Copied from Inman News:

Tuesday, March 21, 2006

By Marcie Geffner

A secretive and controversial new real estate business model has cost one real estate agent his job and muddied the already blackened waters that swirl around how real estate commissions are split between the sell side and buy side of most transactions. The business model and the debate and angst over it point to a serious structural problem in the industry and support the argument that the split compensation system should be scrapped altogether.

The agent, Ron Patterson, was terminated from his affiliation with Long & Foster Realtors after he set up Realty Legacy, a network of real estate agents who agree to offer commission rebates to buyers -- and, interestingly, sellers -- secretly and separately from the settlement process. Long & Foster rightly declined to discuss why it cut Patterson loose from the company, yet the timing of events suggests the severance wasn't mere coincidence.

Patterson's business model appears dicey since monies paid through settlement must be disclosed, and disclosure, in this case, would negate the purported purpose of the business model, which is to keep the rebate secret from competitors in general and the brokerage company on the other side of the transaction in specific. But disclosure is not purposeless; it's required precisely to protect the buyer and the seller from this type of under-the-table kickback. Secret rebates also raise concerns because the broker is responsible for the agent, who presumably could offer the rebate without the broker's knowledge or permission and perhaps in violation of company policy. As Dennis Arnold of McGraw Davisson Stewart, Realtors, in Tulsa, Okla., rightly opined in a letter to Inman News, if a business practice is "too secret to tell your broker and others in the profession, then (that) probably is something (you) should consider very strongly before" doing it.

And yet, rebates aren't the demon that some in the industry claim they are. Rebates make good sense, in theory, for at least four reasons: First, the buyer's agent's compensation should be a matter for the buyer and the buyer's agent, not the seller and the seller's agent, to decide. Second, brokers and agents should be free to set their own prices for their own services as any other businessperson can do. Third, rebates are a form of price competition, which is healthy in any business sector, even though individual competitors naturally dislike it. Fourth, rebates reduce the amounts sellers and indirectly buyers pay for real estate brokerage services, and frankly folks, when selling a home can cost as much as a brand-new luxury car, something, alas, is sadly amiss.

But theoretical rebates don't take into account the peculiar nature of how real estate brokers are paid for their services. In practice, a secret buyer rebate differs little from the notorious "roundtrip" transactions that cooked a certain dot-com company's books and landed some of the company's executives in a lot of hot water. The home buyer who has been promised a secret rebate can offer the seller a higher price for the house, which may capture the deal, especially if multiple offers are on the table. The seller then pays a commission to the listing agent from the proceeds of the sale and the listing agent divides that commission with the buyer's agent, who puts the money back into the buyer's pocket. Paying the rebate outside of the settlement to keep it secret doesn't solve the problem; it just makes the rebate itself smell fishy.

But the rebate itself isn't the problem. Rather, it's an unhappy side effect of a structural problem in the industry -- that the buyer cannot negotiate how much his or her own agent is paid. That inability to negotiate prevents price competition on the buyer's side and indirectly keeps commissions artificially higher than they otherwise would be. Buyer agency and compensation aren't new ideas, but unfortunately, the split system and the inflated commissions that the system protects are so entrenched that no challenge has been able to make significant inroads against them.

The solution is the same as it has been all along: The buy-sell split and the outmoded sub-agency model that spawned it should be illegal; instead, the seller should pay the listing agent for his or her services in selling the home, and the buyer should pay the buyer's agent for his or her services in buying the home. That would be in the best interest of both the buyer and the seller. Laws to this effect should have been passed way back when buyer agency and agency disclosure forms began to supplant sub-agency, but alas, change comes slowly, if it comes at all.

Marcie Geffner is a real estate reporter in Los Angeles.

I love how off the books accounting is another 'innovative model' in the eyes of the press.

I guess Enron was just innovative too?

There are plenty of above board buyer rebate models out there... see Zip Realty.

As these models become more prominent in a seller's market, Buyer side commission depress as more and more agents enter the market with little to compete with other than price.

However, as Buyer's commission fall the ability to rebate 1% and run a profitable business gets more difficult... again see Zip Realty's change in rebate strategies effectively reducing their unique selling proposition as commission rates have fallen.

Finally our 'reporter' ignores the fact that a Buyer pays system would eliminate certain financing options and cause a drop in sale prices and property values which is the major driver in keeping the status quo.

This reporter is stupid yeah like we want commission to go down and work the same for less money.These people are so funny!

Other than the fact that Inman is always anti-realtor... I don't see where he has a problem with Realtors in general in this case.

The brokerage fired the offending agent for his activities. Should we consider Inman in the same class as the reporters from New York Times that faked their new sources?? Or should we just consider him as another self promoting book seller in a field he is growing more distant in his understanding from each day?

Seems to me that if Buyers had to pay 1/2 the commission, they'd work hard to go around us and find FSBO's.

With the growing complexity of actually closing a real estate transaction, most people prefer to be professionally represented.... unfortunately professional representation is not a given just because some one is licensed.