domino effect part 2
Issue 113 - December 9th, 2022
Welcome to “domino effect part 2”! Today’s post is a continuation of my thoughts on the brokerage industry, and how a new real estate brokerage business model needs to be built from the ground up to thrive in today’s world.
You cannot simply slap bells and whistles on outdated business model architectures and foundations. You must start from scratch and build entirely new from the ground up!
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…
What is my vision of the future for this industry?
The real estate brokerage firms that succeed in the future are focused on reinventing the relationship between brokerage and agent. Believe it or not, agents are still involved in over 89% of transactions today in America.
So many “new” companies in our industry are just old business models dressed up in hip new clothes, and so many other “innovative” models are trying to chop agents out of the equation. I don’t think either of these paths have staying power long term though some may see 15 minutes of fame before failing.
Various prop-tech and venture backed companies over the last decade have tried to delete agents entirely from this industry BUT in reality agents are only getting stronger and stronger.
The “legacy brokerage” models that rule the industry today in terms of agent count are struggling to innovate and agents are starting to seek new ways of doing business. Many of these “legacy brokerage” firms are making the laziest move of all which includes adding more and more fees onto their commission split revenue models which are a further burden on their agents.
Agents in today’s world value pricing, service, freedom, support, community, network, and brand - not in that exact order but these are all very important to agents in today’s world.
Agents are looking for the ultimate combination of great service at the lowest cost but also a community and support for when they need it; “agent brand” is also becoming a very important theme in the industry and more and more agents want total brand control, BUT they also don’t want to necessarily launch their own brokerage firm from scratch - agents love selling and spending time with their clients not setting up businesses and worrying about the operations side of the business.
The platforms of the future will give agents incredible pricing, incredible support, and freedom to operate as they wish. Combine this platform mentality with “on-demand service” and partnerships with other incredible tools, and you have a win/win for agents and brokerages.
Revenue Models - “commission splits” versus other forms of revenue
The “commission split” revenue model is the standard today for most real estate brokerage firms. An agent has a pre-determined “split” with their brokerage and when an agent successfully makes a sale then the brokerage takes a “split” of the commission from the agent as their “fee”.
I think commission splits are horrible for agents and also a bad business model architecture for brokerage firms.
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.
Brokerage business models that rely on successful transactions as their sole source of revenue cannot plan properly for the future. Their success is so tied to successful deal closings that their service and support side of their business deteriorates in down markets as they have to lay off staff quickly when transactions slow down. These businesses have hardly any recurring revenue so they do not have a solid foundation on which to plan their future to make a better environment for their agents and a more solid way to run a business and invest in its growth.
I believe that transparent subscription-based pricing is the future for this industry and empowers agents to plan better and find pricing plans that work best for their business.
A combination of subscription pricing + fixed transaction fees also could be where the industry evolves too but more transparency and fixed pricing is much better for agents instead of commission splits.
Pipeline Versus Platform Mentality
There is a famous Harvard Business Review article from 2016 called “Pipelines, Platforms, and the New Rules of Strategy”, and you can read a copy of it here.
Platforms have existed for years. Malls link consumers and merchants; newspapers connect subscribers and advertisers. What’s changed in this century is that information technology has profoundly reduced the need to own physical infrastructure and assets. IT makes building and scaling up platforms vastly simpler and cheaper, allows nearly frictionless participation that strengthens network effects, and enhances the ability to capture, analyze, and exchange huge amounts of data that increase the platform’s value to all. You don’t need to look far to see examples of platform businesses, from Uber to Alibaba to Airbnb, whose spectacular growth abruptly upended their industries.
How does this apply to the real estate brokerage industry?
Most real estate brokerages as they get bigger and bigger all start to look the same today. Once they see agent growth plateauing, they try to slam additional service based revenue into their business to show “attachment revenue” to the public markets and push a narrative that these tools create value.
They all try to vertically integrate everything from title to mortgage and other services in the name of additional ways to generate revenue on their already poor revenue model of commission splits.
These brokerages think that by forcing agents or trying to force agents to use a “preferred lender” or “preferred title” company that they are somehow providing value to their agents, but in reality they are thinking with a self-serving mentality to try to fortify their failing business model. Go ask any agent at a firm that has these types of “preferred partnerships” and ask them how many of them like to refer these “partners” to their clients…
The right way to solve this problem is through a platform mentality that gives agents more choice and better service.
How do you solve this problem in the best interest of agents, consumers, and vendors?
Platforms create value because they connect people together. A great platform connects agents to things they need and gives them CHOICE. Agents value freedom and choosing what works best for their business.
Instead of forcing agents to use certain tools, mortgage companies, or title companies along with many other things in their day to day work, why not connect them with hundreds and hundreds of vendors and let them choose what works for them?
Vertically integrated brokerage business models that try to force a certain way of work are not the way of the future in the real estate brokerage industry. These companies are not thinking with an “agent-first” mentality and are simply trying to force certain ways of work to pad incremental revenue to their bottom line.
When a platform enters a pipeline firm’s market, the platform almost always wins.
Hopefully you found today’s post interesting, and I will leave you with this one slide which is how we think about things at Pinnacle Realty Advisors as we continue to scale. Everything we do revolves around making agents work and life better, and we are obsessed with creating an incredible “Brokerage As A Service” platform that gives agents an impeccable level of service in a fixed cost method and also gives them choices to run their business however they wish - we are there to support them with whatever they need along the way.
Newsworthy Links To Share
Robot Landlords Are Buying Up Houses (Vice.com)
Zillow acquires real estate marketing company VRX Media to boost listing services (GeekWire)
Silverstein Raising $1.5B Office-To-Residential Conversion Fund
Zillow has released its predictions for the 2023 US housing market. Zillow’s forecast, based on the most recently available real estate data and trends, is mostly what you’d expect: Bet on the Midwest: In 2021, the housing markets in the South and West were projected to be the strongest. Moving into 2023, Zillow is still betting on the Midwest because of its affordability. Average mortgages remain below 30% of income across states like Ohio, Pennsylvania, and smaller metro areas in Illinois. Rent is also more affordable, probably because there’s more inventory in the Midwest compared to other parts of the country.
Zillow predicts that joint home purchases (made together with friends or family) will start trending due to rising housing costs. In fact, a Spring 2022 Zillow survey found that 18% of homebuyers made their home purchase with a friend or relative other than their spouse. The survey also showed that 19% of prospective homebuyers intended to purchase their home with a friend or relative within the next 12 months.
Airbnb's Double Disruption: Airbnb is a housing company. Always has been. Landlords, property managers, and brokers should start paying attention.
RLTY Capital launches suite of agent Success Services (Inman)
T. Boone Pickens' Texas Panhandle ranch sells for $170M
As demand for real estate VR booms, Founders Fund leads $16M round into Giraffe360 platform (TechCrunch)
The Guru Of Greensboro: How A College Dropout Built A $2.9 Billion Real Estate Empire (Fortune)