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Buying a home is expensive<\/a> these days, but not just because of sky-high prices<\/a> and burdensome<\/a> mortgage rates\u2014costly commissions for real estate agents are eating into homebuyers\u2019 bottom lines, too. In fact, Americans pay roughly $100 billion<\/a> in real estate commissions annually, according to a 2023 Keefe, Bruyette & Woods analyst report. But the good news, at least for anyone who isn\u2019t<\/em> a real estate agent, is a new working paper titled Real Estate Commissions and Homebuying<\/em><\/a> suggests that roughly $30 billion of U.S. real estate agents\u2019 commissions could be slashed by using a new compensation model.<\/p>\n In the paper, Richmond Federal Reserve Bank senior economist, Borys Grochulski, and vice president of research, Zhu Wang, argue that the U.S.\u2019 model for real estate commissions is \u201cpuzzling\u201d and an \u201canomaly\u201d when compared with other systems abroad. The pair note that home sellers in the UK, Ireland, the Netherlands, Singapore, Sweden, and Norway pay less than 2% in commission to their real estate agents on average, compared to 5.5% in the U.S, according to a 2015 study<\/a>.\u00a0\u00a0<\/p>\n As for buyers, a large portion in many countries, including Australia, Canada, and Denmark, purchase properties without agent representation, while 87% of homebuyers use an agent in the U.S, according to National Association of Realtors data<\/a>. That\u2019s a huge percentage of Americans choosing to use buy-side agents considering half of all buyers<\/a> find their own homes online anyway.<\/p>\n All of these issues with real estate agents\u2019 current compensation model contributes to \u201celevated home prices, overused agent services, and prolonged home searches,\u201d according to Wang and Grochulski. In order to correct the problem, the economists proposed a new \u201c\u00e0 la carte\u201d model for buy-side real estate agents that could reduce buyers\u2019 commissions by roughly $30 billion.<\/p>\n \u201cThe results suggest that switching to a cost-based commission model\u2026may increase U.S. homebuyers\u2019 welfare by more than $30 billion a year,\u201d Wang and Grochulski write, noting that \u201cmost of the consumer welfare gains would come from the redistribution of buyer agents\u2019 profits.\u201d<\/p>\n The \u00e0 la carte compensation model would require home buyers and sellers to both pay their own agents separately\u2014and independent of the final home price in the transaction\u2014in order to prevent something called \u201csteering<\/a>,\u201d where agents tend to direct their clients away from properties that have low commissions.<\/p>\n The model would also force homebuyers, but not sellers, to pay for each task that their agent undertakes individually, whether it\u2019s searching for a home, helping with negotiations, or showing properties\u2014hence the \u00e0 la carte name. The economists argue that this would enable consumers to shop around for individual buyer-agent services, and even haggle for a better price. \u201cUnder such a system, competition among agents would likely align agent compensation with cost, and buyers would not overuse agent services,\u201d they write.<\/p>\n The new paper from the Richmond Fed comes at a difficult moment for real estate agents. The National Association of Realtors and several national brokerage firms<\/a> are facing multiple lawsuits<\/a> alleging collusion to inflate real estate agent commissions. This, after a jury in Kansas City sided against NAR last fall in a similar case, leaving the organization with a $1.8 billion <\/a>judgment (which it plans to appeal).<\/p>\n The pressure on real estate agent commissions has been so intense that it even prompted the noted short-seller Spruce Point Capital to put out a short report<\/a> on Zillow<\/a>, the real-estate marketplace that derives a large portion of its revenues from buyer agent commissions, warning that the company\u2019s stock price could drop up to 60%. One of the major issues the short-seller cited was analysis that shows recent lawsuits could change the way buyer-agent commissions are handled, leading the total addressable market of commissions to drop as much as 30%<\/a>.<\/p>\n Still, in spite of the negative impact of changing the current compensation structure for the real estate industry, Wang and Grochulski believe that a new model for commissions is necessary, and their \u00e0 la carte approach would likely be the best option for the economy as a whole. From eliminating agents\u2019 incentive to \u201csteer\u201d clients away from low-commission homes and increasing \u201chousing search efficiency,\u201d to enabling buyers to use multiple agents throughout the home buying process (putting agents\u2019 time toward \u201cmore productive uses\u201d), the economists lauded their model\u2019s potential benefits. \u201cWe propose that policymakers may consider shifting to an \u00e0 la carte model,\u201d they concluded.<\/p>\n<\/div>\n\nSubscribe to the CFO Daily newsletter to keep up with the trends, issues, and executives shaping corporate finance. Sign up<\/a> for free.<\/div>\n