|December 31, 2006||Posted by Staff under Progress Report, The Progress Report|
by Fred E. Foldvary, Senior Editor
by Fred E. Foldvary, Senior Editor
Real estate is sold through brokers who earn a commission, which in the U.S.A. has averaged six percent. With rising prices, some brokers offer lower commissions, but many still offer full service at six percent. If there is a separate agent for the buyer, they split the commission.
On a $300,000 property, the six percent commission is $18,000, which is a rather large transaction cost, often paid with borrowed money, so the buyer has to pay interest on top of the commission. An alternative way of paying the commission could be to charge an annual amount based on the value of the site. The buyer would not have to borrow as much, and would save the interest expense. With the real estate market in the U.S. slowing down, as properties stay for sale longer, this could be an attractive option for buyers.
For example, suppose for a $300,000 property, $200,000 is land value. Instead of the $18,000 commission, the broker charges an annual fee based on the land value. Using an interest rate of seven percent and a duration of 20 years, a monthly mortgage payment is $140, or $1680 per year, which is .84 percent of the land value. Since the average homeowner will move in less than 20 years, the broker could charge a fee of one percent of land value so long as the buyer has the title to the real estate. That would be $2,000 per year, charged monthly at $167.
This would be a land-value commission (LVC). The fee would be based on each year’s appraised land value, so if the site value goes up, so would the fee of one percent. Suppose the owner seeks the real estate as a rental to tenants. He would factor in the annual one-percent land-value commission as part of the cost that comes from the tenant rental, and so the buyer would bid that much less for the property. The land-value commission would be capitalized down as a lower purchase price. The burden of the commission would thus be on the seller, not the buyer.
The benefit for the seller is that with the slowdown in real estate, the owner can sell the property sooner if he offers a better deal, such as not having to pay an up-front commission. Rather than simply lowering the sales price, he could offer it for sale with a land-value commission at the reduced price. A lower price also implies lower property taxes. Less tax and less borrowing and less interest – it’s a good deal for both. The bankers would lose the interest; too bad for them.
Land-value commission have the same benefit as land-value public finance in saving interest payments, as the borrower pays the land-value charge rather than mortgage interest. But with the LVC, the payments end when the property is sold. Those who hold the property for a short time would benefit from having to pay less commission, reducing the transaction cost of moving more frequently.
For an owner-occupied property, the economics is the same as for a rental property, as the owner in effect rents it to himself, being tenant as well as owner. The LVC burden is still on the seller, as the owner factors in having to pay the annual commission along with the property tax and mortgage interest.
A broker who uses LVC instead of an up-front commission would be someone who has a good understanding of land economics, and can appreciate the benefits of switching to LVC. Other brokers would then adopt it as they see the LVC broker attracting more buyers. As a great benefit of LVC is reducing the transaction costs for frequent movers, those who intend to hold the property only a short while would prefer LVC. But also for long-term owners, since the commission is greater the longer the owner keeps the property, the broker would have an interest in providing excellent service to those who intend to stay put for a long time.
Those familiar with tapping site values for public revenue will also recognize that with LVC, there would be no commission penalty to improving the property. The broker would share the increased value of the land, and so would retain an interest in maintaining a good local environment. If many brokers use LVC, they would seek to influence government to avoid waste and have the greatest possible benefits from public revenues. If real-estate commissions switch to LVC, this would benefit everybody. So, brokers, how about trying LVC?
Copyright 2006 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report. Also see:
Real Estate in 2020
Cut Mortgage Tax Deduction
Foldvary: The Real Estate Bubble
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