In the United States, 25,000 residential real estate transactions are closed every day. Each of these complex deals requires the participation of a broad group of businesses: law firms, real estate agencies, lenders, title and home insurers, and a host of other ancillary service providers for home furnishing, remodeling, power supplies, telephone, cable TV, newspapers, and alarm systems. While a home buyer views a closing as a single (and often stressful) event, none of these providers does. Each supplies its own service, and it is up to the buyer, sometimes with the help of a realtor, to bundle them all together. Our research shows that much of the stress for home buyers stems from this lack of integration. At the moment, though, no one sees residential real estate closings as a service in itself.

Therein lies the opportunity. Just as The Home Depot emerged as a new channel for home remodelers, and Staples meets the needs of the home office, there is a huge opportunity to serve the home buyer better at the time of purchase. In 1995, real estate closings generated $110 billion in revenues. This is the equivalent to roughly $20,000 for the average consumer, not including property taxes or the financial institution’s cost of mortgage funds borrowing. At $110 billion in directly affiliated revenues, this industry is bigger than the entire soft drink industry, approaches the size of the telecommunications and grocery store industries, and is half the size of the computer industry.

The largest piece of the revenues from this latent channel, just over one-third, belongs to real estate brokers (see Exhibit 1). They are closely followed by the retail and institutional investors that fund mortgages, either by holding them in their portfolios or by buying mortgage-backed securities or other mortgage-based financial products. Completing the pie with stakes of 10 percent or just below are homeowners’ insurers, mortgage originators, and servicers (institutions that collect payments from borrowers and transfer them to mortgage investors and insurers). Interestingly, players with a high nuisance quotient for home buyers, such as attorneys, title/escrow providers, and appraisers, have small stakes (around 2 percent of the total each).

What consumers want

The current system—if it can be called a system—fails to give consumers what they want in terms of price, speed, and service. A real estate closing is in many ways the prototypical PFS transaction. The findings from our research into consumers’ views on home closings echo many of the themes from our other research into PFS purchases.

Price is important to mortgage customers, but perhaps not as important as many companies think. Though price is a key concern for the majority of consumers, rare is the individual who selects a provider purely on the basis of price. Moreover, most consumers view price in an unsophisticated way, often focusing exclusively on rate and seeking a rate that is merely close to that of other providers, rather than the absolute lowest. Our research shows that "close" can mean anything from 0.25 to 2 percentage points above the lowest rate available.

As our PFS consumer research revealed, consumers value face-to-face relationships; they engender trust and provide information and guidance through often complex and daunting real estate transactions. Most consumers rely on realtors to provide them with a shortlist of lenders, insurers, and other providers. Yet our research indicates that consumers actually perceive loan officers as the critical players in the real estate transaction, and scarcely even notice the other parties involved. To some extent, this perception is encouraged by realtors, who would prefer to have loan officers (rather than themselves) viewed as the transaction gate-keeper—the person who can deny your mortgage and snatch away the keys to that perfect home. Yet despite their influential roles, few loan officers or realtors currently deliver the trust, education, and transaction integration that consumers want.

Perhaps surprisingly, consumers’ relationship with their loan officer does not generally extend to his or her institution. Many banks believe that providing a mortgage is the first step to a broader relationship with a consumer. Not so. For most consumers, a real estate closing is an uncomfortable experience that they tend not to associate with their other financial business. Indeed, many prefer to put the transaction behind them and avoid further dealings with any of the providers.

The nature of the opportunity

Given the gap between current practices in real estate transactions and consumer needs, we believe this industry is ripe for a restructuring that could create better than $30 billion a year in economic value. This value is likely to be shared between industry participants and consumers, who should benefit from lower prices.

Technology will play a vital role in extracting this value. Information technology will be used to integrate processing and eliminate piles of documents, cutting transaction costs and creating more than $10 billion in annual value. Upgrading credit underwriting so as to separate good borrowers from bad and price loans in line with risk could unleash a similar amount of value. It will improve pricing and cut processing costs, allowing good borrowers who are unlikely to default to be identified quickly and easily. It will also drive growth, because better underwriting will make it possible to offer loans to higher-risk borrowers who currently have to pay prices far in excess of the incremental credit risk they actually represent.

Players will also restructure traditional roles and relationships. The realtor’s role is likely to shift from time-consuming and expensive tours with prospective home buyers to the value-adding tasks of brokering, negotiating, pricing, and closing transactions between buyers and sellers who participate in the market infrequently and have limited experience and confidence. As a result, realtors, who currently take one-third of the total payment that consumers make at the closing table, are likely to see their fees decline. Like First Data Resources in the credit card industry, some players may create value in roles that are not readily visible to the consumer, such as title insurance or appraisals.

Many industry participants are positioned to capture a piece of the opportunity. First are those that already enjoy substantial presence and influence in the transaction, such as Fannie Mae, Freddie Mac, Cendant Corporation (formerly HFS), State Farm, Allstate, Chicago Title, First American, Norwest, Countrywide, and Chase. Second are those that are already close to the consumer in this or other types of financial transaction, such as Cendant through its key realty units, some mortgage originators, dominant distributors such as First USA, Merrill Lynch, Fidelity, and Charles Schwab, and some of the more promising Internet-based start-ups, such as HomeShark and Keystroke. Third are those with the ability to set the rules about what happens at the closing table because of their clout in the investment community, especially subprime players such as ContiFinancial, Greentree, and The Money Store. Finally, in a category all its own, Microsoft announced in July 1997 its plans for a consumer-focused Internet real estate service that, in its words, "will work seamlessly with the real estate industry, facilitating communication and consumer traffic to local agents, lenders, builders, and service providers."

Capturing the value

How would a player exploit the opportunity? Within the existing business system, roughly a quarter of the total value up for grabs will come from cost and skill improvements—especially the upgrading of credit expertise. A further half of the value will be derived from the restructuring of the business system across categories that will occur when an individual player or type of player emerges as a dominant force within the transaction, unlocking additional cost and skill improvements. Such players may increase their dominance by knocking others out of the picture; it’s not hard to imagine buying or selling a home without a realtor or mortgage originator or lawyer. Current players or new entrants may also create entirely new roles that draw together a range of closing products and services, just as The Home Depot does.

The final quarter of the value will stem from the emergence of multiple business systems. These systems will cluster the provision of all services needed to close a transaction in a fashion specific to the preferences of distinct customer and market segments. Examples of possible segments include Internet-based transactions, Affordable Housing lending, the ultra-affluent, do-it-yourself borrowers, and highly service-oriented consumers.

How quickly this new channel evolves depends largely on regulation. The two major regulatory barriers are Reg. X, which implements the Real Estate Settlement and Procedures Act (RESPA) and prohibits the payment of referral fees by one service provider to another, and a range of legislation that prevents banks from developing full-line insurance capabilities. Though still stringent, Reg. X/RESPA is being amended to allow single providers to offer multiple settlement services.

As these regulations are reformed and technology advances, players are beginning to experiment and jockey for position. Internet-based players and many lenders are beginning to bundle services at closing, facilitated by Freddie Mac and Fannie Mae’s automated underwriting products. Countrywide now handles online loan applications. American Finance and Investment advertises the lowest mortgage rate available on line. Intuit has launched an online financial bazaar for mortgage purchases. The Web site www.financenter.com allows consumers to capture large discounts on listing and/or selling commissions.

Among those positioning themselves to shape and dominate the new real estate closing channel, Cendant Corporation is perhaps the most aggressive. Over the past two years, it has acquired three of the top five realtors (Century 21, Coldwell Banker, and ERA) and a top mortgage originator (PHH), broken its ties with all mortgage originators except PHH, and formed an alliance with America Online to establish a private online network for Century 21 brokers and agents, as well as an online service for consumers. By consolidating and integrating different elements of the home purchase transaction, Cendant is hoping to lead what will certainly be a fundamental transformation of the residential real estate industry.