Antitrust challenges to brokerage commission system rock real estate industry

Vasiliki Yiannoulis-Riva wrote an article in Westlaw Today that discusses recent lawsuits that have challenged the real estate brokerage commission system and raised the prospect of changing the standard practice in many jurisdictions.

In November of 2023, a class action lawsuit (March vs Real Estate Board of New York et al.) was filed in the Southern District of New York against the Real Estate Board of New York (REBNY), the preeminent real estate trade industry in New York City, and over a dozen other real estate brokerages (including some of the biggest names in New York City residential real estate) operating in New York City.

The lawsuit, among other suits filed in states such as California, South Carolina, and Illinois, comes on the heels of a similar case (Sitzer et al. vs. National Association of Realtors et al.) filed in the United States District Court for the Western District of Missouri against the National Association of Realtors (NAR), the influential national trade association for realtors, and a number of other well-known brokerage firms. In the Sitzer case, a jury ultimately issued a late October 2023 bombshell ruling in favor of the plaintiffs.

The Sitzer and March actions have rocked the real estate industry. At stake is the brokerage commission system that is commonplace in most residential transactions throughout the United States.

Although real estate is a field that is often governed by local custom, resulting in many variations in the way transactions are run in different localities, the typical rule in residential arms-length transactions nationwide is as follows: At the closing of the sale of real property, the seller pays the seller's broker a commission of between 5-6% of the purchase price, which the seller's broker then splits evenly with the buyer's broker.

On a million-dollar transaction, for example, assuming a brokerage commission of 6%, at closing $60,000 would be paid directly out of the sale proceeds to the seller's broker, who would then pay $30,000 to the buyer's broker. In exchange for agreeing to the commission split, the seller is given access to the Multiple Listing Service (MLS), the most sought-after database used by the largest and most reputable brokerage firms to market properties for sale (or whichever other exclusive listing service is then in use in the region where the property in question is being sold).

For decades and with few exceptions, this has been the default rule across the country, and few, if any, sellers ever challenged it. However, perhaps in response to a spike in the cost of real estate and the general cost of living, among other things, consumers have recently begun to question whether this industry rule serves their best interests.

The seller in the Sitzer case eventually filed a class action lawsuit in a Kansas City court on behalf of sellers who had recently sold their homes in compliance with the rule. While a few of NAR's co-defendants opted to settle before trial, NAR and other co-defendants decided to fight the action in court, which ultimately proved costly.

A Kansas City jury found that NAR and its co-defendants colluded to artificially inflate commissions under the industry rule, in violation of antitrust laws (in particular, the Sherman Antitrust Act of 1890), and awarded damages in the amount of $1.8 billion, which may be trebled under U.S. antitrust laws to $5.4 billion.

While NAR and the other defendants argue that brokerage commissions have always been negotiable, and that the rule helps first time buyers and other buyers with more limited means enter the market, the jury appears to have reasoned that the arrangement was a form of price fixing and that collusion occurred when the various trade associations and brokerage firms all agreed to adopt the rule requiring sellers to pay for a standard commission split in exchange for access to the MLS. Accordingly, under the Sherman Antitrust Act, the practice would be deemed an artificial raising of prices by the brokers and industry trade groups, working in concert, and therefore a monopolistic practice in violation of those laws.

The NAR and its co-defendants are expected to appeal the Sitzer ruling, and it is likely to be several years before that case is resolved. In the wake of Sitzer and March, industry observers further expect to see a spate of similar actions across the country, which, as noted, has already begun.

The U.S. Justice Department, which has been at odds with NAR for years over alleged antitrust behavior, is also thought to be following developments closely. If Sitzer is upheld and additional cases such as March are also decided in favor of plaintiffs, this could result in a seismic shift in the manner in which commissions are negotiated and paid on the residential side, beginning with the decoupling of commissions that are paid to the sell-side and buy-side brokers.

With respect to the March case, REBNY has indicated that it will vigorously defend itself. However, seemingly in response to recent developments, REBNY has also adopted new rules, effective as of January 2024, which have been implemented in the Universal Co-Brokerage Agreement that governs REBNY and the Residential Listing Service in New York City.

As per the new rule, offers of compensation to the buy-side broker must originate with the seller of the real property. Listing brokers will be prohibited from making offers of compensation to buy-side brokers and from paying the buy-side compensation, which is a significant change that will likely have a material impact on the market. Further, particularly when it comes to real estate, where New York City goes, the rest of the country often follows. As they come under pressure from various lawsuits, other local trade associations may perhaps implement similar rules concerning their own brokerage agreements.

Ultimately, the writing may be on the wall for the industry rule requiring commission splits in exchange for access to the MLS. If the various cases making their way through the court systems are successful, such decoupling of brokerage commissions could become standard practice in many jurisdictions.

Put simply, as is often already the case on the commercial side, sellers in residential transactions would be able to negotiate directly with the buyer's broker regarding the commission owed by the seller to the buyer's broker at closing. Buy-side agents could, in certain scenarios, become incentivized to compete with each other for commissions, resulting in a fee structure that is more in line with the fee structure found in other markets across the world (e.g., the United Kingdom, Australia), where a 1-2% commission is the norm.

Such a development may accordingly result in a significant reduction in the number of real estate agents — in particular, those agents who "moonlight" (i.e., who are not full-time agents) and who often act on behalf of buyers may leave the profession entirely. These developments could also threaten the viability of the MLS and other exclusive listing services in various jurisdictions. Under certain circumstances (e.g., a very hot seller's market), sellers could perhaps even successfully shift the buy-side commission to buyers. In that scenario, the buyer would directly negotiate the buy-side broker's fee with the buyer's own broker.

While it is too early to tell what the fallout will be across the country, potential sellers and buyers of residential real property should monitor developments closely, as these changes could have a significant impact on their cost of doing business.