How Two Little-Known Court Cases Could Change The Way Real Estate Is Purchased

A storm is coming to real estate, and it’s not an impending commercial real estate crash.

Considering the near-constant cycle of bad news emerging about the real estate industry this year, you would be forgiven if you overlooked the fact that two federal class action suits set to go to trial could change the way Americans buy real estate. Keep reading to find out who the players are and how the outcome could affect you.

The Current System

As it stands, buying and selling real estate in America hasn't changed much in the last century. You find an agent and agree on a fee — usually a 5% to 6% commission on the sale price — that you will pay the agent if they can sell the house for the price specified in the listing agreement.

Once the listing agreement is signed, your agent will take photos of your property, write up a description and load it into a real estate database known as the multiple listing services (MLS). The MLS is a national database that is owned by the National Association of Realtors (NAR) but operated in various real estate markets around the country by local Realtor associations in cooperation with the NAR.

The seller agrees to process the transaction according to MLS rules as a condition of having their property listed on the MLS. Under these rules, listing agents representing the seller post the amount of the commission they will split with an agent who represents a buyer who completes the purchase. Usually, the commission split is between 2.5% to 3% of the total sale amount, which is basically 45% to 50% of the listing agent's commission.

Check out:

• Investing in real estate just got a whole lot simpler. With as little as $100, average investors are becoming landlords thanks to this Jeff Bezos-backed startup.
• Elon Musk has reportedly bought 6,000 acres of land just outside of Austin. Here’s how to invest in the city’s growth before he floods it with new tech workers.

What's the Problem?

The MLS predates online real estate services like Zillow and Redfin, and it predates the internet by several decades. Throughout American real estate history, the MLS has established itself as the proverbial 800-pound gorilla in the room when it comes to getting maximum visibility for any real estate you wish to sell.

One of the main reasons for property sellers to sign up with agents and agree to pay the commission is for access to the MLS. Only licensed agents who are members of their local Realtor's association can use the MLS to list for sale properties.

Those realities, combined with the fact that the MLS is owned by the NAR, leave anyone selling property in quite a fix. If they don't want to pay the customary agent's fee, they are essentially shut out of a chance to have their property displayed on the MLS, the most prominent showcase of for-sale properties.

Start generating passive income through real estate

Check out these featured investments from Benzinga's Real Estate Offerings Screener.

One could make an argument that this amounts to a subtle form of price fixing. That argument is being made in two lawsuits that could be worth billions of dollars. The cases, Sitzer et al. v. National Association of Realtors et al. and Moerhl et al. v. National Association of Realtors et al., are basically accusing NAR and some of America's biggest brokerages of using the MLS to facilitate price fixing and preserve high agent commission fees.

The Cooperative Compensation Rule

The specific aspect of the real estate agents' commission structure being challenged in the suits is known as the cooperative compensation rule, the stipulation in MLS listing contracts that requires sellers to agree to have the listing agent's commission split with the buyer's agent.

This means sellers basically compensate buyers' agents for negotiating against them in a real estate transaction. As a buyer, you're likely already stretched to the limit financially, so you don't mind this rule at all. But as a seller, paying the buyer's agent can seem quite counterintuitive. Yes, the buyer's agent brought the buyer, but they also likely tried to negotiate the price for the property down.

Even if the seller makes no price deductions and their agent gets the maximum price, the idea of paying such a high commission to complete a transaction has long bedeviled property sellers. And it basically boils down to the cooperative compensation rule.

If, for example, the cooperative compensation rule wasn't in place, agents could theoretically sell properties for only 3% fees because they wouldn't have to split their fee with the buyer's agent. In fact, you might end up with sellers' agents working on flat fees and dropping the percentage commission structure entirely. The plaintiffs in these two suits believe all of this would be possible if it weren't for the NAR and the MLS's cooperative compensation rule.  

The Fee Isn't The Only Issue

Agents' fees are just one of the thorny issues being raised in these lawsuits. Another issue with the cooperative compensation rule is the potential it provides for steering, which is when the buyer's agent selectively shows properties). Although the cooperative compensation rule requires agents to agree to split some of their fees with buyer's agents, it doesn't specify how much. Brokerages across the country have long had a mutual understanding that the fee would be split 50/50 — or very close to it — between agents.

If by chance a selling agent decided to violate this mutual understanding and list a property on the MLS with a split below 2.5%, buyer's agents may not show that selling agent's property to their clients. That would be steering, which is a prohibited practice in real estate. There have been studies that show homes with sub 2.5% commission splits are shown less often and take longer to sell. So, this isn't a theoretical concern.

The Defendant's Point Of View

It's not just the NAR named in the lawsuits. Other defendants include a who's who of the biggest brokerages in America, including Re/Max, Keller Williams Realtyy Inc. and HomeServices of America. They all love the current system and think it's fair because the buyer's agent really does make up 50% of the sale.

The NAR and all the brokers are also making the argument that if buyer's agent fees are passed on to buyers, who are already overloaded with fees at closing, it may result in even more people being frozen out of the market. Considering the high price of real estate in most of America's premium markets, they may not be wrong.

Would Paying Agent Fees Burden Buyers?

Real estate is expensive. High prices, low availability and now high-interest rates are combining to make home-buying even harder for buyers. So, the thought of adding a buyer's commission to the deal would be unpopular on the buy side of this equation. But it's likely that this fee could be rolled into the financing and paid out over the life of the mortgage.

Long-Term Implications

More than $40 billion in damages is being sought in the two cases. Sitzer et al. v. NAR et al. is slated for trial as early as October. It's the smaller of the two cases, but it could still be worth $4 billion in damages to home sellers seeking damages as plaintiffs in the case. 

Long term, the real estate industry could be in for an earthquake. There is no equivalent of the MLS in many Western nations such as the U.K. and France. Selling agents in those markets also tend to make smaller commissions than American agents. 

The plaintiffs might have some weight to their argument, but the NAR has been sued before, and its business practices remain largely unchanged for the last several decades. 

If these suits are decided in the plaintiff's favor, the MLS's dominance, and by extension the cooperative compensation rule, will be finished. Overnight, you could see the real estate industry go from 6% fees to 3% or even basic flat fees between $2,000 and $10,000 regardless of the sale price. Keep an eye on these cases because they could change the real estate industry forever.

Check out:

• Investing in real estate just got a whole lot simpler. With as little as $100, average investors are becoming landlords thanks to this Jeff Bezos-backed startup.
• Blackstone made a $13 billion bet on the growth in student housing. Here's how you can carve out your own piece of the student housing market with just $500.