November 19th, 2008
Labor, Capital, and Real Estate
I’ve been reading Basic Economics: A Common Sense Guide to the Economy by Thomas Sowell for the past few days. When you’ve got 3 hours of commuting every day, man… you’d read textbooks for fun.
But there are some insights in the book that are thought-provoking — in some ways, because they are so commonsense. For example, Sowell writes on Capital, Labor and Efficiency:
While everything requires some labor for its production, practically nothing can be produced by labor alone. Farmers need land, taxi drivers need cars, artists need something to draw on and something to draw with. Even a stand-up comedian needs an inventory of jokes, which is his capital, just as hydroelectric dams are the capital of companies that generate electricity.
Capital complements labor in the product process, but it also competes with labor for employment. In other words, many goods and services can be produced with much labor and little capital or much capital and little labor. (Basic Economics, p.202; emphasis mine)
When you think about this, and you’re in the real estate industry, some questions immediately come to mind.
Is real estate brokerage today a capital-intensive or labor-intensive business? What are the consequences?
In my view, there is little question that brokerage today is mostly a labor-intensive business. Realtors don’t have large house-making factories (developers do that). They don’t have massive infrastructure costs (MLSes have that covered). It’s really all about how many good agents do you have in the market generating business.
If jokes are a comedian’s capital, what is the realtor’s capital?
Is it listings? Is it contacts and relationships (aka, the sphere of influence)?
Furthermore, is a broker’s capital different from an agent’s capital?
Consequences and Subsequences
The low-capital, high-labor structure of real estate brokerage has significant consequences. For one, it means that the barrier to entry is extremely low in real estate brokerage. You literally need nothing more than a license to start brokering houses. The direct result of this is that existing agents see their earnings erode as competitors continually enter the market.
For another, it means that labor costs — i.e., the commission split — are by far and away the largest cost item for any brokerage company. The precise amount is known only to the owner, but according to the 2007 REALTrends Brokerage Performance Report, the average company dollar appears to be about 26.7% for the largest brokerages in America. So roughly 3/4 of every dollar of revenue goes straight out the door to labor costs in the form of commission checks.
Those are the consequences. The subsequence — I just invented this word, I think — is that it points clearly to a strategy for brokerage companies to respond to these consequences.
High-Capital, Low-Labor Brokerage?
While it isn’t clear what constitutes “capital” for a Realtor, what is unquestioned is that actual capital assets — the furniture, the building, the computers and copiers and such — are real assets, real capital of the brokerage. Just like a machinist in a shop needs precision lathes, a realtor needs computers and telephones to create value. If her broker doesn’t provide those things, then she needs to provide them herself, which translates either to a higher labor cost (as she will demand higher splits) or losing the agent to a broker who does.
Enter the Web.
The fundamental shifts going on in our industry from the advent of the Web as a real consumer tool are attributable to many factors. But from the capital vs. labor perspective, the Internet represents an opportunity to alter the structure of brokerage firms.
A top-notch website with real consumer appeal can cost hundreds of thousands of dollars, if not millions of dollars. Innovative features and functionality are neither free nor cheap. Programmers cost money, and it can take months of time to overhaul an aging ineffective website. At the same time, a top-notch website can provide meaningful competitive advantage to those companies that have it, as consumers are more likely to find them in the first place (SEO, content, etc.) and find the experience enjoyable. Offering timely and useful information to consumers, along with comprehensive housing search, is a key to driving up conversion rates, which in turn leads to actual clients and actual deals.
As the Web takes over in more and more areas of marketing, lead generation, and operations management, the key question to be answered is, “Who invests?”
There are only three options: the broker, the agent, or a third party. Let’s take these in reverse order.
Third party providers — ranging from private companies such as Zillow, franchisors such as Coldwell Banker, or associations such as the local REALTOR association — can invest in such web technologies. That will raise the barrier to entry to become one of these third parties, but lower the barrier to brokers and agents. In saving capital costs, the brokers and agents relying on third party providers either raise their labor costs or keep them constant.
Agents can (and do) invest their own funds into web presences. They may use third-party website builders, or hire a local web developer to do it for them, or spend time doing it themselves. In exchange for this higher investment into capital assets, the agent can expect higher earnings from labor (again, in the form of higher splits) as she can demand brokers offer more and more attractive splits since they’re not doing as much for her. In theory, this should raise the barrier to entry to future agents, as incumbents have already invested tens or hundreds of thousands of dollars into their individual websites. Today, not enough agents have made that investment in a big enough way, so the barrier remains low. But one can foresee a future in which it requires more than just a real estate license to become an actually productive realtor.
Finally, brokers can (and do) invest in these websites and web technologies. That immediately raises the barrier to entry, and also alters the relationship between capital (broker) and labor (agent). When production is the result of capital and labor, and you have invested in a good deal more capital, then labor costs have to go down. Agents who demand too much in splits under a high-capital (i.e., web-centric) brokerage may be let go, as their labor is contributing less to the overall transaction than before.
Investment in web technologies, therefore, needs to be assessed as part of the whole cost structure. If investing $500K into a new custom website means the broker has the ability to go from 70/30 splits to 60/40 splits on $100m of GCI, that additional 10% is $10m, resulting in 20x returns on the initial investment. That’s an investment every single broker with $500k should make.
With the economy the way it is, and the real estate markets not healthy yet, the timing couldn’t be worse psychologically nor better economically. Psychologically, when revenues are down across the board, to write a check to invest in capital infrastructure will be difficult. At the same time, because business is down across the board, now is the time to negotiate favorable terms with developers, vendors, and technology suppliers.
In closing…
I think the tendency within our industry is to view websites as a marketing expense. And one of the first things to get cut in hard times are marketing expenses.
But I believe that websites and web technologies are not mere marketing expenses for a service business like real estate brokerage. They are, in fact, part of the capital structure of a brokerage company. They profoundly impact the productivity and efficiency of operations, and in particular impact the value of labor to the enterprise. Evaluated as part of the overall cost picture, it may be that a company struggling to remain profitable simply cannot afford not to upgrade its web infrastructure, in order to improve the overall profitability.
Tags: capital investments, profitability, Real Estate Sites, websites.
