I recently finished reading Freakonomics, an excellent book by economist Steven Levitt and journalist Stephen Dubner that explores how incentives affect people in ways that we wouldn’t always intuit. They apply the disciplines of economics and statistics to other-than-financial scenarios, like exploring the unusually high incidence of cheating in Sumo Wrestling (a sport that boasts honor as a central theme).
One of my favorite parts of the book deals with whether real estate agents garner higher sale prices for their clients than if the client were to simply sell the house on their own. In order to tease out the answer, Levitt and Dubner look at a variety of sales data in a particular locale and examine the average sales price differences between agents’ selling their own homes vs. other people’s homes. They also looked at how long a property was on the market in each situation.
What did they find?
As you might expect, they found that, on average, a real estate agent’s home sold for more money, and stayed on the market longer than a typical property. They also found that, on average, homes sold with the assistance of an agent didn’t sell for any higher than those homeowners who sold on their own.
What Levitt and Dubner found didn’t really surprise me… it all comes down to incentives.
Realtors Are Motivated to Sell Properties Fast, Not at a High Price
Most real estate agents in today’s market charge 5-6% of the sales price of the house for their services. Of that amount, half is usually provided as an incentive for the buyer’s agent, making the selling agent’s take only about 3%. But, that 3% is usually split 50/50 with the agent’s company, which means that the agent is likely to get about 1.5% of the sales price.
Let’s say you have a house that’s worth $250,000. With some effort and marketing, a real estate agent can get you full price. But, with less effort and marketing, they can get $240,000. To you, the difference between $250,000 and $240,000 is a whopping $10,000 – more than 2 months pay for most Americans.
But what’s the difference in the agent’s take? 1.5% of $250,000 is $3,750, while 1.5% of $240,000 is $3600, a difference of only $150!
If selling the property for $250,000 takes 20 more hours of work (e.g., additional showings, open houses, etc.), you can see that it just doesn’t make sense. The Realtor would only be working for about $7.00 / hour for those hours.
A Better Way to Pay A Real Estate Agent
So if straight commission isn’t a good way to pay, what’s the better alternative?
Levitt and Dubner don’t get into this… but I think the best way is to set a basic fee for listing the house, and then pay a large incentive above a certain sales price.
For instance, you might pay $1000 for standard listing services, and then 50% of the price above some base price. In our example, perhaps we would pay $1000 for basic listing and settlement services, and 50% of the sales price above $250,000. In this model, our agent is highly motivated to exceed the target sales price of $240,000 by as much as possible, since his take is highly dependent on sales price.
Of course, this relies on homeowners knowing approximately what their home is worth and being willing to negotiate with the agent. Unfortunately, since real estate agents are the ‘experts’, they normally dictate the compensation model. Most people buy and sell houses only a few times in their whole lives, and aren’t really ready to negotiate these terms. In most cases, they also wouldn’t know what is ‘fair’ for the base price, and being off by even $10,000 in this attribute could lead to paying an inordinate fee to the agent.
What do you think about Real Estate Agents?
I’m really curious what you think about real estate agents.
Are they worth the price? Is there a better way to motivate them to get the highest price available? How do you make sure your not getting ‘taken’?
P.S. Freakonomics started as a NY Times blog. If you like examining the other side of everything, you can follow it at that link. The link for the first book is at the top of the article. There’s also a sequel called Super Freakonomics, if you haven’t gotten enough 🙂