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Is It Time To End Real Estate Referral Fees?

It’s August in Washington, a time of year when the President, Congress, and much of the local bureaucracy is out of town. A quiet time, a time to ponder new and different ideas….

Imagine if the practice of real estate brokerage were suddenly modified. No longer would referral fees be allowed. From now on, the only people entitled to a commission would be the very brokers who participate directly in a local transaction and sign sale agreements.

At first this may not sound like an especially terrific proposal. In the world of real estate brokerage, a prospect represents the potential for income. If Smith is a broker in Oregon who recommends broker Jones in Cleveland to a transferring buyer, that recommendation has value. Jones may well reap business that would otherwise have been missed. And Jones, being suitably grateful, will send a check to Smith when the transaction closes.

One reason for Smith to recommend the Cleveland broker is that Jones is well known for competence. It could be that Smith and Jones are part of the same real estate franchise or organization, hold the same professional designations, know one another through the Internet, or are related through Aunt Flotsam in Missouri. Or, maybe Jones pays the biggest referral fees of any broker in Cleveland.

For Smith referral fees are good money, the trade of a business opportunity for cash. If Jones is good at what he does, a referral fee is virtually assured.

So what’s the big deal?

Doctors, as an example, routinely ban referral fees and a similar standard might advance the profession of real estate for a variety of reasons.

First, the buyers in our scenario, the folks from Oregon, know and trust Smith and so they rely on his recommendation. But you have to wonder how many buyers realize that somewhere in the recommendation process money can change hands.

Second, if something goes wrong, Smith may be liable. It may be that Jones has a hidden side — he’s incompetent, doesn’t properly represent buyers, and in his role as head of the local hate group does not feel especially-obligated to treat all parties fairly and fully. In a litigious society, Smith will no doubt hear from the buyers’ attorneys.

Third, what work was done by Smith and what is the value of such labor? If it took Smith an hour to obtain basic financial and housing preference information, then compensation for that hour is appropriate. But if compensation is a big number, then the real reason for payment is the ability to supply a name, a so-called “naked” referral for the most part.

Fourth, end the referral muddle and a lot of Internet squabbles will disappear. Listings posted online by every licensee but the listing broker might finally and actually be “free advertising.”

Fifth, buyer brokers and listing brokers would both be fully paid for their services, without fees reduced by referral costs.

Sixth, corporations could pay for employee transfers by simply getting a copy of the HUD-1 at closing and issuing a check.

Seventh, brokers would not be surprised by after-the-fact referral claims. “Mr. Conklin visited an open house we sponsored in 1957 and thus we have an eternal and exclusive agency agreement which applies to him, his current spouse, any future spouse(s), and all descendants born on or before June 14, 2185. Please send your check to….”

Okay, so what would happen if the system were changed. No referrals allowed. Why would Smith recommend Jones?

A very good reason might be that Jones is competent, holds certain designations, is within a franchise or organization, has good recommendations from professionals and consumers, or is known to Smith.

Certainly Smith might hope for a similar courtesy in the future, but that’s not assured and cannot be relied upon. Absent a referral fee, the most valuable and likely benefit for Smith will occur when the buyers tell Oregon friends and neighbors about how well Smith was able to help with their transfer.

There are other benefits as well. The shrinking “broker dollar” — the money brokers actually hold onto after a transaction is completed — would be substantially larger if referral fees could be eliminated. Broker liability would be reduced and it might be that rates for errors and omissions insurance would drop significantly for those who did not offer or collect referral fees. And real estate transaction dollars would remain in the community, something which seems eminently fair given that real estate is a localized commodity.

But most importantly there would be clarity. The public — as it does with physicians — would understand that when a broker makes a recommendation, it’s because the suggested professional is simply the best person to do the job. You wouldn’t want your gall bladder removed by a surgeon whose leading qualification was an ability to pay steep referral fees, so why would you want that with someone handling your largest lifestyle and financial transaction?

What are some of the pros and cons associated with an end to referral fees? Let’s take a look:

It Won’t Happen

A common viewpoint goes like this: Referral fees are part of real estate today, were common in real estate brokerage in the past, and will be with real estate forever. Like DNA, referral fees are with us always.

We’ve heard this before and with much the same passion. Remember:

  • Buyer brokerage will never work.
  • MLS information can only be available in face-to-face meetings with local brokers.
  • Continuing education courses require actual classroom attendance, no online education can be allowed.
  • No one needs a home inspector.

Referral fees certainly won’t end tomorrow, but opposition has been simmering for a long time. Perhaps we have the start of a movement here….

How Do We Start?

One of the most frequent questions has been “how do we start?”

Just say no. It really is that simple. Explain why, and explain as well that the policy works both ways: You welcome referrals, you make referrals, you just don’t ask for referral fees and you don’t offer them. You’ll quickly find out who gets it and who doesn’t.

Selective Referrals

What about going half way, continuing referral fees among individual licensees but not organizations? In effect, a partial ban.

All licensees must be treated equally, and in this case that means no referral fees. None. Zilch. Status as a natural person, a small business or a corporate colossus does not alter the fact that referral fee money is changing hands, sometimes without informed consumer consent.


Good Money

Referral fees produce good money with little work, a tough combination to dislodge according to several commentators.

Agreed.

It’s also enticing to smoke, but the long-term impact can be devastating. The moment to kick the referral habit is now. In time, perhaps skilled scientists will be able to develop an anti-referral patch….

What About “Free” Services?

Some say that referral fees should be encouraged because they are not an additional consumer expense, instead they are merely a cost of doing business for brokers. The consumer, it is argued, is actually getting a “free” service.

Other than accountants and analysts on Wall Street, no one believes this.

If a broker has higher costs, those costs must be passed along to the public, otherwise the broker is out of business. Costs, according to most economic studies, are not the same as free.

As to “free” services, use of the term “free” regarding the provision of realty services should be regarded as inherently misleading, unfair, deceptive, and unconscionable when checks are sought or expected. Such claims should be automatic grounds for license suspensions.

Should Referral Fees Be Outlawed?

Some argue that because referral fees are a cost for consumers and not fully disclosed in too many cases they should be banned. My alternative works like this: If brokers want to pay such fees, then with the stipulation below they should have the right to do so.

The caveat is this: If there must be referrals, then there ought to be a clear disclaimer consumers must sign with mandated language from the state real estate commission explaining that referral fees of approximately x dollars — depending on the expected minimum value of the transaction — will be paid on the basis of a successful referral. Such disclosures should be universally required so that no brokerage is at a disadvantage. Also, they must be signed prior to the creation of a client/agent relationship.

Big Firms

Won’t big brokerage companies oppose an end to referral fees?

Some will, some won’t, but one thing is clear: If you keep doing things the same old way you get the same old results — and many brokerage firms would like to see a stronger bottom line. At the very least, you can bet that big firms will run the numbers, comparing income and costs.

Local Benefits

Won’t brokers in states with declining populations want referral fees when they send prospective buyers to Florida, Georgia, Texas, Arizona, California, Colorado, Nevada and North Carolina?

People are going to move whether referral fees are paid or not.

Brokers who pay such fees need to look carefully at their economics. Outgoing referral fees raise the cost of being in business. Would brokers have a greater profit without such fees? Is not the Internet obviating the need to pay referral fees for leads from distant states?

What About Production?

Do not referral fees produce additional business? Is not such business valuable?

Look at a number of energy and telecom companies. They were able to bulk up sales by trading commodities back and forth among themselves. It looked good on paper, but such transactions were a wash — no profits were produced.

Big revenue figures are nice, but the goal in business is to maximize profits, not sales. It’s the “broker dollar” that counts, the broker’s profit after all costs, fees, and charges. Without a “broker dollar” there is no brokerage. A company that sells real estate worth $1 billion but loses $1 million will fail unless the bottom line changes.

The Good Old Days

How did brokers and salespeople get business without referrals?

They marketed themselves and their services online and off. They did good work and grateful clients and customers told friends, co-workers, neighbors, and relatives. And they pocketed every dollar they earned.

Today referral fees represent a trade: More work, but reduced revenue and profits per transaction.

A second and more insidious trade works like this: Brokers spend big money on marketing expenditures to build up their own names, but when brokers pay referral fees they effectively tell consumers that it’s okay to go to a middleman, to someone other then themselves.

Paying referral fees blesses third parties with an importance and utility which are debatable and perpetuates a cost growing numbers of licensees can no longer afford. For many brokers and salespeople, the value of such trades is increasingly in question.

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Published originally by Realty Times on August 20, 2002 and September 3, 2002 and posted with permission.

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