30. Real Estate’s Dirty Secret

by H. W. Moss

There is a sacred cow in the real estate industry no reformer can butcher. It is called “dual agency” and it is sacred because it brings in so much money.

Dual agency exists in real estate when one agent or brokerage represents both the buyer and the seller of a single piece of property. Obviously, this is an inherent conflict of interest. As a result, everyone involved in such a transaction must, by law, be informed in writing and asked to sign a consent form admitting that a dual agency situation has been created and has been disclosed to them.

“Full disclosure” was first applied almost exclusively to the real estate industry in the post the savings and loan bailout of 1989. Now it is gaining adherents on Wall Street in the wake of a crisis of “trust in our system,” according to Goldman Sachs. The spillover on Wall Street has implications for real estate. Out of the blue and from a completely different world of investment theory, dual agency has been debunked.

But at the moment, nobody knows that.

Although less common today, dual agency usually occurred when a listing agent sat in the same office as an agent who had a willing and able buyer. Why should either of these two people be disqualified from working the same transaction? Or why should one agent who has the property as well as a buyer be disqualified from earning both commissions?

Dual agency has for decades been a wonderful means of boosting the bottom line. Brokerages love it because it keeps all the commission within the same office. Agents love it because they get paid twice and, not unheard of, with a higher percentage split if they bring in both sides of the deal. And dual agency is completely legal in every state as long as it is fully disclosed and written assent has been given by all parties.

Dual agency is allowed in forty-seven of the fifty states. Colorado, Florida and Kansas specifically prohibit the practice.

Frankly, dual agency should be abolished for several reasons. It is impossible for a dual agent to be fair and honest to two parties, a buyer and a seller, during negotiations. Obviously, where there are two sides but only one person has complete knowledge, that person must keep a secret from one side or the other.

Another line of reasoning flows from the fact that it is not legal in California for an attorney to represent both parties in a contract. A real estate purchase agreement is a contract. Therefore, it should be illegal for a single real estate brokerage to represent both parties in a real estate transaction. But that argument is fatuous in the face of political action committees which hire lobbyists to fight any mention of following such a pragmatic rule change.

Full disclosure is an attempt to deflect charges of conflict of interest by informing both sides in advance. In effect, the argument for full disclosure says that if both sides are informed this is happening, neither side will be damaged.

That is simply not true and a recent Carnegie Mellon experiment devised to test conflict of interest within the securities industry demonstrates the point.

In the wake of a meltdown of confidence in the accounting (And then there were four: Arthur Anderson is no more) and securities industries, it has become clear that a conflict existed, again for decades, as auditors pumped up profits in order to help research analysts sell more stock in dubious investments.

To resolve this embarrassing revelation and restore confidence, Wall Street developed its own form of “full disclosure,” albeit at the behest of the Securities and Exchange Commission. Business articles quote sources, but now carry disclaimers such as,
“. . . which owns no Dryer’s shares.”

The Carnegie study was done by economics professor George Loewenstein who was interested in determining if there were biases separating the judgment of a stock analyst, who benefits from higher purchases, and a person taking that advice to make a purchase.

Loewenstein discovered that even though buyers knew they were being advised by someone who would gain if they took higher estimates offered to them, they made higher estimates anyway. As reported in The New Yorker, “Full discloser didn’t make them any more skeptical.”

In real estate it is a far more damaging scenario. On a simplified level, all sellers wish to receive the highest price possible. Alternatively, all buyers want to pay the lowest price possible. Since the broker or agent in the middle is privy to the most current and correct information available from these principals, there can be no true negotiation process.

More complex is the idea that property is usually listed as an “exclusive agency” relationship with the listing (selling) broker owing no allegiance to the buyer. Generally, a buyer works with a “co-operating” broker who, in the absence of an exclusive buyer’s agency agreement, is actually working for the seller. If that is not an easy concept to understand, look at it this way: the seller pays the commission. Therefore, all agents in the transaction are working for the seller. In one survey, 70 percent of all buyers thought the co-operating broker was their agent.

On top of that, another conflict exists. Since sales commissions are based on price, an incentive exists for an agent to secure the highest price in order to earn the largest commission. An agent working for both sides consciously or unconsciously wants to garner the highest sale price. In other words, there can be no true “lowest” price for a buyer to pay.

Signing a dual agency disclosure form is meant to absolve any agent of a conflict. Thus, all of this would be moot if Loewenstein had not discovered harm may actually arise from disclosing a conflict of interest.

You read that correctly.

Telling someone they may be subject to a conflict of interest is tantamount to shifting the possibility of being damaged onto their shoulders. “It’s as if people said, ‘You know the score, so now anything goes,’” Loewenstein said.

Here’s a trick question. Of these three real estate brokerages, which is larger: ERA, Century 21 or Coldwell Banker? Answer: How about the company that owns all three of them and several more? That would be Realogy, formerly Cendant Corporation.

Cendant, once believed to be the world’s largest real estate company, was not considered to be a real estate brokerage house. It was a conglomerate that owned title insurance companies, property management firms, real estate brokerages, property inspection services as well as Avis car rental. Originally they were in the hotel business so Cendant owned a lot of rooms including Days Inn, Super 8 Motels and Howard Johnson International.

Here’s the rub. You might list your house through Coldwell Banker, then along comes a buyer whose agent works in an ERA office. Is that a conflict of interest? Not according to any existing state or federal law.

Since we have a full disclosure policy, here is my disclaimer: I bought stock in Cendant. I figured any company with that many irons in the fire has got to get better as the economy blossoms.

Should buyers and sellers be allowed to sign a dual agency assent form? Although Wall Street believes conflicts of interest are unavoidable, that does not have to be true in the real estate industry. It is as simple as changing existing real estate law in each state to outlaw dual agency for individuals and between brokerage houses.