Realtor Fees Play Role in Home Prices

realtor feesMy family and I recently made a change that apparently thousands of my fellow Americans have made: We moved to Texas -- in our case, from New Jersey. As a result, I am now in the extraordinarily interesting position of being not just an industry observer, but a client. My first observation? Realtor fees matter.

One thing I did not realize until it happened to me was how much the nature of real estate agent compensation would affect my own decisionmaking. I believe the way that we compensate real estate agents for their work affects how we price homes to buy or to sell. Anecdote follows.

I put my little house on the prairie -- if by "prairie" we mean wealthy New Jersey bedroom community filled with Wall Street bankers and lawyers and their herd of German automobiles -- on the market a couple of weeks ago at $480,000 (this is considered affordable housing in that
realtor fees
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part of the country, by the way) upon the advice and counsel of my Realtor, Sue Adler. Now, I've known Sue for a while, and for this story, the pertinent fact is that she's pretty much the best damn agent in the area with over thirty years of experience (more if you count her teenage years working for her father's real estate brokerage) in buying and selling houses. She's the #1 KW agent in New Jersey since 2005. Given her expertise and track record, I take her pricing advice wholeheartedly.

A couple of days later, I get an offer from some family interested in the house. They bid $465K -- below asking, but certainly within negotiation distance. Without getting into details, negotiations fall apart, and I elect to wait it out. The buyers also elect to keep on looking, I presume.

We both -- myself and the buyers -- think nothing more of it.

A day later, I get a bill from my attorneys, whom I've retained to pursue a totally separate legal matter. Looking at the bill, I start thinking, "Wow, I hope this case ends soon in settlement." And I catch myself.

Why was I so willing to turn down an offer "within striking distance" and yet, somewhat anxious to see my legal case settled?

The answer: I'm paying the lawyers on an hourly basis; I'm paying Sue when the house sells.

Financial Calculus and the Human Being

A central tenet of economics is that human beings modify their behavior based on incentives, both positive and negative. In every single professional services situation I can think of, there is an ongoing cost to using a professional. There is a financial impact to using a lawyer for two hours vs. twenty hours. Seeing your doctor once a month is a different thing than seeing her once a week, even if your insurance picks up much of the cost. A tax accountant will charge more to spend an hour doing your 1040EZ versus spending a week on your corporate tax filing. Even project-based fees -- common in advertising, web development, and consulting -- have clauses that say that if the amount of work goes way beyond what the firm estimated, there will need to be an adjustment.

In cases where time and effort equal money, there is a strong incentive on the part of the principals -- the buyer and the seller -- to come to agreement. Because every day, every hour that they don't reach agreement, the meter is running on all of the professionals they have on retainer.

With residential real estate, however, there is no such pressure. Incentives to get a deal done quickly stem from things like mortgage payments, additional rent you might have to pay, more utilities, or life situations (you've been relocated, and the family is still back over there). But the cost of real estate brokerage services is not one of those factors. Those boys and girls get paid only upon a successful sale.

The buyer has no real incentive to hurry up and get a deal done, since that nice lady who is showing them around, sending them listings, and negotiating terms isn't costing them anything -- until the end. Might as well hold out for the absolute best. The seller's incentives to get a deal done quickly is also much less: if I expect to pay another $5,000 in professional fees by foregoing an offer, that would change how I'd respond. But since Sue's time and effort are not costing me anything out of pocket, I also might as well hold out for better offers.

(To be fair, experienced real estate agents constantly tell their sellers that houses for sale age badly, like cheese, rather than wine. But the point is that the seller doesn't feel it as there is no out-of-pocket cost.)

Does This Compensation Model Distort the Market?

If you speak with an experienced real estate agent who handles listings, they will tell you that their top concerns are (a) convincing the homeowners that their dream house isn't worth what they think it should be worth, and (b) convincing the homeowners that it is time to drop the price. They go through all sorts of contortions and tools and data and so on to convince their clients to do the right thing.

Now, as it happens, when someone who only gets paid upon a sale starts advocating a price drop, the average human being gets a wee bit suspicious. Is she telling me to lower the price for me, or for her paycheck? That's natural, I think, despite the fact that many a real estate agent recommends that step precisely because they want to help the client.

I think broker compensation does in fact distort the market, by decreasing the incentive on both the buyer and seller to get a deal done. And given the naturally suspicious minds of humans, it is difficult for a professional to break through.

The situation is even worse when we're talking about distressed properties, whether owner-occupied, or foreclosed. There, the carrying cost is so low (no mortgage payments, minimal utilities & upkeep) that the seller really doesn't have much of an incentive to drive a bargain.

If somehow the heavens and the earth moved, and Realtors were to start being paid like any other professional, and buyers and sellers both take on costs to dither and wait for a better situation... I think we'd see transaction speed pick up significantly. Sellers would respond to the incentive by calculating how much more money they would need to pay to wait for a better offer; buyers would respond by thinking about how much the search is costing them. And frankly, real estate agents would find that they're no longer worrying about whether the client is actually going to pan out or would be yet another moneysink that ends up costing them more cash in gas, time, and expenses. It's a win-win-win.

If only...

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