“Those who cannot remember the past are condemned to repeat it.” (George Santayana) “What you see and what you hear depends a great deal on where you are standing.” ? C.S. Lewis, The Magician’s Nephew
Innovation and disruption are words that are used frequently in today’s real estate business but are often used inappropriately and without thought. And while they are often used interchangeably, the truth is that innovation without execution doesn’t cause disruption. In fact, something only constitutes disruption when it impacts the entire industry, not just the people employing the disruptive practice.
We have seen other industries disrupted, and we are sensitive to the possibility that the real estate business may be next – but the conversations around the disruption of the industry often take place without context, because we haven’t recognized how the industry has been disrupted in the past. But there are major disruptions that changed the way everyone does business, the way we are compensated, and the manner in which we serve the consumer. Perhaps we fail to recognize them because frequently the disruption is gradual, so that we, like a lobster in a slowly heating pot, never notice the change that is about to change the world as we know it. But if we wish to be prepared for disruption, we could benefit by knowing how it happened in the past and how it might happen in the future. So here’s a little recap and some thoughts.
Franchises Set New Standards
The first real estate franchise was Red Carpet Realty which started in California in 1966. Five years later Century 21 was created by Art Bartlett. The Century 21 franchise went national more rapidly than their predecessors. In 1977 they had 6,000 brokers and revenues of 23 million dollars, compared to 970 Red Carpet offices in 13 states. By growing their brand faster and farther they became the first effective national franchise followed shortly thereafter by Red Carpet, ERA and so many others. Franchises bring the concept of national branding, marketing , recruiting and training for the small operator to the real estate industry. All of it became systematized in ways never before thought possible by local real estate brokerages. Standards for marketing material become much higher, the cost of producing it become irrelevant, and brokers were exposed to business training superior to that which was previously available. As an interesting side note, of the first national franchises, only one was actually technology based. ERA (which stood for Electronic ealty Associates) was created around a technology which “established a national multiple listing service”. The technology the core of their initial value package and involved syndicating property information using facsimile machines – things we now call faxes. Over the long run, the technological advance touted by the franchise became the equivalent of our appendix, a vestige of the organism’s evolutionary development.
Agent Compensation & Broker Relations
As the “brand name” type of franchises flourished, Realty Executives created the 100% compensation concept, which shifted the operational profit of the real estate firm from the net retained by the company on the real estate commission to income generated by a management fee, with the expenses either deferred through a shared expense structure (desk fees) or shifted to the agent. Previously the agent’s income had been net of all expenses, now that game is in for some serious readjustment. Dave Liniger, like the Century 21 executives, executed better, disrupting the relationship of real estate agents and their employers forever. Prior to this , agents worked for brokers, independent contractor status notwithstanding. They didn’t look at themselves as “small businesses” or “self-employed” and they viewed the broker agent relationship as symbiotic rather than parasitic. Post ReMax, the entire compensation structure of even traditional firms is impacted as the concepts of Gross and Net income become confused by agents. Percentages increase, the cost of operations starts to be shifted to agents this new model, and everyone starts playing a shell game to make the percentage of compensation look better than it is while retaining enough income for the company to be stable and profitable. Broker agent relationships become less collegial and more adversarial in many companies. There is a seismic shift as the brokerage looks for income not from the production of the agent but from the desk rentals, shared office expenses and management fees. This model creates a need for massive recruitment because the income of the company is based around the number of agents rather than the Gross Commission Income generated by those agents. In a desk cost model, the least productive agent generates the same income for the firm that the most productive agent generates, and the number of recruits is more important than the quality of the recruit to the health of the company. This impacts not only the 100% firms, but every firm, as recruiting experienced agents becomes more central to the operation of a real estate firm than ever before.
The Birth of National Real Estate Companies
Merrill Lynch by building company stores around the country hoping to attract consumers through the Merrill Lynch name and their background of financial planning. Sears tries to create a national company by taking purchasing the Coldwell Banker name and tries to control markets over 35,000 in population through company owned stores, franchising only in markets if less that 35k. Neither Merrill Lynch nor Sears were successful as real estate operators, and they both exited the real estate industry after a few years. Sears ended up selling the regional offices to their managers , who were able to buy these huge operations through the creation of exceptional debt. Merrill Lynch sells their company owned offices to Prudential who tries to make it work, before deciding that they should break up their company owned stores , selling to their regional managers, retaining large debt, and eventually becoming just a national franchise until they decide to get out of real estate , selling their assets to Berkshire Hathaway. Sears gets away from Coldwell Banker which is in turn sold to Realogy, who operate it initially as a franchise. Apollo LLC, an entity closely related to Realogy, succeeds in creating the first national real estate brand through acquisition of company stores, first under three brands, and later consolidated un CB into the first truly national real estate firm, bringing corporate thinking into the traditionally small business arena that was real estate. Their buying spree memorialized the way real estate businesses were bought and sold. Prior to them, in many cases, the life of the real estate brokerage was the life of the real estate broker. Now real estate firms had real measurable value. Concurrent with the creation of the NRT, regional players like Howard Hanna, Douglas Elliman, John L Scott, Weichert, Long & Foster used these formulas to expand to larger regional Mega-Broker operations, even franchising and licensing the use of their name in some instances. Berkshire Hathaway Home Services, with their acquisition of the Prudential Assets, is positioned to become the second one of these national players. In a business where the largest number of firms are still small businesses, the impact of these national players has yet to play out, but it will not be small. In a recent post on Facebook my friend Rob Hahn said “Evolution is bloody, red in tooth and claw. Innovation is destructive, as the new displaces the old. True “innovators” are conquerors, the Goths sweeping over the Tiber. If what you do does not cause pitchforks and lamentations… it isn’t innovative.” I am not sure I agree, though the poetry of the statement is undeniable. In fact, I think that evolution causes initial consternation, but true industry sweeping innovation seems to me to be the things that are then embraced by the larger community and made a part of their daily life. Evolution is a process,a part of the natural, and is more of an aggregation of small changes, perhaps a false start or two, and then a widely accepted paradigm shift. Perhaps not as poetic, but just as world changing.