| Reinvent the closing--2nd of two parts |
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$30 billion in economic value could be created
January 23, 1998
Inman News Features
By Beth F. Cobert and Catherine Kenworthy
Special report from McKinnsey
Editor's note: This report was adapted from research conducted by international management consulting firm McKinsey & Company. The following is the second of two parts; the first part talked about opportunities created by a lack of integration and real estate closing services.
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 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.
Beth Cobert is a principal in McKinsey's San Francisco office and Cathy Kenworthy , formerly a consultant in the Washington, DC office, is senior vice-president of marketing and strategic planning at GE Capital Mortgage Corporation.
They would like to thank Lenny Mendonca, Tom Skinner, and Jim Yocum for their contributions to this article.
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