Friday, April 15, 2005

The Best Defense is a Good Offense

A recent Business Week article highlights a current battle between the traditional real estate brokers from organizations such as Century 21 and Coldwell Banker and new on-line discount real estate brokers. While on-line discount real estate brokers have gained significant market share, they continue to be held back by a raft of industry-backed state regulations that mandates minimum commission fees and service offered. This left the doors closed for brokers interested in offering stripped down services for a discounted price. But now on-line brokers such as ZipRealty and the federal government, are challenging the realtors, claiming that such regulations violate anti-trust laws since they limit consumers’ choices and keep prices high. As the Justice Dept. has shown in Kentucky, those regulations may soon come tumbling down.

Average real estate commissions have dropped sharply over the past decade, and this trend will surely continue, mirroring similar trends in other industries impacted by the Internet. This decline in commissions has rightfully been portrayed in the media as a great benefit to the consumers. Consumers can save money by cutting commissions, or by cutting out the broker completely. This lower cost structure is threatening traditional real estate brokers, and some analysts have portrayed these changes as a fundamental threat to the business. After all, why not just buy (or sell) your house on eBay? Much less attention has been paid to the long-term impact on real estate brokers, and looking at the appropriate response from realtors.

The real estate brokerage industry should stop being myopic about their changing industry. Rather than trying to prevent the inevitable, brokers should adapt to the changing demand of consumers and take a critical look at their business model. They should recognize the new opportunities, thereby shifting their focus from protecting their turf to growing the real estate business. This is truly a situation where best defense is a good offense.

While some analysts see a gloomy future for the traditional real estate broker, we believe this is not necessarily the case. A similar situation took place when the stock market was deregulated in 1975. Analysts predicted a similar fate for stock brokers but in fact the number of stock and commodity brokers has increased over four-fold since commissions were deregulated. As transaction costs drop, this will drive more transactions, and create new business models. By recognizing that the source of value-add in real estate transactions is changing, realtors can identify new money-making opportunities. In the past, much of the value of the residential real estate broker came from controlling information – only they had access to the MLS database. This database had value because real estate markets were relatively opaque, and buyers and/or sellers were willing to pay a hefty 6% commission for access to the MLS. The real estate market, however, is changing---as the market becomes more transparent the power is shifting towards the customer.

In order to survive, the traditional real estate brokerage firm’s capability will become more important. Automation, efficiency, and volume, will become crucial elements to their competitive advantage, and will lead to greater economies of scale. We believe prospecting by individual agents will be less important and the value add a brokerage firm offers will come from services, not access to information. Real estate brokerage firms in the future will take on one or a combination of the following two fundamentally different strategies:

1. Offer more and better service: Firms can become a one stop shop for all of customers real estate needs, proving not only transaction services, but also mortgage brokering and other related real estate services. Firms should emphasize their local market knowledge and expertise, something online discount brokers do not possess. There is broad agreement among most brokers that the new business models will require the brokers to be more connected with the consumer at an earlier stage at a more intense level. To succeed at this, they will also have to establish trust. Consumers have consistently ranked real estate brokers just above used cars salesmen in terms of trust. This is in large part due to the misaligned incentives in the industry. While a broker claims to be an advocate in getting the cheapest and best deal possible, their cut depends on what their client pays for a property --- the more expensive, the better. One way to deal with this problem is to change the compensation structure of brokers to be more fee-driven.

2. Offer Ala Carte services: The fact is that many real estate buyers/sellers do not need the full range of services offered by brokers. Sometimes, for example, a customer simply wants to list their house on the MLS. This strategy will allow firms to break down services by component parts and offer ala carte services. For example, if a consumer wants to do everything himself, except to have broker help negotiate a purchase price, he could purchase this service for a fee. After all, when drafting a will, you pay your lawyer an hourly or fixed fee, not a percentage of your estate. A further advantage to this is that real estate agents could specialize in their area of expertise – for example staging houses – and therefore provide superior service.

The real estate brokerage industry will evolve to the point where there are a range of types of brokers with varying levels of service. It will become more like the securities industry, where you have a range of choices when buying stocks: You can use a full service broker, who does research and provides advice, you could use a discount broker who does nothing more than execute a trade, and whose employees are paid a salary, rather than a commission. You could also use something else – for example one of Schwab’s financial advisors who are lower cost that full-service brokers, but still provide advice.

Revenues for stockbrokers are up 30-fold since 1975. How much will the real estate brokerage business grow over the next 30 years? The answer is up to the industry.

Sophia Kamberos, Chris Rodskog and Veronica Herrero

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