The Jerry Maguire Moment: Disruption is Coming for Real Estate Brokerage.

A high conviction case for a changing market.

They say your should never bury the lead. So here it is:?

The foundational document used to generate revenue for real estate brokerages?—?the listing agreement?—?has been materially changed for the first time in 70+ years. This new listing agreement contains fee structure language that nearly guarantees commission revenue will decline substantially over the next 1–4 years.

You may be in the majority of people who believe that it will take a prolonged time for the appeals process to sort out the final conclusion of the landmark Sitzer/Burnett trail which found the National Association of Realtors (NAR) and several brokerages “guilty of conspiring to keep commission rates artificially high.”?

This view assumes while we wait for the legal concrete to dry, the way in which home sale transactions work going forward will look much like they did before this news hit. So it’s just a shrug of the shoulders and move on then, right?

Believe so at your own peril.?

The impulse to think tomorrow will look much like today is understandable. Humans are confirmation basis machines. We are prone to think that because something has not changed for a long time, it probably never will. Moreover, we believe when change comes, it happens slowly. We assume we will have plenty of time to make adaptations along the way. Based on history, this is false, particularly around large scale events like these:

• The Great Depression
• World War I
• World War II
• The Dotcom Boom & Bust
• Disruption of the Music Business
• The Great Recession / Global Credit Crisis
• COVID-19 pandemic?

Consensus ahead of all these market moving events was wrong. There’s a traditional adage that comes to mind here which finds its roots in old-time stock operator lore: “markets don’t correct with a scalpel, they correct with a hand grenade”. It’s a lesson the brokerage business would be well-served to remember as real estate consumers just “pulled the pin” and chucked something unsavory at the industry.?

How did we get?here??

At bottom, this is a story about a shift in real estate consumer sentiment that is being shaped by:?

1. Home affordability

2. The spike in interest rates

3. The NAR under legal siege?

Home Affordability

The pandemic recast the definition of “home” for many Americans. More space and less immediate population density became the theme at a time where buyers had maximal urgency and a cheap source of funds with which to chase property.?

And chase they did. Real estate markets that were laggards for decades suddenly found themselves being bid up by “city-folk” wanting an additional Zoom-room and a place for the little ones to run around out back.?

This resulted in a demand signal for single family homes so strong that pricing in many markets went up by 30–40% between 2020 and 2022. Buyers at that time faced best and finals so competitive that they were forced to wave deal contingencies at a stomach churning pace.?

Take a look at the S&P/Case Shiller U.S. National Home Price Index and you’ll notice the hockey stick like pricing action post-Pandemic:?

As a result of the surge in pricing, many found themselves unable to identify a suitable home to buy during a time that they felt desperate, irrational and afraid. Buyer agitation was not far behind. The blind process of attempting to secure a signed purchase contract only to lose over and over again to some fantom cash buyer was crazy making. This revealed a key point:?

The residential real estate industry does not treat its buyers with much respect and the pandemic made it?worse.?

Buyers are required to participate in bidding wars on homes with little pricing guidance. When they lose, they seldom get price discover data that would help them calibrate their valuation assumptions and win the next deal.?

Moreover, buyers are made to suffer the awful bait and switch game played by Zillow and its Premier Agent program. Most consumers are unaware that Zillow makes approximately 74% of its revenue from real estate agents buying leads from unsuspecting consumers when they use the “Contact Agent” button on Zillow listings.?

More on Zillow later, but for now we can say that by the time interest rates start their move upwards, housing prices have risen so dramatically that most buyers can’t afford their home of choice and they are consumer experience in real estate would be considered by most to be poor.?

Then Interest Rates?Spiked…

At some point in 2021, many homeowners took advantage of money being “stupid cheap” and refi’d their mortgage. And of course, the government was just handing money to folks like Lloyd Christmas:?

Who would have thought that inflation would soon be an issue? This question is a posed rhetorically and with full snark.?

Take a look at the average 30-year fixed mortgage rate in the U.S with particular attention paid to the period of time between 2000 and 2022.?

Post the Dotcom bubble bursting, many investors turned to real estate as a stable, predictable brick & mortar investment they could see, touch and hopefully protect. This coincided with a period of time where interest rates found lower and lower levels for two decades.?

Real estate was off to the races in a major way until that credit crisis thing mucked up the story. But the GFC only seemed to solidify the “low rates are here to stay” mentality held market wide. That brings us back to our human nature and bias towards believing that the future will look like the past.

The Fall of 2021 proved that wrong as it pertains to mortgage rates. In fact, over the course of 18 months, 30-year mortgage rates increased over 350% from their lows. As a frame of reference, the last time mortgage rates went up by that much it happened over the course of 9 years. That’s 6-times faster this time around.?

The acceleration of interest rates presented a system shock for real estate. In the Spring market of 2022, you had potential buyers walking in houses with pre-approval letters not 3 months old that were completely useless given the move in rates. That put a wide spread between buyer purchasing power and seller pricing expectations. So then, home pricing got crushed, right??

No. The market just froze.

Transaction volume in 2023 for existing homes sales was just little north of 3MM homes, 50% below the go-go 2021 peak of 6MM+ homes sold. It was as if all discretionary moves in homes sales were wiped off the board and only those truly needing to transact did so.?

Counterintuitive as it may be, because listing inventory remained so low through the spike in rates, homes that are perceived as reasonably priced and showed well found multiple offers. It seemed as if there was an invisible hand holding home prices up while mortgage rates soared from the lows.?

This made buyers even more angry. By the time the Sitzer/Burnet vs NAR verdict hit the tape on October 31, 2023, the real estate consumer had found a righteous place to aim their discontent?—?their local realtor.?

The NAR “colludes to keep commission rates artificially high”.

For about 70 years, the language detailing broker compensation in the listing agreements has remain unchanged. Here’s an example of that well-traveled clause:

If the Property is sold during the Term, you will pay BROKERAGE XYZ six (6%) percent of the Property’s sale price at closing. If a co-broker (including another agent from BROKERAGE XYZ) is involved in the sale, BROKERAGE XYZ will split the above commission equally with the co-broker.

You can see here that the seller pays the listing agent. However, the listing agent needs and wants to place the seller’s home on the MLS. The MLSs are a NAR controlled listing distribution and marketing platform which require listing agent split their commission with the buyer’s agent.?

In doing so, a strange cross-purpose relationship is created between the seller and buyer’s agent. The seller is paying an agent they never formally hired and from whom they do not receive fiduciary duty from in return for this compensation. The buyer’s agent?—?in theory?—?wants to get the home for their client at the lowest price possible while the seller is trying to maximize the property's value. Are you confused? That’s a reasonable response as this opaque seller-buyer’s agent conflict is central to the cases against NAR and erodes consumer trust in the industry.

Post the Sitzer/Burnett verdict, many brokerages around the country quietly edited their listing agreement to decouple listing and buyer agent compensation. This was done in hopes of avoiding penalties in the 15+ additionally cases that the NAR is facing around the country. They are right to do so, just ask Keller Williams what it feels like to stroke a $70MM check in case you were thinking otherwise.?

On January 1, 2024, the new listing agreement made its debut. Here’s an example of what it may look like when you go to sell your home in today's marketplace:?

If the Property is sold during the Term, you agree to pay compensation as follows:

• To BROKERAGE XYZ as Listing Broker: __% of the Property’s final sales price.
• To BROKERAGE XYZ as Listing Broker with a Direct Buyer: __% of the Property’s final sales price.
• To BUYER BROKERAGE FIRM (including BROKERAGE XYZ): __% of the Property’s final sales price.

This change in language has set in place a decline in commission income that is structural nature. This revenue model shift will compound over time to disrupt the US residential real estate brokerage industry as we know?it.?

How can you say that with full conviction??

Let’s engage in a scenario analysis. You are a top-producing listing agent in your neighborhood. Like most in the industry, your 2023 was below target. Your revenue was materially down while your expenses remained high. You are counting on and working towards a big Spring selling season in 2024 to make up the difference.

You’re pitching to list the home of a potential seller who has a beautiful $2MM property that you know the market will likely clamor for, particularly as mortgage rates have come off their highs as they are doing now. You’ve demonstrated your value throughout the presentation. You like them and they seem like they’re going to hire you.?

You get to the commission part of the listing agreement and you're trying out a new script for the first time. For 15 years you said “we are a 6% team” and most folks agreed given your track record and who you were referred by. Now, your pitch is “we are 3% on the list side and suggest you offer a buyer’s agent likewise to make sure the most amount of people in the marketplace are interested in your property.”?

There’s an awkward pause. You’ve hit a snag. The seller’s question comes?—?“after that big trial got announced, I thought we didn’t have to pay buyer’s agents anymore. Isn’t that right?”

To get that listing and maintain their side of the commission structure, many listing agents in this situation right now will quickly reduce the buyer’s agent commission and unknowingly setting off a domino effect that will lead in time to commission pricing pressure on their side of the transaction.?

Most real estate teams generate 40–50% of the gross commission income from representing buyers. As that piece of their business faces extreme contraction over 2024, real estate teams will be forced to take more listings to make up the short fall. What’s the best way to compete as a market becomes flooded with supply? You compete by lowering your price.?

In time, the industry expectation of 5–6% of sales price will likely fall to something closer to 3% or below. And for an industry populated with razor thin operating margins, chaos is on order. That brings us back to the market cap leader in the space?—?Zillow.?

What does this mean for established real estate companies??

Companies with revenue driven by the $96B in annual real estate commissions marketplace should prepare for a 30–40% contraction in their top line.

Most brokerage shops pay 70–90% of their respective revenues out to their agents. To stay afloat, brokerages will likely need to reduce their agent payout splits which will force the best talent to leave. You're also likely to see large staff layoffs at brokerages with cuts to marketing and tech staff to save on overhead. This may also cause top agents to strike out on their own as service offerings from their firm become tepid and the value proposition of branded brokerage to top agents dwindles.?

Which brings us to Zillow, the leading real estate website across the country. Many real estate agents buy leads from Zillow while hating the company at the same time. Why? Agents view Zillow as monetizing their listings off the backs of their hard work through selling leads to their competitors via the Premiere Agent program. Buying real estate leads is big business, at least it was when the industry operated in its traditional form. Given where we are in the conversation, it’s clear that future is not likely to look like the past.?

The Premier Agent program works off a buyer’s opaque understanding of of how a real estate transaction works. When a potential buyer reaches out for property information on Zillow, instead of being connected to the listing agent as intended, consumers are placed in the lead conversion pipeline of an agent who has paid for the “lead”. Unknowingly, a buyer’s want for property information results in their contact information being sold to the top bidder whose only qualification outside of having a real estate license is that they spend a lot of money on Zillow leads.?

The “best” Premiere Agents are the ones who commit to a vigorous speed-to-lead contact system and follow up campaign in hopes of converting the potential buyer into a client. This works well when a buyer is inexperienced and doesn’t dig into the concept that they are not in fact the listing agent for the property they originally inquired on.?

Here’s a glimpse into the Zillow Premiere Agent advertising platform which highlights how one might purchase 35 leads per month for a cost of $2,353 in “advertising” costs.?

That’s $67 a lead for a zip code in Brooklyn that is not overly competitive. Zip codes like Park Slope and Brooklyn are $150+ per lead.?

Historically, many agents in the industry have made a great return on this business model because seller’s have been paying all commissions and their side of the transaction has been yielding 2.5–3% of the sales price of a home.?

But will a 100% commission based agent be able to afford paying $2,000+ per month for leads if sellers are now contractually allowed to offer buyer’s agents ZERO in compensation and still be listed on the MLS??

A likely outcome for Premiere Agent program at Zillow is double-digit revenue decline for 2024 and 2025 respectively. Zillow’s best hope is to grow the 25% of their revenue that doesn’t come from buyer’s agents like mad in an attempt to make up the difference. Otherwise, according to their quarterly earnings call in November 2023, Zillow executives believe they will be able to simple flip a switch on a “pay for play” model where agents buy right to display their listings on the site. That seems anything but simple as revenues in the industry for agents are contracting fast.?

What Happens?Next??

Chaos is an agent of change. Where there is disruption, there is opportunity for renewal. Looking to how other industries dealt with a sea change like this, the record business is fertile ground for analogies. In 2000, the music business found itself at the tail-end of the CD conversion trend that boosted industry revenues for many years. Labels were riding high after many people bought additional copies of their favorite titles on CD while tapes and vinyl records were seen as lesser quality products.?

Then sentiment with consumers began to shift around the way labels treated artists at that time. The VH1 show “Behind The Music” became a pop-culture sensation by telling stories of the rapacious practices used by record labels against artists. Soon thereafter, Napster introduced a new way to enjoy music without having to paying for it. Much like the real estate brokerage business of 2024, a structural change was set in place that resulted in the revenue model of the industry being changed forever.?

Taken in concert, consumer sentiment shifted to the point where music industry revenues fell to $7B per year in 2014. That’s a 70% decrease from 2000.?

Can the real estate sales food chain face a similar headwind? Yes, it very well may. The best question to ask then is?—?what kind of companies will come to market and grow in the wake of its disruption??

The Birth of New Real Estate?Tech

Clearly themes that will be on the minds of consumers and entrepreneurs alike are business models that lower the transaction costs of selling and increase transparency in the process. To that end, we could see buyer-meet-seller platforms that facilitate transactions happening independent of agents or with agent-lite models. What would the process be like if an EBay concept were to mind meld with the the UI of an AirBnB??

Affordability is also a key pillar of new real estate tech ideation. How can more Americans be able to afford buying a home as housing prices remain high along side increased borrowing costs? Look for breakthroughs in the fractional ownership of real estate via blockchain with owners holding a proprietary lease to a house for a possible solution.

As traditional buyer’s agents are exiting the industry due to its contraction, first-time homebuyers will be underserved in the marketplace. How can AI be leveraged to help? A large language model could advance to the point of being the ultimate advisor to buyers. You could even have Snoop Dogg or Willie Nelson be your narrator.

What about all the agents who will remain in the industry but are required to operate with tighter margins??

To be clear, there will always be a place for excellent real estate agents who provide a strong value proposition in the marketplace. Their respective worth will now be determined by the free market as opposed to the closed-system dynamic of the NAR-based MLS system.?

Agents will need to keep more of their gross commission dollars and share little to nothing with a traditional brokerage shop. Perhaps more agents will become brokers themselves, opening up a marketplace for tech companies to provide them the “one-touch” tech of an Uber to handle their back office operations.?

In the face of all the marketplaces that will be born out of the disruption to the current industry, investing in real estate tech startups will become a great source of return for smart capital. Now is the time to find the founders of tomorrow’s real estate industry and invest in them today.?

Whatever is to come, the future will be quite different from the present. It’s clear that there is a huge wave of change forming off the shore of real estate brokerage. Standing on the beach with your back to the waterline is sure to get you washed away. Better to fetch a surf board, paddle out and ride the swell.?