What the shift in real estate fees means for homebuyers and agents nationwide

On April 23rd, a US District judge signed off on an agreement that will fundamentally change the way in which real estate agents get paid. The agreement, which resulted from a successful class action suit brought by a group of home sellers in Missouri against the National Association of Realtors (NAR) and several large real estate companies, prohibits the long-standing practice of having the seller’s agent commit to paying the buyer’s agent’s fee. While the agreement is still subject to final approval, most observers believe that NAR’s agreed-upon changes will go into effect across the country sometime in early fall this year.

Under the existing system, in order to list a property on NAR’s local multiple listing service (MLS), the seller’s agent must commit to paying the buyer’s agent a specified fee. While there is no minimum fee required (e.g., the seller’s agent could offer to pay just a $1 fee), plaintiffs successfully argued that the practice has led to price-fixing and artificially high commission rates. Under the new regime, the seller’s agent will no longer be required or even able to offer to pay the buyer’s agent’s fee in their MLS listing. Instead, that fee will be determined as part of the buyer’s initial agreement with their realtor. While the new rules will still allow the seller to pay the buyer’s agent’s fee as part of the negotiation process, what was once a well-established practice will become at best, inherently uncertain, and at worse, relatively rare.

When the agreement was first announced, it was widely heralded as a win for the nation’s homebuyers. But on closer examination, some obvious problems have emerged. The primary concern is how the new rules will affect cash-constrained first-time homebuyers. In a paper I recently authored with Amy Cutts and Vanessa Perry, titled “Be Careful What You Ask For: The Economic Impact of Changing the Structure of Real Estate Agent Fees” ,we demonstrate how requiring these buyers to pay their agents fee directly would have a devastating impact on their ability to buy a home. For example, even if fees fell to only 1.5 percent, the maximum amount that a potential first-time buyer could pay for a house would drop by 12%—an outcome that reflects the high degree of leveraging that is made possible by low downpayment mortgages. In that situation, the buyer would have three choices—forego the services of a real estate agent, look for a lower priced home, or continue to rent until they came up with the additional cash.

Even if the seller agrees to pay the buyer’s agent’s fee, this is an inherently uncertain outcome which would not be known at the beginning of the homebuying process. Several industry groups have already asked that seller-paid agent fees be excluded from regulations capping the total amount of seller-paid fees that can be included in closing the loan. Indeed, Freddie Mac, Fannie Mae and FHA have recently confirmed in an industry letter that if:

‍“these fees continue to be customarily paid by the property seller according to local convention, they will not be subject to financing concessions limits”. -
Kevin Kauffman,
Senior VP of Single-Family Seller Engagement,
Freddie Mac

Still, there is no way that potential homeowners can know in advance that a particular seller of a particular home will be willing to pay their agent’s fees as part of the negotiation process. Again, such uncertainty would likely cause many potential homeowners to forego the services of a real estate agent or drop out of the market all together. Not surprisingly, minorities and lower income families would be the ones affected the most.

Of course, another outcome that could conceivably mitigate these negative effects is for lenders, the federal government and the GSEs to simply allow buyers to include their agent’s fees as part of the mortgage amount—a practice that is currently prohibited. Based on our experience in the industry, we believe this is unlikely to occur. One of the primary drivers of underwriting models is the loan-to-value ratio, where value is based on the sales price or appraised value of the home, whichever is less. Allowing the fee to be included in the mortgage amount would essentially require lenders to increase the maximum allowable LTV across the board, a highly unlikely outcome that would inevitably increase systemic risk. Even if the industry discovers ways to mitigate that risk, changing underwriting models and standards would take years to implement, exposing an already fragile housing market to significant additional stress.

So, what to do? Unfortunately, assuming that the existing agreement holds, there are no easy answers on how to avoid the disruption that is likely to occur by changing the model that has characterized the real estate market for the past 100 years. Ultimately, new models will inevitably  emerge that will force a new equilibrium in the ways homes are bought and sold. But until that time, the best that policymakers can do is focus on mitigating the resulting uncertainty in ways that do not increase the underlying risk, while educating consumers about the choices they face.