Real estate’s dirty little secret: Inflated fees
Commentators, ordinary Canadians, and economists (us included) have been struggling to explain the parabolic rise in house prices, particularly in Canada’s two largest cities, Toronto, and Vancouver. Explanations focusing on low interest rates, demand-supply imbalances, speculators, and foreign buyers go a long way in explaining the rise, but they all fly in the face of fundamental metrics such as house prices compared to disposable income, house prices compared to rents and some others that are all flashing red.
In our view, another culprit in the current house price inflation and affordability crisis has escaped most pundits’ notice, namely, the overall opacity of Canada’s residential real estate market. The blind-auction process, the lack of real-time sales data in the public domain and the poor transparency concerning fees to enter and exit real estate all clearly exacerbate the housing affordability crisis. A fully transparent residential real estate market is in every Canadian’s best interest and would go a long way toward slowing down house price inflation. Of all potential reforms to the Canadian real estate market this seems to us the obvious place to start.
The market frictions around residential real estate transactions are breathtaking and their scale is poorly understood. For example, according to the last census, the average household income in British Columbia, where one of us lives, was a little over $90,000 in 2016. Suppose it’s now $100,000. Using conservative assumptions, that produces after-tax income in the neighbourhood of $80,000. In February, the average sale price of a house in B.C. was just over $887,000.
The transaction fee on that, including the typical commission plus HST but not municipal taxes and/ or legal fees, was just under $30,000. So the average B.C. family must work more than four months just to pay the real estate commission on the average home. If the family moves five times in their life, they will spend two years of their working lives paying real estate commissions of roughly $150,000. In the same exercise for Ontario, the commissions would take three years to pay and total more than $240,000.
We can split hairs regarding the assumptions behind these calculations, but they reflect reality for most families. That should give every Canadian pause.
Canada’s mutual fund industry was recently required to fully disclose all fees in a forthright manner. The residential real estate industry needs to do the same. A simple way to address the current information gap would be to publish the total sales commission for the property at the asking price in dollar terms on each listing on realtor.ca, in the same way other property metrics are displayed. A home is most families’ largest investment. Buyers deserve to know all the costs of a transaction, in dollar terms, before making their decision.
Blind auctions in real estate transactions should also end. Properties should be sold in a transparent way so potential buyers can more easily assess the market value of any home they are interested in purchasing. The easiest way to establish transparency would be a transition to open auctions. A home inspection can be carried out by an impartial third party paid from the transaction fee, and potential bidders could be vetted to ensure financial pre-qualification. This would end the common practice of underpricing a property so as to spark blind-bidding wars designed to juice the price as far as possible beyond fair value. Getting used to such a system would require cultural adjustment and would generate strong push back from some corners but it would ultimately rationalize the market. Accurate real-time pricing information would allow market participants to make informed purchase decisions that reflect current conditions.
These are reasonable policy changes given the housing affordability crisis in this country. We aren’t suggesting these factors are the ultimate cause of the crisis but there is no doubt they reduce the efficiency of the Canadian housing market.
At a minimum, every Canadian should know that it is perfectly possible to sell a house at its fair market value for well under $2,500 in professional fees. It’s also a relatively simple process in the current sellers’ market. One of us (Gryba) has completed three real estate transactions without an agent and can tell you from experience that it’s not very difficult once one obtains accurate market information. If the property is priced correctly and is listed on the Multiple Listing Service (MLS), the house will pretty much sell itself.
Don’t let anyone tell you otherwise.