In the best-selling book Freakonomics: A Rogue Economist Explores the Hidden Side of Everything, Stephen Dubner and Steven Levitt pick apart much of what could be called the conventional wisdom on a variety of modern realities, including real estate.
Levitt, a University of Chicago economist, and Dubner, a former editor and now regular contributor to the New York Times Magazine, contend that real estate brokers only work as hard as they have to in selling other peoples’ homes, especially if that work gets them a relatively tiny boost in commission. This contention has become,
Dubner said, perhaps the most controversial one in Freakonomics. Dubner, in a recent podcast interview with The Real Deal, explained in depth why brokers do what they do and why their business is so inefficient. (His and Levitt’s theories were first covered in a story last year in The Real Deal, A Freaky Explanation for Broker Effort.)
THE REAL DEAL: Can you explain what you and Steven Levitt in Freakonomics say motivates real estate brokers to sell other people’s homes?
STEPHEN DUBNER: It’s pretty straightforward, really. What we try to do is really look at economics as the study of incentives. So, what’s the incentive for a real estate agent in selling a home if you’re the listing agent? What we suspected is that the way the commission fee is set up, the real estate agent as the listing agent doesn’t often have a huge incentive to get the maximum price for your home if you’re the seller.
Let’s say that a real estate broker’s getting 6 percent. In fact, half of that is going to go to the buyer’s agent. So, now the listing agent is down to 3 percent. That 3 percent, typically, about half of that is kicked back to the agency itself. Now, you’re down to 1.5 percent. So, instead of thinking about the commission on, let’s say, a $1 million home, think about the 1.5 percent commission. Now, you’re still getting a good payday when you’re selling the home, but you have to think about the marginal increase in a price rise.
In other words, if I’m selling my apartment and a broker brings me an offer of $1 million, my asking price, on the first day, I have to think, “Well, how much harder would it be for that real estate agent to work just to get me an extra $10,000?” Well, to me [the seller] that is worth a lot; it’s $10,000 minus 6 percent, so it’s $9,400. But, to the listing agent, it’s worth $150 — 1.5 percent of the marginal increase.
So, what we see is that real estate listing agents will often encourage people who are selling their home to take the first decent offer because, to the agent, that makes sense. They want to take as good a commission as they can in as short a time as possible.
TRD: What does the commission structure have to do with this effort — or lack thereof?
SD: The pricing mechanism in residential real estate is bizarre. It’s very random, if you think about it. In most markets, there’s a market maker who sets a price, or they bring together buyers and sellers who agree on a price. That’s what happens on Wall Street a few billion times a day. A real estate agent is different; a real estate agent is setting the price and acting as the commission-based agent for the sale of that property. And, so, the pricing mechanism is a little bit polluted, you could say, but it’s OK. If you’re selling the house, and you’ve got your agent wanting to set a high price, that’s good for you, certainly. But, you have to look at the kind of arbitrariness of it.
TRD: Is it a matter of ethics with real estate brokers and their incentives?
SD: I think it’s a matter of information and people feeling they don’t have good access to it. In the past, one of the reasons that people hired a real estate agent was to be the expert in pricing a home. Now, the Internet has finally started to chip away at that advantage, with things like Zillow and a variety of other pricing mechanisms. And, also now, I know in New York, there’s a new site called Brokerate.com. To me, it’s such a natural thing. People can anonymously rate their transactions with real estate brokers.
TRD: The National Association of Realtors recently attacked your contentions, saying that brokers build relationships with customers for life and, therefore, would never take advantage of a customer.
SD: It’s a very plausible argument, except their data kind of undercuts their argument. Let’s say that you’re a dentist or let’s say that you’re a car mechanic, someone to whom a customer will return once every year or once every couple of years. When the NAR said that one of the reasons that they didn’t like our findings was because [real estate] is a repeat-customer business, they then said that the average American homeowner moves once about every seven years.
Think about that for a minute. What kind of loyalty am I, the customer, going to feel toward someone who works for me once every seven years? Plus, when you sell a home, you’re often leaving the area, so it’s not like you’re using the same realtor every seven years. So, let’s say half the time you leave the area, half the time you don’t. Now you’re down to once every 10 years. I don’t think that’s a remotely plausible argument for why the typical agent would find it in their best interest to maximize profit for each and every client.
That said, I think that the typical good real estate agent — and I think most real estate agents are good — does know that reputation is hugely important. Our point is not to drive real estate agents out of business, not by a long shot. Our point is that the real estate brokerage business is, for a variety of reasons, extraordinarily inefficient.