears in the regional data. In both years, the average commission is below 5.1 percent only for the Middle Atlantic and Far West regions, which together comprise 11 states and the District of Columbia. Southern and Midwestern states, which account for about 60 percent of annual existing home sales, have average commission rates well above 5.1%. If the regional Real Trends commissions are applied to the NAR regional distribution of existing home sales, the 2002 average commission would be between 5.27 and 5.40 percent, and the 2003 average commission would be between 5.19 and 5.31 percent. 17 A further complication arises because the same average commission rate is cited by di erent sources for di erent years. For 15 These data are at ( newsletters.asp?article=newsletters/ htm). 16 The varying data on coverage by size of rm may cause some misinterpretations of the average commission. The veteran real estate reporter Ken Harney, for example, reports that the average commission in 2003 was 5.06 percent (Harney, 2004), based on data from nearly 900 of the largest real estate brokerage rms across the country. This is exactly the reported average rate for the Top 50 rms, and is lower than the average for any larger number of rms. Harney accurately reports the average commission rates by region that appear on the website. 17 These calculations match the REAL Trends and NAR Midwest regions and match the REAL Trends Southeast region with the NAR South region. The lower numbers multiply the REAL Trends Middle Atlantic average commission by the NAR Northeast region share of existing home sales, and the REAL Trends Far West average commission by the NAR West region share; the higher numbers multiply the REAL Trends Northeast average commission by the NAR Northeast region share of existing home sales, and the REAL Trends Southwest/Mountain average commission by the NAR West region share. The regional divisions are not identical (Texas and Virginia are in dif-

6 124 REAL ESTATE LAW JOURNAL [VOL. 35: ] example, Lehmann (2005) states that the average commission in 2000 was 5.48 percent, but Kannon Consulting (2004) assigns this average to the year 2001, when other sources state that the average was about 5.1 percent. This confusion may occur because REAL Trends itself refers to surveys both by the year for which the data are collected and the year the survey is reported. The data reported in Table 3, for example, are listed by REAL Trends as the 2004 REAL Trends 500, when published in April For this reason, when the same gure is cited by two di erent sources for two di erent but consecutive years, I have assigned it to the earlier year in Table 1. Interpreting the Data During the last 14 years, home prices have risen while commission rates have apparently been falling. The nominal increase in the average existing home price has outpaced the decline in the average commission reported by REAL Trends, so the dollar value of the average commission has been increasing. However, when house prices are adjusted for in ation, the real dollar value of the average commission declined from 1991 through 1998, and then rose in most years until These data are shown in Table 4. While the average commission rate declined by 16 percent between 1991 and 2004, the average commission in real dollars increased by 11 percent. The average real commission declined by about seven percent until 1998, and then rose by 19 percent through However, it was not until 2003 that the average real commission exceeded the 1991 level. During the same period, there were large, steady increases in existing home sales volume as well as existing home prices. Between 1991 and 2004, nominal average prices nearly doubled, and the total dollar value of existing home sales nearly quadrupled. The 16 percent decline in the average commission reported by REAL Trends, and the 39 percent in ation over the period, together o set part of this increase; total nominal commission income may have risen by 230 percent, and total real commission income by about 140 percent. NAR reports a substantial but much smaller increase in the annual nominal incomes of both brokers and agents; median ferent regions in the two groupings), but these di erences do not a ect the basic conclusion. 18 However, Kannon also reports that the 2002 average commission was 5.12 percent, which is consistent with Lehmann and also Roberts and Mara.

7 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 125 agent income more than doubled, and median broker income increased by about 75 percent, from 1992 through Thus it might be reasonable to expect a substantial increase in the number of agents and brokers, especially since it is generally believed that the occupational barriers to entry are low for real estate agents and for brokerage rms. 20 The reported downtrend in commission rates has been attributed variously to rising employment and to changing technology. Given the quantitative and qualitative limitations on the commission data, it is not worth attempting any serious discussion of either hypothesis. But even if the commission data are taken at face value, there are limitations in the employment data. The most consistent time-series on employment come from two surveys conducted by the U.S. Bureau of Labor Statistics (BLS), the Current Population Survey and the Current Employment Survey. The former surveys households and asks about the occupations of members; it publishes the total number of individuals in real estate sales occupations, including the self-employed as well as employees. The latter surveys business establishments and includes employed workers only; it publishes the number of workers in o ces of real estate agents and brokers, and also the number who are production workers, which may correspond to actual brokers and agents as opposed to administrative sta. 21 As might be expected, the total including the self-employed is about three to four times the total of employees only; other data suggest that the self-employed far outnumber employees. 22 The three series move very closely from year to year; the simple correlation coe cients are all above y.90. All three also show a generally rising trend in employment since 1990, during periods 19 Roberts and Mara (2005). 20 GAO (2005, p.8). 21 The CPS series is reported annually at ftp://ftp.bls.gov/pub/ special.requests/lf/aa200x/aat11.txt for years since 2000, and ftp://ftp.bls.gov/ pub/special.requests/lfaa9x/aat11.txt for earlier years; years before 1995 are not available at the BLS website, but have been provided by Sharon Cohany of BLS. The COS series IDs are CEU for total employees and CEU for production workers, available on the BLS website at 22 Another BLS data series, the National Employment Matrix, reports selfemployed brokers and agents as well as employees, between 1983 and The number of self-employed ranges from two to four times as many as the number of employees.

8 126 REAL ESTATE LAW JOURNAL [VOL. 35: ] when reported commission rates were stable and during years of decline. Further, all show accelerating increases over time. The increase was smallest between 1990 and 1995, when according to the REAL Trends data commission rates were stable; it was greater between 1995 and 2000, when reported commission rates were falling; and it was still greater between 2000 and 2004, when reported rates stabilized again. It is hard to see these patterns as evidence that rising employment has driven down commissions. If that were the case, commission rates should have fallen further after Much better information, particularly about commissions, will be needed to test any hypothesis about employment and commission rates. With respect to technology, the data are not extensive enough to test any relationship between technological changes and commission rates. 23 The Cross-Sectional Literature There is somewhat more empirical evidence on brokerage commission rates from academic studies, but still one is struck by the paucity of research. In their exhaustive bibliography ve years ago Benjamin, Jud and Sirmans (cited hereafter as the BJS bibliography) list 14 studies of commission rates over a period of 18 years. Nine of these are classi ed as theoretical papers with simulation results, one is a theoretical paper without further quali cation, and only four actually have empirical results. 24 For all of the other topics surveyed in the bibliography, empirical studies predominate. To my knowledge, there are no later studies of commission rates, and the only other earlier one is a report by the Federal Trade Commission (1983). 25 The data in this handful of empirical studies are for transactions that occurred between 1975 and 1992; only one has transactions later than GAO notes, Our review cites a number of 23 There is some reason to think that the internet s impact on brokerage is not necessarily negative, from the broker s standpoint. Zumpano, Johnson and Anderson (2003) nd empirically that homebuyers who search the internet are more likely to employ brokers than buyers who do not. They do not investigate the relationship between internet usage and commission rates. They speculate that the internet may increase agent productivity, as well as changing the agent s role. 24 Another empirical study, by Larsen and Park (1989), is included in the references of the BJS bibliography (BJS, 2000:1, p. 275), but not listed or discussed in the text. 25 Neither GAO (2005) nor Hahn, Litan and Gurman (2005) mention anything since the BJS bibliography; nor is anything more recent listed in Econ-Lit.

9 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 127 academic studies that date back many years because, in large part, there is not a large body of more recent research on the real estate brokerage industry. 26 GAO goes on to say that the older and more recent research ndings are consistent with each other, and with the statements in interviews conducted in the course of their study. The most extensive of these studies is also the earliest. The FTC compiled information from HUD-1 forms for a number of metropolitan areas in 1975, 1978, and Data from 16 areas was collected in one or more years, for a total of 23 city/year samples. 27 FTC reported the distribution of the commission rate data in each sample; 28 subsequently, Carney (1982) conducted some statistical analyses of the data. FTC distinguished between stated commissions, those listed as a percentage on the HUD-1, and calculated commissions, where the HUD-1 reports the dollar amount of the commission as well as the sales price of the house. Calculated commissions tended to be lower, and showed more variability. FTC also conducted a survey of a national sample of home sellers in , nding that 85 percent were quoted a commission rate of either 6 percent or 7 percent. About nine percent of sellers ended up paying somewhat less than the quoted rate when the transaction actually occurred. Table 5 summarizes the FTC data for the calculated commission rates in individual markets. FTC reported the full distribution only for sales of existing homes. The distribution shows the modal commission rate, and the proportion of transactions that took place at that commission. As the table shows, the mode was always an integer, either 6 or 7 percent. In all but one sample, more than half the transactions took place at the mode; in eight, the proportion was 80 percent or more. On average across the 23 samples, 64 percent of transactions occurred at the local mode. FTC did not report the usual descriptive statistics for the distribution; those are taken from Carney s article. 29 Not surprisingly, the mean rate is nearly always quite close to the mode, and in all but three samples, slightly lower. The standard deviations range from 0.4 percent to 1.5 percent; the unweighted mean standard deviation is 0.96 percent. There is some- 26 GAO (2005, p.9). 27 The FTC also collected a large sample of HUD-1 data on the state level; because these cannot be attributed to individual markets, they are excluded from this paper. 28 FTC (1983, pp.44-52). 29 Carney (1982).

10 128 REAL ESTATE LAW JOURNAL [VOL. 35: ] what more dispersion among the smaller samples (shown at the bottom of the table); for samples of at least 50 transactions, the unweighted mean standard deviation is 0.90 percent. Eighteen of the 23 samples have standard deviations between 0.8 and 1.2 percent. The 1975 FTC are drawn from all lenders located in the central counties of each Standard Metropolitan Statistical Area; it is not clear if the loans are also limited to homes in these counties. The 1978 and 1979 samples are limited to lenders located in the cities, but the data extend beyond the city boundaries because lenders made some loans outside them. In addition, the FTC separately sampled listings from more than one local MLS in some markets. In Los Angeles and Seattle, listed rates were highly concentrated at the same rate for all MLS, but in Boston and the Twin Cities there were di erences. About 70 percent of listings for Greater Boston carried a rate of 6 percent, while listings for Quincy/South Shore were split about evenly between 5 and 6 percent. Similarly, in Minneapolis, 85 percent of listings had a commission of 7 percent, while in St. Paul listings were split about evenly between 6 and 7 percent. 30 Apart from the FTC survey, the limited academic literature can be easily characterized. Professors of real estate and related elds have collected transaction data in the areas where they live and work. The well-known aphorism, all real estate markets are local, can perhaps be supplemented by, all research on real estate brokerage commissions is local. These are studies of local markets by local faculty or graduate students. A corollary is that all of the studies necessarily pertain to college towns. (This also applies to empirical studies of other real estate brokerage topics, such as the commission split between the listing and selling brokers, and the time a home is on the market before it is sold, as can be seen in the BJS bibliography.) The descriptive statistics for the academic studies are summarized in Table 6. Larsen and Park (1989) collected information on 669 home listings in Lincoln during the rst nine months of Of these listings, 433 were sold and the data include the actual sales commission; the data in Table 6 refer to the actual sales only. Larsen and Park report the selling broker s share of the commission, not the 30 FTC (1983, p.53) 31 Both Larsen and Park were on the faculty of Wright State University in Dayton when the paper was published, but Larsen had received his Ph.D. at the University of Nebraska.

11 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 129 total commission. They report that the selling broker s share is nearly always 40 percent, with rare exceptions. 32 Their data bear this out. Larsen and Park, unlike the other studies, report the full distribution of brokerage commissions in their sample. Some 84 percent of sales transactions have a 2.8 percent selling broker s share, implying a 7 percent commission. 33 For purposes of comparison, I have in ated the data to represent the full commission in Table 6. At about the same time, Goolsby and Childs (1989) analyzed commission rates in Knoxville, using two samples totaling 275 transactions from 1983 and They also looked at the share of the commission to the selling broker, which in Knoxville as in Lincoln was nearly always 40 percent. They do not report the distribution of commission rates or the mode, but it appears that the standard commission in Knoxville was apparently six percent rather than the seven percent in Lincoln. Goolsby and Childs report a mean selling broker s share of 2.36 percent, with a standard deviation of 0.33 percent, equivalent to a mean commission of 5.90 percent with a standard deviation of 0.8 percent. A few years later, Sirmans, Turnbull and Benjamin (1991) analyzed commission rates in Baton Rouge over , using a sample of 1,275 transactions limited to two subdivisions. 35 They also do not report a mode or a distribution of commissions, but the mean rate of 5.81 percent suggests a mode of 6 percent. The standard deviation is reported as 0.6 percent. The only other academic empirical study, by Sirmans and Turnbull (1997) for Baton Rouge between 1985 and 1992, does not report descriptive statistics. Comparison of Tables 5 and 6 shows that the standard deviations for the data in the individual market studies are generally lower than for the FTC data. Only two FTC samples have standard deviations as low as or lower than those reported by Larsen and Park and by Sirmans, Turnbull and Benjamin. Only three are lower than the 0.8 percent reported by Goolsby and Childs; ve others are also Larsen and Park at 428 (1989) 33 The same is true for 96 percent of those not sold (the di erence suggesting that there may be some exibility in commission rates when there is a distinct possibility of a sale). 34 Goolsby was a professor of nance at the University of Tennessee at the time. 35 Sirmans and Turnbull were professors of nance and economics, respectively, at Louisiana State University, and Benjamin was a graduate student.

12 130 REAL ESTATE LAW JOURNAL [VOL. 35: ] All of the academic studies, including Carney, go beyond the FTC survey methodology and attempt to identify factors that a ect commission rates. Carney analyzes commission rates by each factor separately, while the other studies report results for multivariate regressions with the rate as the dependent variable. The most important results of these statistical and econometric analyses are shown in Table 7. New homes are often marketed through di erent arrangements than the standard brokerage model for existing homes. Builders may sell the homes directly, through sales people who are employees, or by contract with an independent brokerage rm which handles all homes in a subdivision. 36 Builders may therefore be in a position to pay a lower commission because of the volume of business they are o ering the rm, and to simply pay their employees less than an independent broker would charge. All of the studies except perhaps Sirmans, Turnbull and Benjamin include new homes as well as existing homes. 37 (The FTC data in Table 5 is limited to existing homes, but the FTC also collected data on new home sales, which Carney includes.) All nd that commissions are higher for sales of existing homes. In the 10 FTC samples where the sample size for both new and existing homes is at least 20 transactions, the unweighted mean di erence is 1.6 percent. In Baton Rouge, Sirmans and Turnbull nd a di erence of about 0.6 percent. Goolsby and Childs treat age of home as a continuous variable, so a similar calculation is not feasible. Carney also nds more dispersion in commissions for new homes; the standard deviations are higher by 0.7 percent, on average, almost double the mean standard deviation for existing homes, and the di erence is signi cant in seven of the 10 samples. A second factor is whether the same broker both lists and sells the home. Listing brokers typically o er a share of the commission to the broker who brings in the buyer (60 percent in Lincoln and Knoxville in the 1980s, for example). For some sales, the listing broker is also the selling broker, and the commission may be lower; Carney suggests that listing brokers may withhold listings from the MLS if they expect to be able to sell the home relatively quickly, 36 Carney (1982). 37 Sirmans, Turnbull and Benjamin do not state speci cally that their data are limited to existing homes, but all transactions occurred in two subdivisions, and the mean age of homes sold was seven years. Whether the data include new homes or not, the analysis does not include age of home as an independent variable in the regression explaining commission rates.

13 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 131 thus incurring lower costs; they will also be able to keep the full commission. Carney terms the case where the listing broker works with a selling broker as a co-op transaction, and the case where the listing broker is the selling broker as a non-co-op sale. Carney nds that co-op sales have higher commission rates in all of the FTC samples, and signi cantly higher rates in eight of the 16 where the sample size in each category is at least 20 transactions. The unweighted mean di erence is 0.9 percent for the 16 larger samples. Goolsby and Childs, however, nd no signi cant di erence, to their surprise. The two Baton Rouge studies do not distinguish co-op and non-co-op sales. Carney does not crossclassify type of brokerage by age of house, and it is clear from the two-way tabulations that there are new homes in both categories in most if not all of the samples, but none of the ve samples with fewer than 10 new homes have a signi cant di erence between co-op and non-co-op commission rates. This pattern, combined with the Goolsby and Childs result, suggests that the measured e ect of type of brokerage may in fact re ect the di erence between new and existing home sale arrangements. Commission rates are generally expected to vary inversely with house price, on the basis that the e ort needed to sell a home is not proportional to the price of the house; although it is also argued that the market for high-priced homes is smaller and therefore more effort may be needed to sell a home at or close to the seller s reservation price. 38 Carney nds lower rates on higher-priced homes in 14 of 19 samples, including six of the seven with statistically signi cant di erences. (The exception is Jacksonville.) The other studies all also nd negative relationships. The magnitude of the e ect is not clear, because the studies use di erent formulations, but it appears to be small. Goolsby and Childs nd that the commission rate declines by about 0.06 to 0.11 percentage points for each $10,000 increase in home price, e.g. from 5.90 percent to 5.84 or 5.79 percent. Sirmans, Turnbull and Benjamin use the natural logarithm of house price, and nd that the commission rate declines by about 0.04 percentage points per $10,000 increase in price around the mean price of $92,000 in the sample, e.g. from 5.81 percent to 5.77 percent. Sirmans and Turnbull s later study of Baton Rouge uses both the price and the square of the price to test for non-linearities, and nds that price declines at a decreasing rate. The net e ect is that commission rate declines by about 0.02 percentage points per 38 Carney (1982) discusses these relationships.

14 132 REAL ESTATE LAW JOURNAL [VOL. 35: ] $10,000, for sales prices around $100,000, e.g. from 6.00 percent to 5.98 percent. Carney simply reports correlation coe cients between home price and commission rate. The length of time that a home is on the market is important to the seller as well as the sales price; indeed, days on market is one of the research categories in the BJS bibliography. The paper by Sirmans, Turnbull and Benjamin, which develops a three-equation simultaneous model to explain house price, commission rate, and days on market, nds a positive e ect for days on market in the commission rate equation; the longer it takes to sell the house, other things being equal, the higher the commission rate. They also nd that the higher the commission rate, other things being equal, the longer it takes to sell the house. The papers by Goolsby and Childs, and by Sirmans and Turnbull, both use single-equation models of the commission rate, and nd no relationship with days on market. Larsen and Park reverse the relationship, treating the commission rate as an independent variable in an analysis of time on market before sale. They nd a negative relationship between the size of the commission and the probability that a property will sell at any given time. Houses with lower commissions sell faster. This is the opposite result from Sirmans, Turnbull, and Benjamin. The two Baton Rouge studies relate the size of the brokerage rm to the commission rate. The earlier paper nds no relationship, while the later nds that large rms charge higher commission rates. The purpose of the Sirmans and Turnbull paper is to test a theoretical model relating commission rates to changes in the housing market. They focus on the cyclical behavior of commission rates, hypothesizing that rates rise during booms and fall during recessions. Their results show that pattern: contract commission rates rose during the early years, shortly after the collapse of oil prices, and then began falling in the later 1980s. Also, contract commission rates are negatively related to employment. The better the economy, the lower the commission rate. 39 Thus to summarize the ndings, commission rates appear to be lower on higher-priced houses and lower on new homes. The evidence is mixed on whether rates are lower when the listing and sell- 39 In the model developed by Sirmans and Turnbull, this result is to be expected because an increase in the demand for houses results in a greater number of sales at higher prices and an increase in the number of brokers, driving the commission rate lower. The possible o setting e ect theoretically, an increase in industry costs driving up costs for individual rms, is not strong enough to generate the opposite empirical result.

15 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 133 ing broker are the same, and whether they are di erent for houses that take longer to sell. The one study that looks at rates in a macroeconomic context nds that they are higher in recessions and lower in booms. Limitations of the Cross-Section Literature Unfortunately for the purposes of this paper, there are limitations to most if not all of these studies which a ect their value or relevance for the purposes of the present paper. As noted, Larsen and Park do not try to explain the commission rate; their interest is in explaining the number of days on the market. While they report the full distribution of commission rates, they do not attempt to explain why some rates are higher or lower than the 7 percent norm in Lincoln. Thus they have no ndings to be included in Table 7. The analysis by Goolsby and Childs su ers from multicollinearity problems. The selling broker s share is the dependent variable (termed R); one of the independent variables is the selling broker s commission multiplied by the list price (E}RL); and another is the sales price (S). The variable E (commission x list price) is very highly correlated with S (selling price); the simple correlation coef- cient is y0.93. In the regression analysis, the following patterns appear: (1) the coe cients for E (itself a function of the dependent variable) have very high t-ratios, between 15 and 50, with positive coe cients; (2) the coe cients for S, highly and positively correlated with E, also have very high t-ratios, between 15 and 40, but have the opposite signs from the coe cients for E. Taken at face value, these results imply that the higher the sales price, the lower the commission rate; but the higher the list price, the higher the commission rate. This is possible, but unlikely. The more logical explanation is that the high multicollinearity between these variables has a ected the results. A safer procedure would have been to exclude the variable E. The two Baton Rouge studies are the most sophisticated. The earlier paper by Sirmans, Turnbull, and Benjamin is the only one with a simultaneous-equations model to explain the commission rate; the later paper by Sirmans and Turnbull uses the most elaborate econometric speci cations of any study, with several quadratic terms to capture non-linearities, and with regressions employing

16 134 REAL ESTATE LAW JOURNAL [VOL. 35: ] instrumental variables as well as ordinary least squares. It also has much the largest data set, consisting of 15,608 home sales over the eight years from 1985 through Unfortunately for my purposes, the dependent variable in the later study is the contract commission rate on the listing rather than the actual rate on the sale, and thus does not re ect any adjustments or changes that might be renegotiated between the house seller and the agent at the time of sale. 40 Given the FTC nding that some sellers enjoyed reductions in the actual commission they paid, compared to the contract commission, this casts some doubt on the validity of the ndings. It is not clear if the commission rate in the earlier study is also the contract commission. If it is, the same problems arise. Carney uses the least sophisticated methodology. The simple tabulations limit any inferences about the validity of the relationships; as noted previously, it is possible that the higher commissions on co-op sales re ect di erences in the extent of co-op sales in the markets for new and existing homes. Carney does perform multiple regression analyses combining the data for all cities in a given year, with results that match the simple correlations, but each of these regressions includes cities with di erent modal commissions. In effect, he is trying to explain why commissions are typically 6 percent in some markets and 7 percent in others, and at the same time why some commissions are higher or lower than the mode in each market. A di erent approach to de ning commission rate has been taken in some research. Frew and Jud (1987) analyzed the relationship between sales price and the use of the MLS through a broker, using a sample of over 3,300 existing homes sold in Charlotte in They found that homes sold through the MLS had a higher sales price by two to three percent. This result has been interpreted to mean that the net commission rate is the relevant rate, and that the net rate is subject to competition among brokers, even if the gross commission rate is more or less xed. 41 Other economists have found the opposite result, however, and argued that the theoretical relationship between MLS listing and price is indeterminate. 42 Whatever the empirical relationship, it seems clear that the net commission rate is not the relevant rate. The ability of brokers to provide useful services to homebuyers and sellers is not at issue, and it is 40 Sirmans and Turnbull (1991, p.111). 41 Zumpano and Hooks (1988, p.13). 42 Yavas and Colwell (1995).

17 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 135 reasonable to expect that both would pay for such services. That does not imply that gross commission rates would be uniform and rigid in a competitive market. Interpreting the Cross-Section Studies It is di cult to draw any very rm conclusions from such a small body of empirical research. Some economists have suggested that they may refute the common perception that commission rates are rigid. 43 That is a perfectly possible interpretation, and may be true. But there are some reasons to think that such a conclusion is premature, and some anomalies in the results that bear further analysis. (1) The popular view that all commissions are six percent (or seven percent, or some other even number) is surely incorrect; there is certainly variability, as shown by the mere existence of standard deviations and regression results using the commission rate as the dependent variable. But even when there is a high concentration of rates at one number, the corresponding standard deviation can be large enough to suggest more variability than the underlying data actually show. In addition, of course, the standard deviation will be a ected by one or a few outliers in the distribution. The e ect can be illustrated by the FTC s sample for Washington in 1979; one of the 75 commission rates is below 5 percent, while all the others are between 5 and 7 percent. When the one outlier is excluded, the standard deviation drops from 0.5 percent to 0.3 percent. 44 This general pattern can be interpreted either as an indication of a competitive market, with a few outliers, or alternatively as giving a somewhat misleading impression of the degree of dispersion and competition that actually exists in the market. (2) What is surprising about these comparisons is that the earlier data show the greater commission rate variability. The common perception seems to be that commissions were more rigid in the past. Multiple Listing Services often established commission rate schedules that they recommended to their members, until the 43 See for example Zumpano and Hooks (1988, p.13); Benjamin, Jud and Sirmans (2000:2, p.18). 44 The FTC does not report the precise rates for commissions other than the even rates of 5, 6 and 7 percent; others are listed as less than 5%, 5%- 6%, 6%-7%, and greater than 7%. For this reason, I have used the standard deviations reported by Carney, who had access to the data.

18 136 REAL ESTATE LAW JOURNAL [VOL. 35: ] Department of Justice brought antitrust cases against the practice. 45 NAR adopted a policy prohibiting members from establishing recommended schedules in 1971, but it seems reasonable that habits would change only gradually, and commission rates would show more variability as time passed more in the mid-1980s than the later 1970s, for example. (3) Existing homes have generally carried higher commissions than new ones, and this practice may still be common; 46 thus a data set containing both new and existing home transactions is likely to indicate more dispersion than really occurs in the market. Similarly, transactions involving both a listing and a selling broker may carry larger commissions than transactions where one broker performs both functions; the research results are mixed, but the di erence is also supported by current anecdotes. 47 A data set containing both will therefore also show dispersion in commission rates. Further, the data will show more dispersion, the more equal the split in the data set between new and existing homes, or between co-op and non-co-op transactions. Unfortunately, the published studies do not provide enough information to evaluate this contention. Carney reports standard deviations for the separate categories (existing homes vs. new homes, co-op vs. non-co-op), but not for the full data set, while Larsen and Park, Goolsby and Childs, and Sirmans, Turnbull and Benjamin, all report standard deviations for the full data set but not the categories. One might expect smaller standard deviations for Carney s individual categories than for the full data sets in the other two studies, but the opposite is generally the case. (4) Carney provides interesting information about California commission rates. He reports that California historically (between 1935 and 1960) had a tapered rate structure, quoting a 1960 listing by the San Francisco Board of six percent on the rst $25,000, ve percent on the next $75,000, and 2.5 percent above that. Carney further states that such tapered structures are common today (presumably around 1980) in both the United States and England, with citations to support his statement. If Carney is correct, the tapered rate structure is a possible explanation for the size of the standard deviations. In his data, the three Los Angeles city/year samples, and the state of California, have fairly typical standard deviations: 1.0, 1.1. and 0.7 percent for Los Angeles, and 0.9 for California. A fairly 45 GAO (2005, pp.12-13). 46 Harney (2004), quoting anecdotal evidence. 47 Harney (2004).

19 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 137 large standard deviation could arise even if all sales commissions rigidly adhered to the same tapered commission rate schedule; it would depend on the distribution of house prices. Moreover, if tapered commission rate schedules were still widespread at the time Carney wrote, but gradually became less common, then standard deviations would tend to decline over time. This may help to explain some of the dispersion in the literature. Comparing the Time-Series and Cross-Section Data The cross-sectional literature suggests several possible explanations for the apparent downward trend in the time-series data produced by REAL Trends. The general cross-sectional nding that commission rates are lower on higher-priced houses is certainly consistent with the reported decline in rates. This hypothesis does not explain the rate stability in very recent years, as house prices continued to rise, if anything more sharply since 2001 than in the preceding decade. The nding that commission rates are lower on new homes has less apparent relevance to the trend. New homes have constituted about the same share of the market since 1995, ranging between 14.5 percent and 15.1 percent of the total. The new home share was unusually low in 1991, at 13.6 percent, but this di erence is not enough to a ect the average commission rate. Moreover, it should be remembered that the REAL Trends data come from the larger brokers, and what is important is any change in the share of new homes in their transactions, not in the overall market. The Sirmans and Turnbull nding that commissions were higher for homes listed by large rms suggests that the REAL Trends data may have an upward bias. But the commission rate in their study is the contract rate, not the actual rate paid by the seller. Sellers contracted to pay higher rates to larger rms, but may not have actually done so. Similarly, the Sirmans and Turnbull result that commission rates were countercyclical in Baton Rouge from 1985 to 1992 is consistent with the reported trend. The economy has been generally expanding over the period covered by REAL Trends, so the national commission rates reported by REAL Trends should have been declining. Rates did not rise during the recent recession, however. Also, the Sirmans and Turnbull model suggests that rates in 1991, the earliest publicly available from REAL Trends, may have been unusually high because of the recession in the early 1990s. The trend itself may be spurious, as a secular phenomenon.

20 138 REAL ESTATE LAW JOURNAL [VOL. 35: ] But none of these possibilities should be pushed very far; they are only speculations. It is important to emphasize that any serious attempt to synthesize the cross-section and time-series evidence is dubious if not heroic; all the cross-sectional data (except the last year or two of Sirmans and Turnbull) is for years before REAL Trends began collecting national data. Conclusion This is perhaps a long paper to discuss a small body of data. By limiting myself to systematic empirical studies, I have ignored a much larger corpus of theoretical research on real estate brokerage. Similarly, by trying to look systematically at commission rates over time, I have limited myself to a single, proprietary, and private data series, which is reported only sporadically in the press. There is not much to talk about. This is largely because the data needed to talk about it are very closely kept. There is perhaps one important inference that can be drawn from the literature. The cross-sectional studies may provide a basis for reconciling the common perception that commission rates are administered and sticky with the research ndings that show variability and reasonable relationships between commission rates and other phenomena. Commission rates for a given set of transactions may cluster rather tightly around a norm, and still vary because the norms are di erent for di erent kinds of transactions (e.g., existing vs. new homes), and because some brokers do lower some commission rates to e ectuate a sale. But it is not at all clear how much the rate dispersion in these studies results from the variability in the kinds of transactions and how much from actual variability in commission rates. The most obvious conclusion is the academic economist s standard complaint: we need further research. In this case, we rst need the data, in order to do the research. Table 1 Average Real Estate Commission from REAL Trends Survey Year Average Source Commission % Hahn, Litan and Gurman

21 PRICE OF RESIDENTIAL REAL ESTATE BROKERAGE SERVICES 139 Year Average Source Commission % Lehmann % U.S. Government Accountability O ce % Lehmann % Roberts and Mara % Roberts and Mara % Roberts and Mara; Lehmann % Hahn, Litan and Gurman; U.S. Government Accountability O ce Sources: Robert W. Hahn, Robert E. Litan, and Jesse Gurman, Paying Less for Real Estate Brokerage: What Can Make It Happen? Working Paper 05-11, August 2005, AEI- Brookings Joint Center for Regulatory Studies R.J. Lehmann, The 6% Solution, In Lehmann s Terms, May 10, ( lehmanns terms/2005/05/the 6 solution.html). Glenn Roberts, Jr. and Janis Mara, Real Estate commission under pressure/part 1: Pro ts high despite commission erosion, Inman News, April 18, ( htm). U.S. Government Accountability O ce, REAL ESTATE BROKERAGE: Factors That May A ect Price Competition, GAO , August Year Table 2 Comparison of REAL Trends and Market Home Prices REAL Trends Average Home Price Existing Home Average Price New Home Average Price Existing Homes Sold New Homes Sold Weighted Average Price 2002 $229,530 $199,200 $228,700 5,631, ,000 $203, $247,721 $215,000 $246,300 6,183,000 1,086,000 $226,453 Sources: REAL Trends, Inc., Analysis of the 2004 REAL Trends 500, REAL Trends Monthly Newsletter, April ( newsletters.asp?article=newsletters/ htm) U.S. Department of Housing and Urban Development, U.S. Housing Market Conditions, 3rd Quarter 2005 (November 2005), Tables 6-9. Table 3 Commission Rates by Firm Size and Region, Firm Category: Size of Firm 2002 Average Commission 2003 Average Commission Top % 5.06% Top % 5.07% Top % 5.24% Up-and-Comers 6.20% 5.36% Firm Category: Region Northeast 5.20% 5.14%