A recent legal ruling may break the National Association of Realtors (NAR) stranglehold on the real estate market, allowing for the creation of new products and services, resulting in increased market efficiency.
Expect lower sales commissions, and less real estate agents.
Why should you care? Isn’t a 6% commission small compared to the recent rise in home prices?
Assume that you bought some property in California for one million dollars in July of 2020, and just over two years later, sold it for $1.35 million, netting a $350K gain, or a 35% ROI over two years.
Are you wealthier? Is this a trick question?
Let’s do the math.
First need to deduct the present-day real estate sales commission, which in this example will be 6% of $1.35 million, or $81,000. Leaving you with net sales proceeds of $1,350,000 – $81,000 = $1,269,000, which reduces your two-year ROI to about 27%. Still not bad.
Also need to account for California’s annual 1% property tax, paid twice over this two-year period. Will simply assume that the house’s appraised value remained at $1M, meaning that net proceeds are now $1,269,000 – 2 x 0.01 x 1,000,000 = $1,249,000, just under a 25% ROI. Still OK!
Given this monetary profit, there will be some taxes to pay, computed using this online tax calculator.
Will unrealistically assume that this is your only income for the year, understanding that any additional income may push you into higher percentage tax brackets. For a $249,000 income, filing married, you will pay $41,000 to the IRS and $16,000 to California, reducing your net proceeds to $1,249,000 - $57,000 = $1,192,000, or an ROI of about 19%. Still positive!
Finally, will use this very useful website to compute the real effect of inflation on your investment. Simply enter in the initial purchase price of $1,000,000, plus the date range from purchase to sale. The official monthly CPI rate is then compounded over the entered time period to compute the net devaluation of the dollar.
Which means that in September 2023 dollars, your real wealth gain is $1,192,000 - $1,188,000 = $4,000.
Wow. A paltry 0.4% ROI over two years, which hardly justifies the risk of the investment.
But look at the bright side, government collected $77,000 (about 20X what you earned) for wealth redistribution, while the real estate agents netted $81,000 (also about 20X what you earned).
The good news for the government and the NAR is that most home sellers ignore the real effect of inflation, ignore the $188,000 increase in the property’s cost basis, and thus are content paying these taxes and fees, naively believing that they are wealthier.
And then later wonder why their standard of living is diminishing…
Admittedly I have ignored other factors such as rental income, insurance premiums, utility bills and repairs, because the point is to bring awareness to the damaging illusion created by our present high rate of inflation.
What if the real estate commission was 3% instead of 6%? Then your inflation adjusted ROI would increase from 0.4% to about 4.4%.
Ditto for lower taxes.
Which can be the difference between breaking even and truly becoming wealthier.