How a Lawsuit Against Realtors Went Sideways

On March 15th, 2024, the Chicago-based National Association of Realtors (NAR) came forward with a stunning announcement: in response to two 2019 class-action lawsuits, it finally agreed to a settlement sum of $626 million and promised dramatic changes in the real estate business. The lawsuit charged that the NAR had excessive market power that allowed them to create handsome commissions for their agents, resulting in higher housing prices for prospective home buyers.

A year later, a few law firms earned millions of dollars, but the settlement provided scant benefits to prospective homeowners other than some important clarifications about the structure of agent commissions. Indeed, the lawsuit was all based on a mistake about the scope of NAR’s market power. That mistake led to a domino effect of further errors in how to fix the supposed problem.

The major “fix” proposed by the lawsuit hinged on shutting down online information about buyers’ agent commissions. The idea was to put more power in the hands of home buyers to freely negotiate with their agent what the commission would be. But what sounded good in theory to some was actually a naive misunderstanding of how well the real estate market was working in practice.

One lesson learned: a lawsuit bent on trying to suppress valuable market information is a fool’s errand with unintended consequences that can hurt more than they help. A second one: sometimes what looks like excessive market power is actually a result of buyers and sellers freely deciding on the price of a service which provides high value.

Some history and more details: in the past, when a house sold, a traditional 6% fee came out of the selling price, which was typically split between the buyer’s and seller’s agent, each getting a 3% cut. The theory of the lawsuit was that if the commission could be lowered, that would also lower home prices across the country.

Here’s how the lawsuit promised to upend the home real estate market and lower home prices.

First, it pushed for a ban on information about how commissions would be paid on the multiple listing services (MLS) so buyers wouldn’t be steered by their agents to listed homes with the highest commissions. After the settlement, no information on commission splits is allowed on the listing service.

Second, it added clarity that home sellers could freely pick their own commission structure instead of the traditional 3%-3% split. For example, a seller could pay his listing agent, say 3%, and the buyer’s agent 1%. Or maybe pay 3% to the listing agent and 0% to the buyer’s agent. The buyers could instead come up with their own agreed upon commission rate and negotiate terms with their agent directly.

The idea was to empower buyers and sellers by handing them the negotiation keys with endless possibilities to lower agent commissions.

On the first count, the MLS information ban has been pretty much a joke in terms of stopping information about commission splits. It shows that when information is valuable in the marketplace, people will always find a workaround.

Reportedly in some homes for sale, listing agents leave three cookies on the kitchen counter, a key fob with the number 3, or even the movie Three Amigos playing on the television to slyly indicate the commission of 3% paid to the buying agent. A recent story in The New York Times turned this into a story of real estate agents acting as supposed villains who are evading new policies.

In fact, it is a rational response to an irrational policy solution of attempting to quash market information.

Indeed, aside from a few reported stories like these, most agents aren’t engaging in such colorful behavior. Without MLS indicating commission splits online, it’s just a far more clunky system. A buyer’s agent who is intent on showing ten homes to a client has to make 10 phone calls or texts to find out the structure of the commission split.

Second, the plaintiff’s theory was that after buyers and sellers had the power to negotiate lower commissions, commissions would drop and so would home prices. Yet a year later, very little has changed except that now agents have an upfront conversation with their buyers about who will pay them. That’s the one benefit of the lawsuit.

“It has created a higher level of transparency between buyers and their agents, which I think is terrific,” said Harvey Blankfeld, a Las Vegas-based real estate agent who was quoted in a recent article on the subject. Home buyers now need to sign an upfront contract with their agent as to the structure of the commission and promise to pay if the seller doesn’t. “However, it has not impacted costs here in Vegas,” noted Blankfeld.

The plaintiffs in the lawsuit seemed to forget that few buyers want to come up with the cash themselves to pay their agent when previously the seller paid for it. Putting them on the hook creates more stress and pressure around a home purchase.

As a result, sellers who thought they would save money by paying, say 3%, to their own agent and 0% to the buyer’s agent faced a lot of problems they didn’t anticipate. When buyers discover this arrangement, more than likely it’s time to move onto another listing that pays their agent. A smaller pool of buyers will translate into fewer offers and lower home prices. This explains the lack of change in the commission structure a year later. The traditional 3%-3% split seems to be an equilibrium towards which the market naturally gravitates.

Indeed, the largest change from last year is that the plaintiff lawyers got massively rich. The plaintiff’s lawyers walked away with a third of the settlement- $208 million- and the estimated 50 million affected homeowners will pocket $8 on average, if they bother to apply for past damages.

The NAR is not an all-powerful oligopoly, contrary to The New York Times reporting. Companies like Open Door and Redfin often pay commissions closer to 2% but they are not that popular, with less than 1% of the market. For sale by owner (FSBO) is another option for every homeowner. Most pass because they will get a lower home price, and more hassle in selling their home. The FSBO market share hit an all-time low of 7% in 2023 according to NAR statistics.

In other words, even though there are alternatives, most buyers and sellers aren’t seeing the value proposition. Any hungry new real estate company could enter the market paying lower commission splits, yet this is rare. More than 9 in 10 home buyers and sellers apparently prefer the traditional approach of having a highly personal interaction with an agent from a trusted real estate company.

The reason: Buyers and sellers got a reminder that agents provide value that is both tangible and intangible, and often difficult for newcomers to foresee. They have connections to reputable service providers, checking on everything from plumbing to roofing, understand the fair market value of a home relative to other homes in the area, and provide intuition on the negotiating position of the buyer or the seller.

In addition, there are intangibles that include an agent navigating a client’s idiosyncratic tastes that may differ from the spouse, local environment, style of the home, and much more.

By attempting to shut down important information about disclosing commissions on MLS, the unintended consequence of the NAR lawsuit could have been a decline in new homeowners, unable to come up with cash payments for their agents. Luckily, the market innovated with information hacks that helped these prospective homeowners dodge a bullet.

The nearly 80-year-old custom of sellers paying buyers’ agents about a 3% commission may have its faults, but the principal advantage of having commission-based norms is simplicity and open information that greases the wheels for complex and highly emotional transactions. As we have seen, people are never more clever when there is money to be made.

A year after the judgement, in most cases we are right back where we started, with regard to the 5%-6% commission split paid by the seller. Buyers and sellers transmitted signals to the market that this outcome is what they preferred in most cases, but flexibility still provides options like FSBO. We didn’t need an expensive lawsuit to tell us this.

While greater transparency of the commission structure between buyers and sellers was a needed and welcome outcome, some simple modifications to the buyer’s agent agreement could have spared us the $600 million legal bill that primarily enriched the lawyers.

Craig J. Richardson is the Truist Distinguished Professor of Economics at Winston-Salem State University. His wife Cathy Richardson is a Realtor.