The W2 Model Post COVID: A Reader Request

I don’t often check the “message request” function on Facebook, but did so earlier today and found a request from a reader, Shelley Scanlin, from the state of Houston in the Republic of Texas:

Hi Rob, would love to see you do a piece on w2 brokerages and if this has changed your opinion on that structure at all? Specifically the Redfin furlough announcement today. Hope you are well!

I thought I’d dash off a little something something before diving into actual work for the day. So here we go. In case you were wondering, no my opinion has not changed on the W2 model for real estate brokerage. I see no reason why it would.

The Fundamental Problems of Brokerage

Let’s start with the fundamental problems of real estate brokerage:

  1. Inverse relationship between agent productivity and brokerage profitability; and
  2. Lack of control over the consumer experience.

COVID doesn’t change either of that dynamic. Redfin’s layoffs do not change those.

In fact, in my mind, COVID makes #2 even more problematic for brokerages. Lacking control over independent contractors, a brokerage is going to have to figure something out when it comes to anti-infection protocols. For example, if a brokerage promises sellers that all showings are accompanied by all kinds of safety equipment, total wipedown of all surfaces, etc., it has to then figure out how to get its agents to actually do those things. Hopefully, everyone will be on the same page… but fundamentally, a W-2 based model has more control over who does what, when, where, and how.

The Redfin Layoffs

The second thing I’d like to point out is that Redfin’s layoffs are… interesting. Most of the haters are focusing on the fact that Redfin furloughed or laid off 40% of the agents. They’re not going a bit deeper.

From Geekwire:

Redfin will cut 7% of its staff and furlough hundreds of agents due to decreased housing demand amid the COVID-19 crisis.

The Seattle real estate giant will slash 41% of its field agent workforce, with a majority furloughed until Sept. 1, and the remaining laid off, Redfin CEO Glenn Kelman announced Tuesday.

The company is also making small cuts at its headquarters in Seattle, while temporarily slashing all salaries by 10-to-15% and canceling bonuses for the remainder of this year. It previously halted bonuses for just the first half of 2020.

Redfin had 3,377 total employees as of Dec. 31, and employed more than 1,500 lead agents.

Kelman said the company opted for a large-scale furlough in part because most agents will be able to earn more from unemployment insurance than from Redfin.

“We still have had to furlough people today because of a downturn, but it wasn’t because we didn’t try to trade growth for job security,” he wrote. “Every year, we’ve hired about 25% fewer agents than could be supported by the demand from Redfin.com, so that even if demand fell 25%, our workforce would still be at 100% productivity. Now housing demand is down much more than that.”

The more important number to me is the 7% cut to staff. 7% is not 35% that Opendoor did. That’s not cutting to the bone; it’s more of a trim. I actually think Redfin took advantage of COVID to get rid of some C-players and problem employees, like many other brokerage CEO’s have done.

The couple of million bucks that Redfin will spend on termination is easily absorbable by Redfin who has a ton of cash. So that’s not a huge deal.

The W-2 Model, Post COVID

So taking those into account, I see no reason to alter my beliefs about the W-2 model. Brokerage make more money with W-2 than with 1099; the difference is cash flow vs. profitability. But ultimately, cash flow depends on profitability so those companies that can afford to keep making payroll will eventually see higher cash flows from operations as well. W-2 also gives companies greater control over their workforce, which leads to greater control over the consumer experience, which will be critical when we come out of this crisis.

Finally, since I know that top agent teams have converted to W-2 models, or are actively considering converting to that model in order to make some of its operations profitable, I actually believe that we’ll see an acceleration of the W-2 model take hold in the aftermath.

Layoffs will happen as the business cycle goes down; but guess what? Hiring happens when the business cycle goes up.

A lot of the mid-level real estate agents who are good at real estate, know their markets, know how to provide excellent client service… but aren’t great at lead generation are facing really dark times right now. Those agents might find the prospect of a steady paycheck at some big agent team extremely attractive. And those teams will go on a hiring binge when we come out of this and the already-high demand that has been suppressed for months explode. Most will do the split-based model (but see below), but many will just pay those agents an hourly wage or a weekly salary and capture the higher margins that flow from that.

Finally… Government Intervention

I can’t leave off this brief post without mentioning the fact that I do think we’re going to see at least teams be forced into the W-2 model. I wrote a lengthy post about this, which you can find here. From that post:

You simply can’t exercise the level of control over “team members” that agent team leaders have and do and claim that they are “independent contractors.” And if you don’t exercise that level of control, then you can’t have a unified entity that makes the whole agent team concept work.

If this isn’t a big fat juicy target for state and local governments who are going to be looking for tax money under every rock, then I don’t know what is.

State governments in particular will be looking for tax revenues to offset spending on healthcare and unemployment — the two biggest areas during the pandemic. What are the two biggest taxes that teams didn’t pay by classifying their team members as independent contractors? Healthcare and unemployment.

It might not happen, of course, because politics. But I’d be surprised if it doesn’t.

Real estate brokerages may be immune, because of state law, but agent teams most likely are not. Which will flow upwards into the brokerages as well.

We’ll see, but like I said, I see no reason why post-COVID, the W-2 model is not even more attractive and even more powerful than it is today.

-rsh

PS: Been listening to a podcast about Tupac and Biggie, from whom this blog takes its name so…

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Rob Hahn

Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

4 thoughts on “The W2 Model Post COVID: A Reader Request”

  1. ROB,

    Continuing on with using Wall Street as a guide. We should remember that in the old days “stock brokers” we’re incentivized by commissions through transactions with clients. Then in, or around the mid-90’s the big brokerages pushed their brokers into gathering asset$. At the same time they moved away from transactions-for-commission to paying a “commission” based on the assets under management.

    I think that industry transitioned to the new pay structure quite well….maybe real estate can make compensation changes as well?

    #itsthestructurethatwillmatter 🙂

    We’ll see.

    Thanks,
    Brian

  2. I would be surprised we wouldn’t see more interest in the w2 model. While Redfin got trashed in the agent community, their laid off agents get unemployment without having to get a Congressional exception. I’ve never seen ICs want unemployment coverage more than they do now, while at the same time resisting the model that would give them that unemployment insurance at all times when downturns happen. Basically, real estate agents are clamoring for what Redfin agents got, while at the same time criticizing the treatment of Redfin agents.

  3. The fact that the government opened up 1099 contractors to be able to file for unemployment was a big deal that I think will have unintended consequences later. Agents (and some brokers) throw around that phrase constantly when they want to prove their independence from their brokers, their ability to work when they want/as they want. They don’t want to be told what systems they must use or that they have to attend meetings – and brokers use this same argument when they throw up their hands and state “but they are independent contractors we cannot tell them what to do.” Agents want their independence, the ability to make big bucks when times are good – but now when it all hits the fan they want to claim unemployment like W2 earners.

    You cannot have it both ways (or at least you couldn’t until 2020). If later the government tries to reclassify them as employees they’ll cry foul and fight for their independent status. This is one step closer to helping them lose their 1099 status.

  4. Every legal publication states franchising & 1099s don’t mix. This is a fantastic read: “Avoiding the Accidental Franchise: Best Practices for Structuring Licenses or Distribution Agreements”. http://media.straffordpub.com/products/avoiding-the-accidental-franchise-best-practices-for-structuring-licenses-or-distribution-agreements-2014-04-16/presentation.pdf

    Awuah v. Coverall courts stated the tiered franchise model was like a “modified Ponzi scheme”. Yet ReMax states right in their 10K they are a tiered franchise model. Almost every big real estate firm is charging royalties for use of symbolic IP. Shelley Spandorf has some good publications on this topic. Some of these firms are charging marketing fees or brand fees (just another name for royalties) and are not even franchises! Take for example Weichert (who uses franchise math) and they are not even a franchise. Check out Kennedy v. Weichert recent decision in NJ. I bet more will follow. Guess who tried to intervene? NJ Realtor Association.
    https://www.jdsupra.com/legalnews/independent-contractor-battles-fought-17241/

    Marketing plan + required fee aka royalty + trademark (see slide 11 the 3 legged stool). Is Realogy’s corporate owned company still partnered with Amazon? (marketing plan). Don’t most of these companies have leads through internet and relocation? I know they charge agents royalties (Realogy states it in their 10K). Lanham Act+ control over the trademark, isn’t that by definition “control”. Lets not forget ALL of the manuals which have been left online (sloppy brokers) which state there is a minimum commission agents must charge their clients. I found about a dozen online that have a min. for their agents to charge. One manual actually says, commissions are NOT negotiable (with “Not” underlined and it was updated in 2017). Uber has been under fire in NJ, CA, etc. NJ hit Uber with a $650 million bill. Controlling the rate+ 1099= Antitrust issues for Uber so why is it any different for real estate? Brokerages (the firms & owners) want their cake and eat it too. My huge issue is why are firms not disclosing master franchising aka tiered franchising in the ICAs or during recruitment? These firms are hiding the fact that agents are paying royalties and net paid to agents will be less. Wonder if these firms are paying their fair share to the Department of Revenue on the extra money retained from royalties too? For a big firm it means millions of extra dollars retained. A huge disadvantage for the smaller firm calculating “off the top deductions” v. “fees on gross”. The later is just creative franchise math.
    PS. another recent lawsuit. This one over franchise fees and proper disclosure: Lewis v. Exit Realty. Filed in Monmouth County Superior Court.
    https://marksklein.com/wp-content/uploads/2020/02/Real-Estate-Agents-Employees-or-Contractors.pdf

    PSS. BTW isn’t a return of franchise fees/royalties considered a RESPA violation when a company has an affiliated mortgage company when there is no franchise agreement (or the office is not even a franchise when there is a transaction with an in-house mortgage company?). Check out “iv” under “1024.15 Affiliated business arrangements”: https://www.consumerfinance.gov/policy-compliance/rulemaking/regulations/1024/15/

    (iv) A return on franchise relationship may be a payment to or from a franchisee but it does not include any payment which is not based on the franchise agreement, nor any payment which varies according to the number or amount of referrals by the franchisor or franchisee or which is based on a franchise agreement which has been adjusted on the basis of a previous number or amount of referrals by the franchiser or franchisees. A franchise agreement may not be constructed to insulate against kickbacks or referral fees.

    Thank you if you read down this far:).

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