A modest proposal: real estate reform.

The real estate business model, part 5: real estate reform.

The real estate business model as presented in part 1, part 2, part 3 and part 4: that’s your real estate services delivery system, Mr. and Mrs. John Q. Public.

Now that you know the downside to this system, you’d think there’d be some upside too. Right? Because even the most screwed-up situation has to offer some benefit to someone, somewhere, somehow, sometimes. Otherwise it wouldn't be around.

Let’s summarize the seven drawbacks to consumers I’ve just outlined and see who benefits from them and how.

1. The people who consume the most real estate services are often the least likely to pay for them. Who benefits: flakes and users. How: lets them be themselves, at no charge.

2. When real estate services are so often provided free, it undervalues their value in the mind of the public. Who benefits: discounters. How: makes their implausible sales pitch—the free lunch—sound plausible.

3. Creates the appearance of a conflict of interest that virtually guarantees consumers will distrust their service providers. Who benefits: not consumers, and not service providers. Who’s left? Conspiracy theorists?

4. May actually create a conflict of interest among desperate or avaricious agents willing to mislead unsophisticated clients. Who benefits: desperate and avaricious agents. How: easy money.

5. Requires saint-like behavior from agents. Puts them in situations with actual or potential conflict of interest, yet holds them to the highest legal standard of care. Who benefits: the lawyers. How: easy money. Is there an echo here?

6. Inevitable abuses of the current delivery system create cynicism, both among clients and agents. Who benefits: anyone promising something new, either to consumers or agents, whether it’s an improvement or not. So far, it's not.

7. Illogical system, often fueled by impulsive behavior, encourages impulsive, illogical players. Who benefits: see #1, above.

We’ve seen that agents sometimes work with thin material—the lonely, the erratic, the unqualified, the unfaithful, the unclear-on-the-concept—who regardless get valuable professional services at no cost. Yet we can intuitively understand that in business nothing is free—someone has to pay for “free” services, or there will be no one to provide them. And we know who that someone is: the bona fide buyer or seller, anyone who brings the most good faith to the agent-client relationship.

So it strikes me that, unless you’re a flake, lawyer or conspiracy theorist, the door is wide open to “real estate reform”.

Ever notice that when someone wants to change the system, they call it “reform”, whether it’s really reform or just a way to tilt the system in their favor? I’m going to suggest some changes to the real estate services delivery system that I think qualify as genuine reform. The idea that a mere real estate grunt can rearrange an entire industry is, of course, presumptuous.

But no one's come up with anything better. Improvements so far have consisted of mindless tinkering that resembles rearranging the deck chairs on the Titanic. "Loose a little on each transaction but make it up in volume" is the best our best minds have offered, lately gilded with the alluring fallacy that real estate services can be sold online like wrinkle-resistant chambray sport shirts and vintage-washed totes.

Finally, note that the particulars aren't particularly important. The concept is. What's the concept? Stop the hemorrhaging. Stop giving away services with economic value to consumers who don't need them and won't pay for them. Stop making our best customers pay the bad debts of our worst.

I’ve used seven interviews of imaginary real estate consumers to illustrate typical problems in the current delivery system. Admittedly, these are extreme examples but, as you may have guessed, all come from personal experience. Every seasoned agent has these war stories.

But now let’s look at a more routine occurrence, one I promise you happens thousands of times every Saturday and Sunday across this great real-estate crazed nation of ours.

Observe Joe Tirekicker. Joe’s that guy in the baseball cap easing into the open house. “Open House” signs have a magnetic effect on Joe’s car. Joe was just out for a quart of milk. Joe doesn’t know how much they’re asking for this house. Or if he can afford this house. Or if he can afford any house. Or even if he wants to buy a house.

But open houses are free, and talking to an agent is free, and dreams are free and…and…and Joe falls helplessly and convincingly into the role of Joe Homebuyer.

No, this house won’t work, he says crisply, but here's what I’m looking for. Call me if you find it.

Even Joe’s sure he’s a real buyer—for about as long as it takes him to pick up the milk. By then, he’s not so sure. Hey maybe he’s surprised someone took him seriously—it doesn’t happen that often.

So he doesn’t understand that being taken seriously has consequences. Joe's brief conversation with an agent sets wheels in motion he doesn't foresee. And weeks or months later, after an agent has burned up the roads indulging Joe’s idle daydreams, Joe says no, not me, not this time. And usually he doesn’t even say that. Usually there’s just an eerie whistling sound where Joe used to be.

Or maybe Joe sees an ad and calls an agent on a whim, or e-mails about a listing. Maybe he even winds up making a half-hearted offer that conveniently goes nowhere. Yeah I made an offer back in 2000 and thank goodness I didn't get the house!

But you know what? Joe’s not a bad guy. Joe’s just clueless, as so many of us are about so many things in this complicated ol' world. When all the other kids had GI Joes, Joe wanted one too, and Mom and Dad got him one. Now that all the other kids have houses, Joe wants one too. But this is one bauble Mom and Dad can't buy, and Joe doesn’t have what it takes on his own. Not enough money, or not enough commitment. Someday maybe he will. By then, that hard-working agent he met at the open house will be just a faint memory, if that. That hard-working agent may well be out of the business.

But hey, John, you say, aren’t all these dead-end relationships you’re bitching about just part of the agent’s job? No sir. One of the ironies of the current system is that the “lowlife agent” can bring more good faith and common sense to the relationship than the consumer.

Yes, dead-enders do go with the job, but only up to a point and, thanks to the Internet, that point is reached far more quickly than it was even a few years ago. Yup, I'm talking about the this-changes-everything Internet. For once it did, yet it didn’t. It did change the delivery system. It didn’t change human nature.

Before the ‘net, Joe could be excused for not knowing what he was wandering into. Before the ‘net, none of the information he needed to decide where or even if he should enter the real estate market was accessible except through an agent. Joe didn’t know which homes were for sale unless he called an agent. Sure, Joe could’ve looked in the newspaper, but advertised homes make up only a small portion of homes available. And unless Joe called an agent, or knew enough to call the county recorder’s office, he didn’t know what homes were selling for.

Now, thanks to the ‘net, Joe has easy access to basic screening information. Hallelujah! Now the only piece of the puzzle still missing is whether he can afford the loan he needs to buy the house he wants. Here again the ‘net to the rescue, with online pre-qualification and mortgage calculators; or better yet, Joe can get a loan commitment through a loan agent, face to face and at no cost or obligation.

Well, there is one last essential piece of information that Joe won’t find on the ‘net: whether he’s realistic and motivated. Do the homes or neighborhoods that Joe can afford make him want to put his money down? If his answer is “yes”, then Joe come on down. But if Joe’s answer is “no” or “I don’t know” or “I’m waiting for prices to go down” or the old method actor's "what's my motivation?", then Joe should refrain from inserting himself bodily into the real estate services delivery system.

It's that simple: there’s no excuse. If Joe has Internet access and normal self-awareness and maturity, Joe should know better. Joe should know whether a real estate agent’s valuable professional services will do him any good. But Joe doesn’t know.

If we agree that Joe Tirekicker will simply abuse the real estate delivery system, to the benefit of none and the detriment of all, then how do we bar him from the system? Of course, as any managing broker will tell you, the guard at real estate's gate is supposed to be the agent. The agent holding the open house. The agent taking the floor call. The agent is supposed to carefully qualify his prospects before he spends valuable time with them.

I can think of four big problems with assigning the agent this sentry duty.

First, Joe isn’t always Joe Tirekicker. Sometimes Joe is Joe Homebuyer. That’s rarely true in my area anymore, but until a few years ago, or about the time most buyers discovered the Internet, open houses were a great way to meet prospects who could, with a little work, clean up into presentable buyer clients. And agents are like the Ol’ Prospector. If some form of client prospecting was a goldmine back in the rush of ‘98, we’re still faithfully working that vein in 2007 even though it was played out years ago. Even today, agents in my area jump at the chance to prospect aggressively at open houses. Maybe it still works in other parts of the country, particularly those with lots of new arrivals who don't have a support network (“Sure, I can recommend an agent”). When it does work, it’s one of the cheapest and easiest ways to get a client. But at first glance, Joe Homebuyer looks just like his tirekicking twin. Only valuable time will tell them apart.

Second, agents are certifiable optimists, brimming with confidence, or they wouldn’t be in real estate. By God, they say, I will convert that prospect into a buyer. I can do it. You say, that’s their problem. Yeah, but you can’t blame agents for having the personality trait required for their profession. That’s unrealistic and even cruel, like blaming an engineer for being analytical.

Third, managers expect their agents to do open houses and take floor calls. These passive forms of prospecting are at least free, if rarely effective, and they’re no-brainers—all you have to do is show up and emote, something even an undistinguished agent can do. To your manager, nothing says as cheaply and effectively that you’re out there hustling, even if your numbers aren’t good. And in fact, someone’s got to hold open those houses and answer those floor calls, or the public will have to find a new hobby.

Fourth, asking agents to keep out the flakes and users puts the burden of proof on the party that doesn’t control the outcome and doesn’t have all the necessary information. Wait a second, you’re thinking. The agent does control the outcome of the relationship, through his skill or, failing that, his slimy persuasiveness. A skillful agent helps his client buy or sell, and his reward is a commission check. An unskillful agent keeps his client from buying or selling, and his punishment is not getting a commission check.

Yeah, that’s the idea. That’s what happens “in an ideal world”, as Voltaire’s Professor often told Candide. But as Candide often discovered, this isn’t an ideal world.

Initially, the prospect holds most of the cards. He deals them to the agent slowly, if at all, and sometimes they’re jokers. I’ll repeat the expression common among agents: “buyers are liars”. Whether or not this is true, only the prospect knows his motivation and expectations. The agent has no control over this key part of the equation, no matter how great his skills or persuasiveness. “You can lead a horse to water…”

So sometimes the relationship goes nowhere slowly, grindingly and inevitably, like a car going off a cliff in slow motion. The prospect, seeking to prolong the benefits he receives from the relationship, knows instinctively what to say and what not to say to the agent. On the other side of the table, the agent adept at listening hears what’s not said as well as what is said. The average agent, on the other hand, would rather not ask or hear.

Boding most ill for the agent is long periods of silence from the prospect, punctuated by brief and non-committal communiqués. This means the prospect is scurrying around behind the scenes, up to something he knows would alienate the agent if he got wind of it, but is willing to give the relationship the minimum maintenance required to keep the professional services flowing.

More than anything else, it’s this selective, often one-way communication that puts the agent at a disadvantage. Up to this point you could make a case for the agent as high-risk tolerant investor, investing his time and money in many prospects to find the few who lead to a commission check. He's like an oil driller. High risk, high reward: that’s an equitable business model. But even the gutsiest investor knows what he’s getting into, based on verifiable information; if he doesn't, he’s a speculator, not an investor. The risk taken, however high, is a calculated one when backed up by adequate information. But with the vast majority of prospects, especially those acquired through the passive forms of prospecting such as open houses, floor calls and Web sites, the information is scarce or misleading. The agent isn’t intelligently investing his resources; he’s mindlessly speculating, and there’s no consistent upside in that.

Of course, there’s another reason an agent can find himself at a disadvantage vis-à-vis the prospect: he may be laboring under the considerable burden of his own stupidity. But here’s where I draw the line. I don’t think we can or should design a delivery system that protects the unintelligent from themselves, although our best legal minds have been working on this for years.

So if agents can’t or won’t keep Joe Tirekicker out, who or what will? What system will penalize Joe if he gets past the guards—or, better yet, what system would make Joe think twice about getting past? What real estate delivery system would repel the clueless, yet be attractive enough to real buyers to make them give up the present system?

Maybe you see where I’m going with this: in the ideal system, Joe Tirekicker keeps Joe out of the system, because only Joe can. Pretty radical idea, huh? I’m not sure why it should be. What other profession lets anyone into its delivery system for extended periods of time without payment?

I’ll get to the mechanics of how we get buyer prospects to be self-policing in a moment, but first we need to look at the root problem of the current delivery system: how it compensates agents. From this assertion you might infer that the problem is that virtually all agents are on straight commission. That’s a common perception of the problem, but let’s see if it's true.

You may not even be aware that your agent is almost certainly on straight commission. I’m often surprised by how unclear the public is on the way agents are paid. After ten years in real estate sales, my parents still seem to think I get a salary.

No, Mom and Dad, I’m on straight commission, like the vast majority of agents. If we can’t find qualified clients, we don’t sell. If we don’t sell, we don’t get paid. If we don’t get paid, we have to leave real estate sales. There’s a certain rough justice to this—an efficiency, if you will—that continuously culls the least productive from the herd. That’s why the straight commission model appeals to brokerages.

Straight commission works like this: I, Hot-shot Salesperson, believe that I can do enough sales to make enough money to stay in business. Straight commission offers me freedom. I can work at my own speed, just as long as I keep the pedal near, if not always on, the metal. Straight commission also offers me virtually unlimited income. If I feel like going for the gusto and working 24/7, then theoretically the sky’s the limit, as long as my health and my relationships hold out.

Broker, on the other hand, knows that a) Hot-shot might not be as hot as he thinks, and b) even if he his, he’ll have a dry spell now and then, and c) even Hot-shot doesn’t always feel like flooring it. Straight commission lets Broker reward the relative few who produce, and only when they do, while weeding out those who don’t produce, all with minimal risk to his capital.

Because if Broker’s real estate agents were salaried, he’d have to advance them money on deals not yet completed and perhaps never completed. This arrangement would be similar to the advances against royalties that recording artists receive, and it’s how they end up owing their labels if sales don't meet expectations. In real estate, commission-based compensation keeps Broker out of this bind. If an agent’s sales are sub-par, due either to his own shortcomings or to a market slump, then the agent takes a bullet for Broker.

For example, I knew an elderly agent who years ago had been placed on salary when he was one of his broker’s top salespeople. But that was then, and this is always now. Now found his production beginning to slip, partly because he’d outlived most of his clients and partly because to dewy first-time buyers he looked older than God. He was still doing decent business and, had he been on commission, he'd probably still be in our office today, but his salary made him too expensive.

But eliminating commission-based compensation won’t fix the delivery system. For one thing, it’s not going to happen. Brokers are reluctant to pay salaries, or at least salaries commensurate with what productive agents can make on commission. For change to occur, both mainstream brokers and the established agents who hang their licenses with them have to buy into it. Otherwise, it’s just singing Kumbaya around the campfire.

So let’s look at the idea of salaried compensation from the other side—your side. Instead of brokers paying agents' salaries, what if some financial incentive induced you to pay your agent a salary directly?

No, that’s not the answer either. Paying your agent’s salary would address one potential conflict of interest—agent pressure on you to buy or sell, whether or not it’s in your best interest—but it’d just create another. Like the economists say, it all comes down to incentive: "What's in it for me?" Now that your agent is on a salary, he has no incentive to help you buy or sell. Just the opposite, in fact. Because the moment you reach your goal, his paychecks stop. Now you’re in the same boat as the guy who wonders if his attorney will ever stop billing him and start fixing the problem he was hired to fix. And not everyone has the cash to pay an agent up front.

Fortunately, straight commission isn’t the problem in real estate. The root of the problem is straight contingency-based compensation.

By contingency-based, I mean that a professional, whatever his profession, isn’t paid until, and if, he brings the relationship to a successful conclusion. This arrangement isn’t unique to real estate. An attorney may take your lawsuit on contingency, agreeing that her payday will come only if you win. The size of her paycheck is directly related to the size of your award.

In real estate, just substitute “sale price” for “award”. But that’s not the only difference between the real estate agent’s and the attorney’s model. The critical difference is that the agent receives nothing to offset the expenses he incurs that are directly attributable to his client. The attorney does, even under a contingency agreement.

Let’s use flow-charts to look at the difference. Here’s the sequence of events in a typical, contingency-based real estate transaction, with the agent representing a seller:

Formal agreement between seller and agent

Agent provides professional services and incurs overhead expenses

but does not bill client for either

Contingent event (sale)

Agent compensated by seller with percentage of sale price, out of which he pays his own expenses

Now, here’s the typical contingency-based real estate transaction with the agent representing a buyer:

Informal agreement between buyer and agent

Agent provides professional services and incurs direct overhead expenses

but does not bill client for either

Contingent event (sale)

Agent compensated by seller’s agent with percentage of sale price, out of which he pays his own expenses

Finally, here’s the typical sequence of events in a contingency-based lawsuit:

Formal agreement between attorney and client

Attorney provides client with Attorney incurs overhead

professional services directly related to client

| |

Does not bill client for services Attorney bills client monthly

| for direct overhead

Contingent event (award) |

| Client pays attorney monthly

Client compensates attorney for direct overhead

with percentage of award

Note that the attorney's flowchart differs in two important respects from the agent-buyer (second) flowchart. Here we get to the core of the changes I’m proposing: the “what” and the “who”.

First, the attorney's flowchart shows a formal agreement. Let’s hold that idea up to the light for a better look:

f-o-r-m-a-l a-g-r-e-e-m-e-n-t

Hmm. Doesn’t that sound kind of…oh, I don’t know…formal? Kind of…intimidating? With, like, the rights and obligations of both parties clearly spelled out and agreed to, in a legally-enforceable contract?

Why, yes, it does. The attorney has a formal agreement between herself and her client that “formalizes” their relationship in a way that the relationship between agent and buyer almost never is. It lends credibility, even a certain solemnity to the proceedings. In fact, it’s what makes the proceedings credible: it confirms that this is no idle whim, quickly forgotten and not even vaguely regretted. It’s a test of commitment, a rite of initiation. Somehow that seems fitting for a transaction involving the buying or selling of the largest financial asset most of us will ever own.

This “formal agreement” between buyer and agent isn’t a new idea, incidentally, and it even has a name: buyer-broker agreement. The buyer-broker agreement in my area is a two-page document that spells out the rights and obligations of the buyer and agent, but its bottom line is that it obligates the buyer to pay the agent a commission if the buyer purchases a property within the stated period of time, even if the buyer uses another agent.

This encourages a monogamous relationship between agent and buyer. It’s like marriage vows with teeth. The agent can devote time to his buyer without worrying about whether she’s slippin’ around behind his back. The buyer-broker agreement is the buyers’ agent’s friend and, at least in my area, it’s about as popular with agents as commission reductions. I know of only one who consistently uses it, and only because she habitually deals with opportunistic out-of-area buyers who would gladly pump her for local information and then use it to breathe life into their clueless (but rebating) out-of-area agents. Apparently buyer-broker agreements are far more common in other markets—44% of buyers used one, according to a 2006 National Association of Realtors® study—but that's probably because of a quirk in local custom called "sub-agency".

Sub-agency turns the buyer's agent into the seller's agent as soon as he agrees to accept a commission from the seller. Yes, in some parts of the country (but not mine), the "buyer's agent" owes his fiduciary duty not to the buyer but to the seller. The buyer-broker agreement nullifies sub-agency, giving the buyer her agent back.

So the buyer-broker agreement isn’t exactly ground-breaking. But it hasn’t been widely accepted by agents in my area because, oddly enough, most of us seem to feel uncomfortable pushing it across the table to a buyer prospect. (Maybe we should bring back sub-agency.) You’d think we’d have lost such delicacy years ago, if we ever had it, but this goes to the core of the fragile relationship between buyer and agent. It’d be like everyone was taking off the gloves. The buyer-broker agreement punctures the polite fiction that, hey, we’re all caring, responsible human beings here. I trust you, you trust me. We’ve got a wonderful future together. And yes, that does sound more like the early stage of dating than the first stage of a business relationship. No wonder it ends so often in tears.

So for an agent to feel comfortable about pulling out a buyer-broker agreement, ideally the brokerage should require it (“they make us do it” usually works) and most certainly it has to offer the buyer an incentive beyond the vague “this spells out everything”. If the buyer-broker agreement isn't industry practice, or doesn't offer buyers an obvious benefit, buyers know they can go to ten other brokerages that won’t make them sign this unfamiliar and "entangling" document. So how can we make it attractive? In the case of the agent I cited above, the incentive is “my track record says I can get you a house in Wonderfulville, and your out-of-area agent’s track record says he can’t”. That’s an ideal trade: valuable expertise for commitment or, in areas with sub-agency, agent commitment for buyer commitment.

Usually, however, money will have to change hands to get a buyer’s signature. In other words, a cash rebate.

I’m not a fan of cash rebates in general, because I see them used to cover up shortcomings either in the product (obsolescent automobiles, for example) or in the service. They’re a fair trade, as long as the consumer knows they are a trade, not a free lunch. I think the rebate makes sense in this case. Call it the Barnes & Noble strategy. I can get 10% off their CDs by opting into their “club” and consenting to receive their marketing pitches and those of their “partners”. I trade something of value—their ready access to my Outlook inbox—for a 10% discount. That seems to work well enough for enough CD buyers to make it work well enough for Barnes & Noble.

The real estate buyer who signs a buyer-broker agreement would also exchange something of value—commitment—for a rebate at the end of the transaction. And make no mistake: buyer commitment is something with real value to broker and agent. Agent won’t spend six months working with Buyer, only to lose Buyer to discouragement or to someone with a better smile and bigger promises. That creates an efficiency for Agent (and therefore, Broker) that helps their bottom line. That efficiency lets Broker offer a small but significant rebate—say 5% of the gross commission—right off the top. Agent absorbs most of the cost of the rebate, because Agent typically gets a little more (and sometimes a lot more) than half the gross commission.

First, let’s look at how agent compensation typically works with no buyer-broker agreement and no rebate, in a $500,000 transaction, with the listing agent offering 3% gross commission to a selling (buyer’s) agent who’s on a 60% commission split with his broker.

No buyer-broker agreement or 5% rebate to buyer

Informal agreement between brokerage/agent and buyer

Contingent event (sale)

Listing agent compensates selling agent

with 3% of sale price (3% x $500,000 = $15,000)

| |

Brokerage gets 40% Selling agent gets 60%

x $15,000 = $6000 x $15,000 = $9000

Then, let’s see how the same transaction works with the agreement and rebate.

With buyer-broker agreement and 5% rebate to buyer

Formal agreement between brokerage and buyer

Contingent event (sale)

Listing agent compensates selling agent

with 3% of sale price (3% x $500,000 = $15,000)

| | |

Brokerage gets Selling agent gets Buyer gets

(40% x $15,000)− (60% x $15,000)− 5% x $15,000 =

[40% x (5% x [60% x (5% x $750

$15,000)] = $5700 $15,000)] = $8550

Of course, this 5% rebate isn’t engraved in stone. It’ll need to be fine-tuned, both by area and price range, to find a number that appeals to enough buyers and makes enough economic sense to brokerages and agents. The length of the buyer-broker agreement also has to be appropriate to the market. Six months would be adequate in a market where properties typically sell in ten-to-fourteen days, as they have in my area for most of the last nine years. A slower market might require a longer agreement although, again, this needs to be acceptable to both parties to catch on.

Okay, now let’s go back to the attorney’s model flowchart above. Note that the attorney has two income streams or, to be more accurate, one reimbursement stream for direct overhead costs and one income “balloon”. The agent just has the balloon, and sometimes it deflates.

Maybe you see where I’m going. How about if we adopt the attorney’s model to real estate? That’d benefit the agent, of course, but any change also has to benefit the consumer or there won’t be any takers. So let’s break out the rebate again. That’s fair. The agent is reimbursed now, instead of later (or never), which recognizes the time value of money to the agent: a dollar today is worth more than a dollar in the future. The consumer gets a rebate of, say, 5% at close of escrow, or perhaps a full or partial refund of the reimbursement he’s advanced to the agent, or some combination. The reimbursement model could be offered together with the commitment model, so that the consumer gets both rebates, or it could be offered separately. And since the direct overhead cost reimbursement goes directly to the agent, in this case the rebate comes out of the agent’s pocket, not the broker’s, at close of escrow.

Sound okay? I see at least three objections.

First, you could say that the rationale for reimbursing the lawyer for her direct overhead costs, even if she’s taken a lawsuit on contingency, is that the typical suit can take years to settle, years in which she could go broke without some reimbursement from her client for her expenses. And her client is typically a little guy, without the resources to pursue a lengthy suit on his own.

Granted, real estate deals don’t usually take years to consummate, but they’re often lengthy and strain the resources of the average agent. The risk/reward trade-off differs substantially as well. A lawyer’s payday can be 30% to 40% of the judgment, and in a big suit involving hundreds of thousands or even millions of dollars, that's a very big payday indeed. With that kind of reward waiting at the end of the rainbow, it matters less that it takes the attorney longer to get there. On the other hand, the agent’s upside is quite a bit more modest, generally less than 3% net.

Second, I can see you thinking I like the way things are now, because it lets me work with an agent for a while, for free, to see if I like him. Your arrangement wouldn’t let me do that.

It’s certainly fair and prudent to let you road test your agent for a while to evaluate his skills and your compatibility. But “a while” means a short time—days, maybe weeks—not months or years. It doesn’t take that long to know whether you want to do business with someone. Let’s put it in perspective. A car dealership may let you take one of their cars home and evaluate it for a day or two, but they won’t let you drive it for months, then bring it back because you’ve found something you like better. And a car’s just a commodity. An agent offers professional services. Your accountant or attorney isn’t going to let you take them out for an unlimited test drive either.

Big deal, you say. I don’t care how unfair it is to agents. I like my freedom. That’s okay, as long as you realize that this freedom costs you in two big ways. First, unlimited test drives damage the credibility of the real estate profession, and therefore the vital agent-client relationship. That’s important, more important than you think, because it makes you less likely to listen to the one person you should be listening to, the one person you've taken on as your advisor.

But it also costs you, if you're a real buyer, in another, more tangible way. You pay good money for the freedom to flit about, butterfly-like, from agent to agent.

How do you the buyer pay for anything? After all, the seller pays the commission. Right, but remember, the commission is tacked onto the price of the house you buy. The seller passes the commission cost on to you. Your down payment pays for part of the commission, and you finance the rest.

Here we’ve stumbled upon one of those awe-inspiring, Paul-on-the-road-to-Damascus revelations that a market-based economy occasionally springs, one that few people know exists, yet must exist to keep the wheels of the economic engine turning. You—yes you, the real buyer—pay extra in the current business model because you’re paying for freedom of action. That’s entirely fair: freedom of action is always worth a few extra bucks.

But you pay extra only if you’re a real buyer. If you’re not a real buyer, you don’t pay anything extra under the current business model, because you never pay anything. You don’t buy, so you don’t reimburse the seller her commission cost. But if you’re not a real buyer, you need to face a hard truth: you don’t belong in the real estate services delivery system. And if you don’t belong in the system, there’s no reason why it should benefit you. Right? If you're in the delivery system just for the thrilling ride, you’re real estate’s version of the “vexatious litigant”, the guy who continually files frivolous lawsuits just because he likes the attention. And since vexatious litigants burden an already overburdened court system, a judge can bar them from filing more suits. (“Vexatious buyer.” Hey, I like that.)

But sure, there’s no question agents would have to offer this reimbursement/rebate plan with a free initial consultation, perhaps an hour or two, perhaps longer. The test drive would have to be fine-tuned through trial and error, and probably adjusted by market, as would everything else I’m proposing.

The third objection to the reimbursement/rebate plan is my own: the idea of a buyer reimbursing his agent for direct overhead costs doesn’t go far enough. It doesn’t take into account the overhead expenses incurred just by being an agent, whether or not that agent is working with a client. Why should you reimburse your agent for indirect expenses you don’t trigger directly? Because that’s the only way you’re assured that the agent will be there—ready, willing and able—when you need him. It’s as if you and every other consumer share one home equity line of credit (the pool of agents), to draw upon as needed, except that in this case consumers withdraw real estate services instead of money, and except that in this case it takes years to establish the resource drawn upon (trained, experienced agents) instead of a few weeks.

We’ll look at the nuts and bolts of this reimbursement/rebate plan in a moment, but first I want to iterate that it can offer real benefits to the bona fide real estate consumer as well as to the agent—it has to, or it won’t work. Remember the seven problems with the current delivery system I outlined a while back, and how they impacted not just the agent but the consumer as well? Let’s see how the reimbursement/rebate with buyer-broker agreement would solve or minimize those problems.

First, as we’ve seen, only a percentage of consumers now pay for the services they receive. This inevitably raises the cost of those services to those who do pay. Up-front costs would screen out most of the tirekickers who consume valuable real estate services without paying for them, because consumers faced with the prospect of actually paying for services—right off the bat, not at some point far in the distant future that may never come—would be far more committed, realistic and focused. Money has a way of sharpening even the dullest wit, deflating even the idlest daydream and puncturing even the most over-inflated illusion. That by itself would be a huge benefit to consumers. Tirekickers who do get into the system would pay their way. This would lower the costs of services to those who enter the system realistically and in good faith, and leave it as successful buyers and sellers.

The second consumer benefit is that formal buyer agreements and up-front payments would enhance the perceived value of real estate services by attaching a price tag to them immediately, not down the road. If consumers place a higher value on the services they consume, they’re more likely to value those services. The more they value those services, the more likely they are to act on the expertise they receive and thus benefit from it.

Of course, the real way to enhance the perceived value of real estate services is to improve them: screen out the flakes, incompetents and bad actors before they get in the system, and purge them if they do. I don’t think it’s naïve to expect that we’d attract better people to real estate by raising the bar for agents and offering those who clear it a more logical, predictable business model.

Third, a steady income stream would take some of the pressure off your agent to see you buy right now, today, instead of next month or year. Granted, these reimbursements won’t be nearly as large as the payday he gets if you buy a house. But I think it’s the best compromise, because you do want your agent to have some incentive in seeing you buy. That is, after all, the reason you get into the real estate market, or it should be. This might remove some of the mistrust from the agent-client relationship, which would make the consumer more likely to listen to and act on expert advice.

Aside from dealing with those seven problems, I can think of at least three additional benefits to the real buyer from charging all buyer prospects up-front for the costs they generate.

First and foremost, consumers would be far more careful in selecting their agents. This would inevitably improve the consumer’s experience. No more choosing an agent based on how perky her smile or how nice his suit. If this sounds like I’m underestimating buyers, all I can say is that only a miniscule percentage of the buyers who’ve considered using me have bothered to ask for references or find out anything else substantive about me. A lot of questions that should have been asked never were, or were asked over dinner as we celebrated the close of escrow. There’s risk involved in selecting any agent, but hey, at least make it a calculated risk.

It’s not that buyers are stupid. It’s just that they’re often unsophisticated about business in general and real estate in particular (as are bubbleheads) through no fault of their own, and they’re dealing with salespeople who are often quite sophisticated about passing themselves off as knights in shining armor. And buyers bring considerable emotion to home buying, which leaves them susceptible to anyone who comes across as Prince Charming.

A more reasoned and intelligent agent selection process could easily improve the overall quality of real estate services by eliminating agents who are little more than cardboard characters. Like every American consumer every day, buyers are bombarded with salesmanship, subtle and otherwise. That’s okay, as long as they know what’s happening. Swerving to the other extreme—“all agents are phonies and rip-offs”—isn’t helpful either, because as a mature insight into the inner workings of the universe, that’s right up there with “I just found out there ain’t no Santy Claus.” Salesmanship is part of the job description. You’d want us singing, dancing and selling our hearts out if it was your house.

Here’s another consumer benefit I’ll bet you'll never think of: it’ll make your agent smarter. Seriously. When I first got into real estate sales I suddenly noticed I wasn’t quite as sharp as I’d been. In fact, it seemed like I’d lost about half my brain cells. This wasn’t true, of course, not strictly speaking. I’d just been stunned by a blow from the heavy blunt instrument of real estate reality: a sudden comprehension of the size of the challenge I’d so casually assigned myself. Half my brain was currently out of service, bogged down with issues like whether my clients would buy before I burned through my savings, and whether they’d still be my buyers when they did. Take that considerable weight off your agent’s mind and he’ll perk right up, do a better job and maybe even be more interesting.

Here’s one more huge consumer benefit: it’ll reduce the number of times that buyers abandon their agent for the listing agent. You’re thinking that this would just benefit the buyer’s agent. No, it’d also save the buyer and the listing agent from themselves, from working angles that shouldn’t be worked because they don't exist. Because some people, including myself and many of the people who count—plaintiff’s attorneys, judges and juries—don’t think an agent can faithfully serve buyer and seller, especially if the pay-off for that agent isn’t necessarily a job well done but just a bigger payday. (See Why not use the listing agent to make your offer? for a complete discussion of this.)

So the commitment/reimbursement/rebate model saves agents from flakey buyers, and saves flakey buyers and greedy listing agents from themselves. Now that’s what I call win-win, or maybe even win-win-win. (Who saves buyers from flakey agents? We’ll get to that another time.)

Still with me? Congratulations! You could probably read Thorstein Veblen from cover to cover. Okay, let’s see how the reimbursement model might work.

Now the buyer pays a modest hourly rate to the agent, based on the costs that the agent incurs 1) because of that particular buyer (direct costs) and 2) just to stay in business and be available to buyers (indirect overhead). Both costs are real, and both come out of the agent’s pocket in the current business model. Transferring these costs to the consumer benefits the agent, of course, and in exchange for that benefit, the agent offers the consumer the benefit of an even larger rebate.

The costs most directly attributable to the buyer are those incurred when the agent looks at homes either with or without the buyer. Gasoline is the most obvious of these expenses, but it’s just one of many. Other auto-related costs include lease or loan payments, depreciation, maintenance and insurance. Obviously these costs vary from car to car, so perhaps the best agent reimbursement would be the flat mileage reimbursement allowed by the IRS, currently 40.5 cents per mile.

Then there’s the overhead expenses incurred in just being an agent, whether or not the agent is working with a client. In my area the basic agent fees include the following (my 2005 costs are in parentheses):

· Membership in the National Association of Realtors® $432

· Membership in the California Association of Realtors (included in above)

· Membership in the local Board of Realtors and lockbox key maintenance (included in above)

· Membership in the Multiple Listing Service $439

· License fee and costs of continuing education required by the state ($499 prorated over four years = $125/year)

· Charges billed by each brokerage, such as “desk fees”, “legal fees” and “tech fees” ($2945)

· Business cards ($48)

To these I’d add the following costs, optional but expected by most clients in my area, what might be called the “minimum level of premium services”:

· Mobile phone and wireless service ($1344)

· Voicemail ($115)

· Web site hosting and domain name registration ($132)

· Listing alert ($299)

These indirect overhead costs total $5879, not high considering an agent’s income potential. That’s why the business supports so many marginal and/or part-time agents, although the better brokerages expect their agents to bring in far more than their overhead. Spread my indirect overhead costs over 2000 hours annually, and that’s a billing rate of about $3/hour.

Factor in the IRS mileage reimbursement rate of 40.5 cents per mile, and let’s see how this reimbursement model would work if I was your agent and you were a “typical” buyer.

Let’s say that in any given month I spend three hours with you on each of two week-ends, showing you homes and evaluating them with you. In addition, each week I spend two hours previewing a broad range of new listings so that I show you only the ones you’re most likely to want to see. Then let’s say that I also spend three hours with you that month explaining real estate documents and writing an offer that goes nowhere. Let’s add another ten hours for phone conversations and e-mails with you, your loan agent, listing agents and various vendors and inspectors. I’ve spent a total of 27 hours that month on your quest for a home. At $3 per hour, that’s $81 in billable time that month. The bill is itemized and documented where possible, with phone logs, copies of e-mails, house flyers, listing agent business cards etc.

Now let’s look at the mileage expenses I incurred on your behalf. Let’s say that I traveled 20 miles each week-end I went out with you, plus another 30 each time I previewed homes. So that’s a total of 140 miles traveled just for you that month. At 40.5¢ per mile, that’s an additional $56.70.

So that month I bill you $137.70. That’s a modest fee—in fact, it’s a bargain—because it doesn’t begin to cover my real costs of doing business. The fees I’ve listed suggest (although they don’t guarantee) a basic level of professionalism by the standards of my area. Agents can have other costs, depending on their level of marketing and professionalism. These might include a franchise fee, plus costs to buy leads, obtain and maintain professional designations, take continuing education classes not required by the state, pay an assistant(s), advertise in the newspaper, put out a newsletter etc. etc. etc.

Again, these overhead costs vary from agent to agent. Some agents will buy almost anything that’s new and promises more income and more time on the golf course. Others will bump along with the most minimal of overhead. It’s amazing that the present compensation system doesn’t recognize this difference. Most businesses at least try to pass on their marketing and other overhead costs to their consumers. But no matter how much an agent pays to get and serve her clients, she gets the same size commission check. No wonder most of the additional expenses an agent incurs are aimed at increasing her income rather than her skills.

So now we’re back where we were a few paragraphs ago: some agents have more overhead than others. Then we dealt with this by reimbursing each agent for auto-related overhead without tying that reimbursement directly to the actual amount of overhead. Every agent drives a vehicle, but can an agent who drives a late-model Mercedes charge more for his higher overhead because his Mercedes makes him worth more to his client? In other words, does his prestige car add value to the agent-client relationship? Probably not, although you could make a case that the Merc increases the client’s comfort level because it suggests a successful agent. Don’t laugh—that comfort level is important.

But with non-auto related overhead, we may not need to adjust for the differences between agents, since more of this kind of overhead may mean more service. For example, let’s say that your agent’s “listing alert” is automatically e-mailing you new listings the moment they come on the market, and that his Blackberry instantly shows him your e-mail asking to see one of these homes. Both services raise his overhead, but both also raise the level of service he offers. In any case, the market will decide if an extra level of service is worth additional reimbursement to the agent, and by how much.

Here I think we’ve gone about as far as we can in outlining the structure of a new services delivery system. You can’t pull numbers out of the air, and we can’t restructure the real estate industry in the pages of my Web site, no matter how good it is. Even if the agent reimbursement model did become the industry norm, individual brokers and agents would play around with their overhead charges to position themselves in the marketplace, just as they do now with commission. Good agents are always deal-makers, and bad agents are always willing to give away their money (and yours). Prestige agents wouldn’t compete on price, while marginal agents and discounters would use it as another opportunity to undercut the competition.

Now that we’ve come this far, let’s look at an even more radical idea: pay your agent a flat hourly fee, over and above reimbursement for his expenses. If and when you buy, your agent gives you an even larger rebate, or refunds you what you’ve paid him, or some combination. This recognizes the time value of money (a dollar today is worth more than a dollar next year) to the agent, and rewards the most committed of consumers.

I won’t use any numbers to illustrate this point, because my numbers would come out of a vacuum. Yes, like 99.999% of agents, I don’t know how many hours my “average transaction” (which doesn’t exist) consumes, so I don’t have any real idea of what each transaction should cost the consumer on an hourly basis. I can tell you that each of my transactions cost me almost $3000 on average in 2005, but that’s because almost all of them were listings, and listings have far more direct overhead than buyers (but I ain’t complainin').

And the exact costs really don’t matter, because what’s important is the market value of each of my hours—how much does the consumer value my time? So I’ll let the MBAs back at corporate headquarters, the ones who probably know the true costs of each transaction and, just as important, the focus groups, come up with the numbers. There’d have to be plenty of make-up troweled on this plan before it was ready for its close-up, but it sure sounds good to this agent, and at some level the rebate would sound good to enough consumers to get the ball rolling.

Perhaps a brokerage could offer some form of the commitment/reimbursement model along side the existing model. It’s a new, even radical idea, but if there’s enough money in it, both for the industry and its consumers, it could become the way business is done. Certainly it’s more equitable to everyone who deserves an equitable deal.

And, of course, some brokerages currently offer rebates to buyers without requiring a commitment. But I think something like the strategies I've advanced would still be a powerful tool for a name-brand, nationally-known brokerage. I think most buyers prefer dealing with a company with greater credibility than the small-time discounters who use buyer rebates now. It’d take some persuasion (called “marketing”) to sell the program initially, but that would be a far better use of marketing dollars than the witless but expensive television ads the brokerages inflict on us now.

You’ll also notice that so far I’ve focused on buyers. That’s because sellers are a whole ‘nother story. The listing side of the equation isn’t broken, at least not for agents. Listings are usually how you get ahead in this business. “List or perish” is the mirror image of “buyers are liars”.

For one thing, sellers virtually always sign a formal agreement, called a “listing agreement”. Right here this eliminates most of the flakiness.

And now we’re talking about someone’s house. Homeowners usually don’t decide to sell on a whim. And if they do, there’s often an informal strategic review committee (spouse, kids etc.) that has input in the decision and can bring some rationality to the discussion.

Then there’s the not inconsequential matter of real estate’s “illiquidity”, which is a fancy way of saying that your house takes time and money to sell. Time and money tend to cool all but the hottest of jets.

Finally, sellers offer a tangible object of great value, while buyers offer only promises. The accomplishment of homeownership (and make no mistake, achieving homeownership is a huge accomplishment) proves that the seller was at least at one point realistic and motivated enough to maneuver successfully in the real estate marketplace. The odds are good that s/he’ll be just as successful in leaving it. Buyers can’t always point to this kind of track record.

That’s not to say that every seller is a realistic seller, willing and able to take what the market offers. But with sellers, the agent stops needing protection from the users and abusers, and may just need protection from himself. Because now the agent has all the information he needs to make an informed investment decision—usually; sometimes sellers throw you a change-up at the last minute.

Unintelligent agents will always take bad listings. Sometimes they take them because they think they can get other listings from them (“Hi. I obviously can’t sell your neighbor’s house. Let me do the same for you.”). Or they think they’ll meet buyers (“Hi. I obviously don’t know what I’m doing. How about working with me?”) Or they think that having their sign in front of a house for months and months is great free advertising. Cunning agents will always take an overpriced listing because they think they can eventually wheedle a price reduction out of the seller. They don’t believe that “it’s better to be the second wife and the second agent”.

But an intelligent agent with no hidden agenda can look at a listing and see if the odds say that putting time and money into this will be prudent investment, not mindless speculation. Yes, they say, this one looks like real business, not busywork.

That’s why many agents prefer sellers to buyers. “List or perish.”

So far we’ve just looked at listings from the agent’s point of view, and from that perspective, there’s not much wrong with the current system. But remember, our goal is to reduce costs to consumers by introducing greater efficiencies into the real estate services delivery system. (Real efficiencies, that is, not the imaginary efficiencies of the discounters and the Internet.) So we need a device that rewards motivated sellers and penalizes those who are just fishing for “the right buyer”. And like the buyer-broker agreement, here we can also use something that’s always been around but isn’t used much: the graduated commission schedule.

Let’s say I take a listing in a market and price range where homes typically sell within two weeks. Let’s also say that I’ll offer the cooperating (buyer’s) agent full commission (3% in my area), either because that’s my company’s policy or because it’s just good business for the seller. As listing agent I need to earn a commission that covers not only my actual costs, but also makes the wear-and-tear of the transaction worth my while. My commission also has to cover the liability exposure I incur in any transaction. In other words, I don’t want to sit in court thinking, “I worked for $5 an hour just to get here?”

I’ve decided that I’m willing to accept a 5% commission (2% to me, 3% to the other agent) if my listing sells within the normal timeframe. But if it takes me three-to-five weeks to sell the house, I get a 5.5% commission (2.5% to me) to cover the additional time and advertising involved. And if it takes me longer than five weeks, I get 6% (3% to me).

This benefits the motivated, realistic seller who agrees to price the house properly and spend a minimal amount of money to present it properly: painting, floor coverings, staging and any other high-payback enhancements. It also benefits me, because I don’t spin my wheels with a listing that won’t sell.

Of course, the potential drawback to the seller is that her agent could drag his feet in selling the house just to get into one of the higher commission rates. That’s why the commission structure has to be realistic: it has to accurately match the greater expenses the agent incurs, if the listing drags on, with the savings he offers for a faster sale.

So that’s my modest proposal. It’s a combination of the tried-and-true and radical change. Maybe it works, maybe it doesn’t, but I bet it would make it off the ground and fly a few feet with even a little tinkering. The real question is whether the parties involved—consumers, agents and brokerages—can see enough benefit from it to change the way business has been done for years.