California recently passed a bill (AB5) to target “gig workers” like Lyft and Uber drivers to ensure they are classified as full time employees as opposed to contract workers but there will be other side effects. This law will drastically alter the real estate industry throughout the country with the elimination of many independent agents and help one brokerage firm in particular. Why will this drastically alter the current real estate model?
What was in the bill?
California Bill AB5 changes the classification of many workers from contract employees to full time employees. Full time employees are entitled to health insurance, min wage, vacation, etc… all of which will be absorbed by the employer or passed on to the customer substantially increasing costs. The big change in AB5 is the implementation of a 3 part test as opposed to the current federal law.
The ruling and the bill instruct businesses to use the so-called ABC test to figure out whether a worker is an employee. To hire an independent contractor, businesses must prove that the worker a) is free from the company’s control, b) is doing work that isn’t central to the company’s business, and c) has an independent business in that industry. If they don’t meet all three of those conditions, then they have to be classified as employees.
How is this different than today?
Under federal law there is basically one key test. How much control does the business exert over the contractor? An independent contractor generally can determine when, how and where to perform their work, and is responsible for any necessary tools or equipment necessary to provide the services (National Association of Realtors). The test above drastically alters the federal definition by adding the three-point test.
Why will real estate be impacted?
Under federal law, it is easy for realtors to be classified as independent contractors as they determine when and how they perform their work. Under the California law most, if not all, realtors would fall under the employee category as the work is central to the company’s business and they don’t have an independent business within the industry (they essentially are tied to one brand like Remax or Keller Williams). This means that most California real estate agents should be classified as full time employees.
Under the current real estate model, realtors are paid when a transaction closes. If an agent doesn’t close transactions they don’t get paid. Under the California law, the real estate company would be required to pay agents a min wage, provide health insurance, vacation, pay payroll taxes, etc…. which is expensive. This will lead to the elimination of thousands of part time agents as they will not generate enough revenue to offset the costs to become full time employees.
Brokerages will likely change their business model. Companies like Redfin employ full time agents that cater to the discount brokerage model to drive volume. Other brokerages will go towards some sort of a redfin type model as they are forced to employ agents as full-time employees.
This is just California right?
There are already proposals in Oregon, Washington, and New York to pass similar legislation. This could end up like the auto industry where California sets the standard and other states hop on board. As more states consider this legislation, national brokerage firms will be forced to adapt their business model
Summary
Various companies for years have been trying to “crack” the real estate market and failed. The California legislation will totally change the status quo. As independent contractors are replaced with full time employees, real estate brokerages will be forced to migrate to some sort of a redfin model to drive more volume in order to justify the costs of full-time employees. The discount brokerage model will have a distinct advantage in the new paradigm as they are already compliant with the new laws. Anyone in real estate should not sit idly by watching how the legislation unfolds as it will unleash radical change that you must plan for.
Resources/Additional Reading
https://www.nar.realtor/law-and-ethics/independent-contractor-status-frequently-asked-questions
https://www.vox.com/2019/9/11/20850878/california-passes-ab5-bill-uber-lyft
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).