Exerpt from Freakonomics book regarding real estate agents.

gromicko · February 9, 2011, 6:12pm

Pages 5-8:

It is the quintessential blend of commerce and camaraderie: you hire a real-estate agent to sell your home. She sizes up its charms, snaps some pictures, sets the price, writes a seductive ad, shows the house aggressively, negotiates the offers, and sets the deal through to its end. Sure, it’s a lot of work, but she’s getting a nice cut. On the sale of a $300,000 house, a typical 6 percent agent fee yields $18,000. Eighteen thousand dollars, you say to yourself: that’s a lot of money. But you also tell yourself that you could never have sold the house for $300,000 on your own. The agent knew how to —what’s the phrase she used?—“maximize the house’s value.” She got you top dollar, right? Right? A real-estate agent is a different breed of expert than a criminologist, but she is every bit the expert. That is, she knows her field far better than the layman on whose behalf she is acting. She is better informed about the house’s value, the state of the housing market, even the buyer’s frame of mind. You depend on her for this information. That, in fact, is why you hired an expert. As the world has grown more specialized, countless such experts have made themselves similarly indispensable. Doctors, lawyers, contractors, stockbrokers, auto mechanics, mortgage brokers, financial planners: they all enjoy a gigantic informational advantage. And they use that advantage to help you, the person who hired them, get exactly what you want for the best price. Right? It would be lovely to think so. But experts are human, and humans respond to incentives. How any given expert treats you, therefore, will depend on how that expert’s incentives are set up. Sometimes his incentives may work in your favor. For instance: a study of California auto mechanics found they often passed up a small repair bill by letting failing cars pass emissions inspections—the reason being that lenient mechanics are rewarded with repeat business. But in a different case, an expert’s incentives may work against you. In a medical study, it turned out that obstetricians in areas with declining birth rates are much more likely to perform cesarean-section deliveries than obstetricians in growing areas—suggesting that, when business is tough, doctors try to ring up more expensive procedures. It is one thing to muse about experts’ abusing their position and another to prove it. The best way to do so would be to measure how an expert treats you versus how he performs the same service for himself. Unfortunately a surgeon doesn’t operate on himself. Nor is his medical file a matter of public record; neither is an auto mechanic’s repair log for his own car. Real-estate sales, however, are a matter of public record. And real-estate agents often do sell their own homes. A recent set of data covering the sale of nearly 100,000 houses in suburban Chicago shows that more than 3,000 of those houses were owned by the agents themselves. Before plunging into the data, it helps to ask a question: what is the real-estate agent’s incentive when she is selling her own home? Simple: to make the best deal possible. Presumably this is also your incentive when you are selling your home. And so your incentive and the real-estate agent’s incentive would seem to be nicely aligned. Her commission, after all, is based on the sale price. But as incentives go, commissions are tricky. First of all, a 6 percent real-estate commission is typically split between the seller’s agent and the buyer’s. Each agent then kicks back roughly half of her take to the agency. Which means that only 1.5 percent of the purchase price goes directly into your agent’s pocket. So on the sale of your $300,000 house, her personal take of $18,000 of commission os $4,500. Still not bad, you say. But what if the house was actually worth more than $300,000? What if, with a little more effort and patience and a few more newspaper ads, she could have sold it for $310,000? After the commission, that puts an additional $9,400 while she earns only $150, maybe your incentives aren’t aligned after all. (Especially when she’s the one paying for the ads and doing all the work.) Is the agent willing to put out all the extra time, money, and energy for just $150? There’s only one way to find out: measure the difference between the sales data for houses that belong to real-estate agents themselves and the houses they sold on behalf of clients. Using the data from the sales of those 100,000 Chicago homes, and controlling for any number of variables—location, age and quality of the house, aesthetics, whether or not the property was an investment, and so on—it turns out that a real-estate agent keeps her own home on the market an average of ten days longer and sells it for an extra 3-plus percent, or $10,000 on a $300,000 house. When she sells her own house, an agent holds out for the best offer; when she sells yours, she encourages you to take the first decent offer that comes along. Like a stockbroker churning commissions, she wants to make deals and make them fast. Why not? Her share of a better offer—$150—is too puny an incentive to encourage her to do otherwise.

Freakonomics was written by Steven D. Levitt & Stephen J. Dubner. It’s a really good book.

bkelly2 · February 10, 2011, 7:52am

Hahahahhh, interesting Nick…Thanks for sharing that.

belliott · February 10, 2011, 8:09am

So are you saying people should use their own judgement of what the house is worth when selling and ignore feedback from the Agent?

John_Biggs · February 10, 2011, 7:30pm

I don’t believe Mr. Gromicko is trying to say anything. He has only quoted the “Freakonomics” book. From this little section I would expect the remainder of the book to be interesting and might be worth reading.

To answer part of your question:

Simply put the answer might well be yes! One of the ploys of agents and brokers is to start advising their seller clients to reduce the price of their home after some mythical period of slow activity. If the home hasn’t shown in a few weeks after first listing they might jump in and start the “Price Reduction” pressure tactic then. Somewhere along the line it appears agents and brokers are using a $10K price reduction figure, obtained from whatever logic they use. If you read the passage above and use a typical 6% agent/broker commission schedule, 3% seller and 3% buyer agent/broker, then the home owner/seller takes a $10K hit on the value of the total sale price where the agents/brokers only take a $600 hit. The individual agents/brokers only take a $150 hit after their costs/fees.

As the book points out if the home is owned and being sold by an agent/broker then they are the ones taking the $9400 hit on a price reduction and will bend over backwards to try and save that $9400. The book rightly asks what incentive is there for an agent/broker for just another seller to take the extra time and effort to make sure their client does not take that $10K hit?

So there are times when a seller needs to to not listen to their agent/broker and refuse the price decline. Let the agent/broker earn that large commission check. If you don’t then the agent/broker will eventually scare you into enough price reductions where anyone would buy the home at such a reduced price.

mbeauchemin · February 11, 2011, 2:57pm

John,

I believe that Nick is pointing out that there are many unknowns in a brokerage transaction and that we inspectors are lucky not to have to renegociate all the time.

We have our job to do!

Take the best house at the best price, the selling broker still needs a client with or without a broker to step up to the plate and propose.

You have to see the bottom line! What if the house does not sell John, do you know how much the broker makes? That is right! ZERO! X 100% = 0
As inspectors, we come in during the Buyer and Seller wedding ceremony.
(Please don’t talk about divorce, Valentines day is coming).

John_Biggs · February 13, 2011, 1:18pm

If a home does not sell then that is either the unluck of the draw for the Broker OR the Broker/Broker’s Agent did not perform. Either way it is the nature of the business model that the real estate participants (Agents and Brokers) have established and long supported.

The current commission based business model no longer works as it did and should be changed. The discount brokerages are on the track of changing this but are under heavy attack from traditional real estate participants. Many discount brokerages are offering an ala carte system for sellers which is the beginning of this change. Long ago, before the Internet was so prevalent, Agents really worked for that commission. Now however they do little with part of the reason being so many laws, rules, and lawsuits that have created a very different attitude and way of doing business. Add to it the large number of national chain brokerage operations that do nothing more than add significant overhead cost to the process with little return for the additional expenses.

agallatin · February 13, 2011, 6:04pm

This was an interesting read . What is said here is becoming evident in our area . We are getting the FSBO and Internet home marketers . The RI’s have been trying to fight back , but still see the new way getting stronger with the amount of business they are getting .

jbraun · February 13, 2011, 6:28pm

Their is a roamer going on in the real estate industry that NAR will be forced to make their Multiple Listing Service (MLS) an open source to the public because of the monopoly that they currently hold.