Background
Homeownership represents a key gauge for prosperity. Yet surprisingly, Germany has one of the lowest homeownership rates in the world1 even though most tenants would like to own the property they currently live in.2 A potential reason for this is that buying real estate in Germany is costly: high transaction costs complicate the purchase of real estate. Besides real estate transfer taxes, the typical 7.14% (incl. VAT) commission fee that most real estate agents impose marks the largest portion of these transaction costs.
Not only the size of these commission rates is odd but also is their rigidity. Although freely negotiable, almost all agents charge the same rate, showing no signs of cost reduction through technology over the past two decades. This is surprising, as several international examples highlight that cost-lowering innovations can reduce commission rates. For example, Dutch real estate agents now charge less than 1.25% of the selling price despite highly comparable housing prices and service portfolios as in Germany.
Low commission rates may result from policy. In countries with low commission rates, sellers who hire a real estate agent must also cover the agent's commission. Germany is an outlier: until December 2020, sellers could make buyers pay the entire commission of the seller’s real estate agent. A legal reform changed this, aiming for a unique compromise. Now, if sellers hire an agent, they must pay at least as much commission as buyers, effectively evenly splitting the commission between them. Lawmakers hoped that requiring sellers to pay at least half of the commission would raise their awareness of the commission and would motivate them to seek lower rates.
Results
My research shows the legal reform's failure. Analyzing over 500,000 listings, I reveal that instead of decreasing, the already high commission rates, by international standards, increased even further after the reform. Initially, buyer-only commission rates only varied regionally, from 4% or 5% in low-commission regions to 6% in regions with the highest commissions. After the reform, many agents charged both buyers and sellers 3% each, often increasing the total commission rate from 4% or 5% to 6%. Furthermore, my findings indicate that even before the reform, when buyers formally paid the entire commission, sellers bore most of the economic costs by receiving lower selling prices.
What allowed real estate agents to increase their commission rates? In a subsequent survey with 1,062 real estate agents, I offer evidence that home sellers are inattentive to the commission cost and I illustrate how real estate agents exploit this ignorance.
First, I verify that 85% of sellers do not even attempt to negotiate lower commission rates when hiring their real estate agents. Revealing that sellers pay most of the economic costs of the commission but do not attempt to negotiate corroborates that home sellers neglect the economic incidence of the commission – which they pay through a lower selling price.
Second, I offer evidence that real estate agents influence sellers by using the “regionally typical” (ortsübliche) commission as a misleading benchmark. My data shows that this “regionally typical” rate – which refers to the most common commission rate in a region – is most often larger than the average commission rate. Using randomly incentivized experimental questions highlights that real estate agents knowingly communicate these inflated reference rates.
Policy Implications
In total, my study illustrates that the policy reform caused consumers to lose approximately €390 million every year due to the commission increase. Although economists assume that individuals’ “propensity to truck, barter, and exchange”3 promotes price competition, my survey experiment highlights that sellers rarely uphold this when hiring real estate agents. Combining my results with international observations showcases a policy opportunity: high-commission countries either have confusing commission systems where both sellers and buyers may pay the selling agent or incentivize an extra buying agent, like in the US. By contrast, other global examples point to more effective and less bureaucratic solutions: all countries with low commission rates share systems with just a selling agent who is only paid for by the seller (Bestellerprinzip).
Full article can be found here.
1 See Deutsche Bundesbank Discussion Paper No 40/2019 by Huber, S. J., & Schmidt.
2 See Interhyp-Wohntraumstudie 2022 using a sample of 2,180 respondents from a representative online panel in Germany.
3 Adam Smith (1776) The Wealth of Nations, Book I., Chapter ii. 1, p. 25.
