domino effect
Issue 112 - December 2nd, 2022
Legacy brokerage business models that make the majority of their revenue through agent commission splits are bad business models in today’s world. It is a bad way to build a company, and it is a bad way for agents to build their own business.
Why is the legacy brokerage model a bad business model?
First let me define the term legacy brokerage: legacy brokerages are the real estate brokerages still in business today that have not really changed their business model that much over the last few decades. They typically have huge office footprints with high fixed operating costs and they employ a “commission split” revenue model to generate revenue for their company.
Their revenue model is not predictable: legacy brokerage firms only make money whenever a transaction successfully closes which generates poor cash-flow that hinders future planning in technology, support, and staff hiring.
It costs a lot of money to operate physical in-person offices that agents hardly use
This was a trend even pre-pandemic. Real estate agents are constantly on the go and huge office footprints go to waste in terms of capital expenditures. This money could be reinvested in much better places to benefit the agent’s well-being and success.
Legacy brokerages staff up internally on things like marketing services, transaction coordination services, and other things that they advertise are included as part of the “split” BUT in all reality the service is poor on these initiatives because the brokerages never properly invest in these resources and generally make a half-way effort just to “check the box” that they have this type of service
The best agents are out in the field meeting customers and networking, not sitting in an office on the computer all day…
Innovator’s Dilemma Playing Out In Real Time
Incentives between brokers and agents are misaligned in a “commission split” revenue model. The brokerages are not incentivized to focus on making the agent’s experience better because they only have limited margins to work within a “commission split” revenue model. Brokerages are constantly juggling “just enough service and support” to keep the agents happy but not “TOO MUCH” where it impacts their revenue/profits substantially.
The higher the splits go against the brokerage, the less money they have to invest in resources for agents. When you are staring down high fixed costs like office leases and office staff, then you really run out of margin to reinvest way faster than most people realize.
Legacy brokerages know their “commission split” model is broken in a high split environment but they fear change and further upsetting the status quo. In most cases, they do nothing to radically innovate their revenue model. They solve their shortfall in revenue by adding on other “fees” in addition to the splits to off-set losses. They add on things like “technology fees” or “resource fees” or “franchise fees” that get added on to the agent’s splits, but they always advertise the “split” to the agent as the hook to get them to the brokerage when in fact the “split” is actually 10-15% worse than what it seems on the surface.
When markets evolve and change, a domino effect takes place which hits legacy brokerages much harder than other types of models in this industry.
As transaction volumes fall, the legacy brokerage model’s revenue falls off a cliff
Their fixed costs (offices etc.) remain super high
The staff are usually the first layoffs these firms make in a slowing environment which further erodes the value of their business proposition
Wait, I thought I paid the split to get these services?
In a declining market, agents start to wonder why their brokerage is taking 20-30% of their money when the staffing and support side of the business has completely eroded, and they are having to find other avenues for support and service out of their own pocket.
The alternative is to completely rebuild and rethink the brokerage business model from the ground up, and I will write about this in my post next week.
There are multiple factors involved to build a platform for the future for this industry, and it requires rethinking the entire business model top to bottom.
To use a (somewhat cheesy) comparison that makes sense here… legacy brokerages (and some of the new brokerages popping up) in today’s world are like homes that have been flipped by a house flipper, some of them on the surface look shiny and new with bells and whistles like tech and support etc. but in reality their foundation is still decades old and super shaky.
The best business models in the market today and the future are like new construction homes that have been built for today’s environment from the ground up rethinking every single detail along the way.
Would you rather have a house that has been flipped quickly and cheaply or a well thought out brand new construction home built to withstand the future but having learned so much from the past?
The best path forward for this industry is a combination between old and new. You have to balance great things that have worked in the past, but you also have to have a forward thinking view to build for the next 50 years to thrive in a changing world.
More to come next week!
Newsworthy Links To Share
For the first time ever, the US government will backstop mortgages above $1M in the 3% of counties that qualify as high-cost markets. The move is meant to stimulate homebuying in an ice-cold housing market, but the government’s willingness to assume more risk in uncertain economic conditions is worrying.
Eric Wu steps down as CEO of Opendoor and current CFO takes over role. Wu will remain at the company as Head of Marketplace. (Opendoor Blog)
Hybrid Rocket Engine Manufacturer Firehawk Aerospace Relocates Headquarters to DFW (D Magazine)
Jason Oppenheim: 'There's no fixing Compass. It's unfixable': I think for anyone who understood the brokerage model, you know, there was no other option than Compass imploding. There was no other scenario. Doesn’t matter whether the market stayed healthy, or when the market softened. That had nothing to do with Compass’ implosion. Compass would be in as terrible of a position, even if the market had stayed as strong as it was in 2021. (Inman)
Miami-Dade County asked a judge to immediately terminate a $135 million naming rights deal it struck with FTX so that it may shop the Miami Heat's arena to another sponsor. (Fortune)
Investors Boost OZ Equity By Nearly $10B This Year As Clock Ticks Down
Despite the turbulent economy, and a deadline, investors still want to be in OZ funds. (Bisnow)
Cold hard truths: All signs point to an upcoming surge in home supply. While some would-be sellers will wait out the winter and hold onto their less than 3% mortgages, many will be forced to put their homes on the market—whether they’re seniors who need to move, families that need bigger houses, or workers relocating due to layoffs or new employment. (Bloomberg)
Crypto bros offloading G-Wagons, luxury cars amid FTX crash
Some luxury car insiders believe the purge is linked to the FTX collapse, which caused as much as $2 billion in client money to evaporate. (NY Post)
NAR rejects bid to end no-commingling rule, Zillow reveals
Zillow Senior Director of Broker Operations Matt Hendricks said the portal petitioned NAR to stop allowing MLSs to ban brokers from displaying MLS listings with non-MLS listings online. (Inman)
Airbnb Aims to Attract Big Landlords With a Cut of Its Rental Sales: Airbnb Inc. is launching a listing service for rental apartments with some of the biggest landlords and property managers in the country, a bid to expand its business in multifamily buildings where owners often shun short-term rentals. The new service will feature more than 175 buildings managed by Equity Residential, Greystar Real Estate Partners LLC and 10 other companies, Airbnb said on Wednesday. (WSJ)
10 U.S. cities that are growing the fastest—and New York City isn't one of them (CNBC)
- “The upcoming months should see a return of buyers, as mortgage rates appear to have already peaked and have been coming down since mid-November,” said NAR's Lawrence Yun. #NARPHS