Canada's Housing Bubble

Feb 11, 2010 Tony Keller cbc.ca

For years, the regulators had been after the brokers and their cartel.

The reason? The brokers owned the marketplace where buyers and sellers came together. And for generations, brokers had been using that monopoly to impose high prices on those transactions.

The rates, in fact, were so high they felt like extortion. But if you wanted into the market, what choice did you have?

Will reducing real estate commissions encourage the so-called housing bubble? Some economists say yes. (Associated Press)

It was one big forced transfer of wealth from consumers to a club of monopoly middlemen.

The above story is about the Wall Street and Bay Street brokerage firms, circa 1975, when they controlled the New York and Toronto stock exchanges.

But I might as well be talking about Canada's residential real estate brokerage industry, circa 2010, and its control of the Multiple Listing Service (MLS) of homes for sale.

This week, Canada's Competition Bureau announced that it is taking the industry's long-standing business practices to the federal Competition Tribunal.

Why? Replace "Bay Street securities broker" with "Canadian real estate broker," and "TSX" with "MLS," and you'll get the picture.

Old-fashioned competition

Competition Commissioner Melanie Aitken, says that the Canadian Real Estate Association is "improperly and unlawfully leveraging" its control of the MLS system "to deny good old-fashioned market competition."

What she wants is to "let consumers have the choice, let agents have the opportunity to satisfy and serve those choices."

Amen and hallelujah.

Of course the Competition Bureau investigated the industry more than 20 years ago, promising big changes to the MLS system. Triumphant press releases were issued. And then nothing happened.

This go around may be different. The government that appointed Aitken is expected to deliver a Throne Speech next month built around the themes of free enterprise, free markets and free trade.

Lowering realtor prices by promoting competition fits nicely into that agenda.

If you'd like to see what might happen if Ottawa really pries open the MLS system, take a look at the history of brokerage commissions on Wall Street.

Tony Keller

Within a few months of deregulation on May 1, 1975 — "May Day," to the pin-stripe set — average commission charges had fallen sharply and entrepreneurs such as Charles Schwab were using the new rules to create the first discount brokers.

The arrival of the internet two decades later redoubled the downward pressure on prices.

It allowed consumers to do most of the work of investing for themselves and to rely on a broker solely for the low-cost execution of trades.

Today, you can buy and sell large blocks of stocks through a discount broker for $9.99 or less per trade, a tiny fraction of the pre-May Day price.

Serving clients

The U.S. experiment worked so well that Canadian regulators followed suit in 1983. The Toronto-Dominion Bank immediately set up Green Line Investor Service, Canada's first discount broker. It went on to become TD Waterhouse Discount Brokerage.

Before May Day, if you wanted to buy shares in a company through the stock exchange, your options were limited: Every broker was a full-service agent charging a full-service fee.

That's pretty much what you'll face today if you want to buy or sell a home.

The old system for setting stock market commission rates also matches today's real estate agency commission system.

Pre-May Day, brokerage commissions were based on the number of shares purchased. The bigger your order, the more you paid. That's what you'll be dealing with if you hire a real estate agent and have your home listed on the MLS.

Someone selling an $800,000 house today can expect to pay a commission of about five per cent, or $40,000 (split between the buying and selling agent), regardless of how much work the agents did, and despite the fact that it likely took no more time and effort than earning a $20,000 commission on a $400,000 home.

This can explain why, as the authors of Freakonomics put it, "most real-estate agents seem to spend 95 per cent of their energy chasing clients (for which they are paid nothing) and five per cent actually serving them (for which they are paid way too much)."

In a truly free market, just how far could those commission rates fall?

By many thousands of dollars, according to Scotiabank economist Derek Holt.

He recently speculated that the drop in commission rates might be so steep, putting so much extra money in the pockets of buyers and sellers, as to further overheat an already overpriced Canadian housing market.

No one wants that, but forcing Canadians to massively overpay a real estate agent is not the most rational, efficient or fair way to go about moderating the cost of owning a home.

What's a travel agent?

Another industry that resembles the business of buying and selling houses is travel.

Until a little more than a decade ago, if you wanted to buy a plane ticket or book a vacation, you called up your travel agent, who would take a cut to find you the flights and accommodations you were looking for.

The arrival of new technology-the internet-changed all that. Travel agency commission rates were driven through the floor and thousands of traditional travel agents were driven out of business, replaced by high-volume, low-cost services such as Expedia and Travelocity.

The very same information technology for gathering and making available to customers a world of airline and hotel information already exists for the housing market.

It's called MLS. But as things now stand, consumers can't access all of that MLS information. Nor can they place their own home directly on MLS, or even have an agent provide this basic service for a low fee.

If the Competition Bureau pursues this case to the limit, the future of buying and selling residential properties in Canada will probably look something like a cross between Expedia, TD Waterhouse and Craigslist.

There will still be middlemen between home buyers and home sellers: You will still need a place to advertise your property, a place to compile market information and you may even want some well-compensated expert guidance.

The menu of services offered by real estate brokers may even grow, but some prices will fall and customers will be able to choose what level of service they want.

It will look like, well, a free market. Finally.

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Map: Real estate prices across Canada