Managing Attorney Marx Sterbcow of the Sterbcow Law Group addressed the audience at the Williston Financial Group’s Executive Summit on the future of affiliated business arrangements (AfBAs), with major industry shifts in motion and a rise in regulatory scrutiny.

The conversation started out with the impact of the multiple listing service (MLS) lawsuits and the settlements related to them. Sterbcow said these will likely lead to an increase in AfBAs.

The MLS lawsuits and settlements Sterbcow referred to are the recent cases involving the National Association of Realtors (NAR) and many of the major brokerages in the country. Last October, a Missouri jury awarded plaintiffs billions of dollars in damages related to violations of federal antitrust laws and allegations that NAR and these brokerages engaged in a conspiracy to artificially inflate commissions paid to real estate agents.

Since the finding, all the defendants in the Sitzer-Burnett class action have since settled with the plaintiffs resulting in changes to NAR-owned MLSs, including on how commissions are negotiated between consumers and real estate agents.  One of the major terms in the NAR settlement was the agreement to eliminate the cooperative compensation rule from the MLS.

The cooperative compensation rule requires listing brokers to offer commissions to buyer brokers in order to participate in Realtor-affiliated MLSs. Sterbcow said the elimination of the cooperative compensation rule from the MLS effectively harms the procuring clause protections that buyers’ brokerages have long relied upon for compensation. 

Other copycat cases filed on the heels of the Sitzer-Burnett jury finding are currently being sorted out by the courts.

Settlement impact

The NAR MLS settlement is going to cause a massive shift in how real estate agents and consumers interact, Sterbcow said. For starters, he explained, he already knows of buyer agents who have made the switch over to the listing side, because “they know the impact of this is going to effectively knock out or make it very difficult for the seller to pay for the buy-side commission.”

“I think on the buyers’ broker side we will see between $500 to $2,500 for a buyer’s agent flat fee commission, where the buyer pays the buyer’s agent,” he said. “This is about what the market can sustain in most cases because purchasers are already cash-strapped when purchasing a home with down payments, mortgage/closing expenses, and moving costs. Some of the real estate brokerages I’ve spoken with have already seen a significant drop on the buy-side commission, and a number of brokers across the country are telling me that in many cases sellers are refusing to pay for any buyer broker commission.” 

Sterbcow mentioned he has also heard about some buyer brokers charging their customers an hourly rate or a fee-per-service, and while that can work when purchasers are looking at one house, if they start looking at several homes, the hourly rate or fee per service will likely outstrip what the purchaser can afford to pay the buyers’ brokerage.

On the listing broker side, there likely will be a big change in what MLS is top dog, Sterbcow said. CoStar’s Homes.com, Zillow’s closest competitor, engages in a different business model than most other real estate website portal brokerages and is projected to surpass Zillow as the top real estate search engine before the year is out. 

The Homes.com model is what Sterbcow called “Real Estate Web Portal 3.0.” which is a migration away from the buyer-generated real estate lead model and a technological shift to the listing-generated lead model. Currently, Homes.com is touting its listing-agent-centered model as “Your Listing, Your Lead,” he noted.

The consumer experience online is shifting, Sterbcow explained, and with the changes under the NAR MLS settlement, and Homes.com’s bet that NAR would lose their lawsuit, homebuyers are now starting to contact the listing agents directly for representation. 

One of the biggest impacts in the NAR MLS lawsuit will be MLSs themselves as the industry expects massive MLS consolidation over the next few years.  The MLS model was built around the cooperative brokerage compensation rule and the elimination of this data field effectively calls into question the rationale behind even having MLSs in the future, Sterbcow told RESPA News in a follow-up email.

Buyers will start going directly to the listing agent when looking for a home, he added, and this is where the opportunity for AfBA activity to increase lies.

“You’re going to have real estate brokers with significantly decreased margins, and they are going to have to find some ancillary business to keep their doors open,” Sterbcow said.  “There was a study years ago by RealTrends which found that real estate brokerages nationally on average make between $250 to $440 profit before taxes. The NAR MLS settlement means these real estate brokerages will experience even more pricing compression due to the reduction or loss of the buyers’ brokerage commission. 

“Real estate brokerages, if they want to stay in business, will have to find as many ancillary services as possible to keep their doors open, and that is factoring in the fact that real estate agent-brokerage splits will be changing across the country to offset these company dollar commission compressions.”

As a result of the diminished number of buyers agents, the mortgage and title industry will likely see increased closing times because of consumers not really understanding the process, Sterbcow added.

“Listing agents will incur a lot more responsibility as well and some of that additional consumer workload may fall back on the mortgage and title industry,” he said. “We won’t see the full impact of the new landscape for 15-18 months after the Sitzer-Burnett settlement.”

Increased scrutiny

While companies will be looking to form AfBAs, regulators – the Consumer Financial Protection Bureau, state attorney generals, departments of insurance, departments of financial institutions, and real estate licensing law agencies – have already been putting AfBAs under the magnifying glass.

The cause of this renewed focus on affiliated business arrangements has not been industry behaviors at-large. Those companies that do business compliantly usually have no issues at all, Sterbcow said. But over the years, there have been a few bad actors in certain markets that have operated with reckless disregard for the federal and state laws. The state regulators began in early 2023 to rein in those activities and abusive practices which harmed not only consumers, but also disrupted the marketplace in some cases.

“Unfortunately, you had some attorney generals who had gotten the idea that all AfBAs were the reason that title insurance premiums were so high in some of these states,” Sterbcow said.

The title premium pricing issue speaks to a larger issue which is a lack of regulator education, he added.

“That’s a real problem, because it’s going to speak to the overall health of any sort of affiliation, whether it be an affiliated title operation involving real estate brokerages, or a law firm that happens to have co-ownership in a title agency,” Sterbcow said. “That’s a real concerning piece I’m starting to see.”

He added that as regulators learn more about the title industry and how the compliant AfBAs operate, some of the regulators have even suggested helpful changes and compliance considerations to help expedite any future investigations. However, there are some jurisdictions that are expected to continue their scrutiny, such as the District of Columbia, he said.

Moving forward

With all this in mind, Sterbcow said, if you’re going to start an AfBA or enter into a joint venture, there are several criteria your operation should meet to ensure compliance. Undercapitalization, where there aren’t enough funds to initially operate the AfBA as an independent business, is one of the biggest red flags.

He recommended initial capitalization be equivalent to six months of operating expenses, with no revenue being generated – roughly $100,000 – for an AfBA in one state. Any less, he explained, and the regulators may take issue with inadequate capitalization, which they argue subsidizes the ordinary business expenses of the investors by pricing the investment buy-in at a reduced rate.

Regular audits by third parties and training for investors and title agents to ensure RESPA, UDAAP (unfair, deceptive, or abusive acts or practices), and state law compliance are also things the more skeptical states are looking for when analyzing whether an AfBA is operating compliantly, Sterbcow mentioned. 

“We recently had one client who initiated a RESPA compliance audit, and when the regulators found out the company had hired us to conduct a RESPA audit into their operation, the regulator dropped the investigation and moved onto to another company,” he said.

If forming a JV or AfBA during this industry shift, Sterbcow recommended focusing on agents that are already on the listing side, or brokerages that are more listing centric, as that is probably the “sweet spot” in this market.

In a deeper dive into the regulatory trends, Sterbcow explained how one state is working on updating its AfBA disclosure form requirements. While disclosure to the consumer the agent represents is standard, this state is also starting to try notifying the other party in the transaction about any affiliations. This could be achieved by uploading the affiliated business disclosure form to the MLS or by the buyer’s agent sending the form to the listing agent with the offer. The intention here is notifying the listing agent, who then has a fiduciary duty to provide the AfBA disclosure form to the other party in the transaction for transparency purposes.

Sterbcow said all of the companies who have already started doing this, most have stated it hasn’t been overly burdensome.

He also cautioned that some state regulators are using UDAAP authority to investigate AfBAs that do not pass their “smell test,” as opposed to the sham factors under RESPA jurisprudence. Things like having a website, social media presence, and the independence of resources (such as employees) are critical when setting up an affiliated business to show it is operating in good faith.

“You have to do these things correctly,” Sterbcow added. “If you have a partner, or if there’s someone you’re thinking about doing a joint venture with, and the hair on your neck stands up, and you’re thinking, ‘I don’t know, I don’t trust this person,’ those sorts of people are the ones that create problems for everyone. And they’re going to create an issue for you and your entire operation. … When you’re doing these things, you want people to have the same mindset that you do on having a compliance-oriented operation and creating a joint venture that actually benefits the consumer.”

One thing is certain, though, post-NAR MLS settlement: the demand for AfBAs by real estate brokerages, in particular, will be significant as the real estate brokerage industry contracts, Sterbcow said.

“The contraction won’t be limited to real estate agents and real estate brokerages either,” he added. “We will see contraction due to the post-NAR MLS landscape in the lending, escrow, and title insurance sectors, as well as there will be fewer referral sources, and fewer referral sources means consolidation will hit these settlement service areas as well.”