The Freakonomics Summary
I'll pass along this link, currently active without paywall at the NY Times. I think it presents a short, but balanced summary of Stephen Levitt's study on the behavior of real estate agents selling their own homes vs. the homes they represent. In short, here are Levitt's conclusions via the data.
- Real estate agents had their home on the market 9.5 days longer than non real-estate agent owned homes
- They received prices that were 3.7% higher than non real-estate agent owned homes
Professor Levitt than goes on to speculate why this would be so! And his rationale is (again, paraphrasing) this:
- Real estate agents, due to the structure of their commission, aren't completely aligned with a home seller's desire to maximize price. As such, some home sellers will receive less then they could.
It should be noted that the post and the study were before 2005 - when the market was hot, much like it is now. Also, all the data came from the Chicago area - a relatively inexpensive part of the country - and I'd be interested to see if the trend was consistent in more competitive areas.
The Freakonomics Results - More Detailed Theories
I find the data interesting, but the theorizing behind why the data looks like it does is not complete. On it's surface, Professor Levitt's conclusion about the alignment of the commission contract and and seller's desire to maximize price is completely correct. However, it doesn't have very much to do with "incremental commission" which is what he suggests. And now, if you've bared with me this long, we'll get to the fun part of the post. Here are some of my thoughts on things that haven't been adequately explored in this area.
Maximizing Price isn't Really the Goal
When you hire me to sell your home, it goes unspoken, many times, that the goal is to get the best price. But there are actually two goals. 1) Get the best price. 2) Sell the home.
It turns out that #1 is not the primary goal! Selling the home is. The Freakonomics material overlooks this very basic point, and they aren't alone. Many sellers forget this, as obvious as it sounds, until they are on the market for a month and the showings start drying up. Very quickly, the conversations go from "how can we get a higher price?" to "how can we get an offer?". If you change what the goal often is, you're changing the advice you get - and the behavior that will likely follow.
As agents, we know how quickly things can turn. When a house doesn't sell quickly, especially in a good market, home sellers get frustrated fast. Since all agents have seen it happen, we are more likely to encourage attractive market prices to avoid a negative experience.
Penalties of Failure
One of my main criticisms of the Freakonomics rationale for the data set is no discussion (that I see cited anywhere) about the disproportionate penalty that real estate agents have for not selling a house. It turns out, that if you're an agent, even the best ones, they don't sell every house. There are many reasons for this, but any experience agent knows that the ones you don't sell have all sorts of "penalties" associated with them.
1) No referrals. If you don't sell someone's house, they are unlikely to refer you to someone else. Since this is often 70-80% of new business, each house you don't sell has wide effects, that can hurt your business for years. And this is assuming you don't get any "bad press", which you most certainly will.
2) Out costs
It costs money to list a home, and usually the agent fronts it. We don't get paid back for the money we have spent when it doesn't sell.
3) Out time
The homes that don't sell paradoxically take up the most time! Agents don't get paid for that time either - it's a sunk cost. The New York Time article, like most, are happy to point out the commission an agent gets "for a few hours of work*" but the truth is agents bear the costs on all houses listed - not just the ones that sell.
As you can see, from an agent's perspective, the costs of not selling the home are great. I'll be the first to admit, the costs are so great agents are incentivized to make sure the home sells. This is largely what the data suggests, but I would argue that the main reasons that agents list their homes longer and sell for more is that on their own homes, there is no risk of them getting fired and not selling the home. After all, you're not going to fire yourself! However, when we work for others, we have a very real risk of getting terminated - and paying all the penalties associated with the failure to sell the house. What I'd really like to see, if we're going to talk about how real estate agent contract works, is what happens if you can't fire them? If you promise - no matter what - to list the house with them until it sells? I'd be willing to bet that the data would no longer be very interesting, because the real penalty has been taken away.
Risk Tolerance
An experienced agent who has sold dozens or hundred of properties isn't going to look at the real estate sales process the same way as someone who is selling their home for the first time in 10 years. This manifests itself in many different ways, all of which are likely to have small impacts that can add up. The easiest way to look at an element of it is in negotiating. If I'm negotiating a deal for clients, oftentimes their risk tolerance isn't the same as mine, or similar to what I might do personally. It easier for an agent to drive a hard bargain because if the deal fall apart, they have no one to blame but themselves - and so they go back to the drawing board. But if you drive a hard bargain with your client and the deal falls apart, the agent is going to get blamed. Again, this is because the vast majority of home sellers care far more about selling the home than getting top dollar (there are exceptions!). When they find out the buyer has walked away from the transaction over a few thousand dollars they would have conceded on, that is a failure of negotiating, and the agent is going to take the fall.
Benefits of Success
Along with the penalties of failure, comes the warm embrace of success. By and large, home sellers who sell quickly are very happy with their agent. They refer them to others, offer warm endorsements, and are likely to use them the next time they need to buy or sell. This behavior is irrespective of price! Again, the lesson here is that price maximization isn't the primary goal. The way home sellers behave before, during and after the transaction all reinforce the behavior of the agent around the true goal - getting the home sold.
Successful Dialog With Your Agent
None of this is to suggest that by listing with an agent that you are automatically not going to price maximize. But you should have clear conversations with your agent about your risk tolerance and your goals for price maximization - don't leave it unspoken. Good agents have no trouble pointing out that the goal at one price-level is to sell "first week", at another price-point is to sell "quickly", and the goal at a higher price level is to test the market - and may not work. If you decide on a higher price point, make sure you've discussed how long you will wait, how many showings you will entertain, and how much the first price cut will be, as part of an advanced plan to get the home back to where it likely needs to be. Remember, most houses (80-90%) that test new price levels in a market fail, even in good markets. The time before you list, when you have time to think, and can be dispassionate, is the right time to discuss strategy and pricing, the wrong time is 2 months after it was listed.
*Don't get me started.
An Educated Home Buyer is a Happy Home Owner. Read On!
About Matt Heisler
Matt Heisler is a real-estate professional and owner of this website. He has been selling homes in MA for buyers and sellers for over 20 years. He is an expert in foreclosure purchases, short-sale purchases, short-sale sales, buy and hold investing, fix and flip investing, and of course traditional residential home sales. He is happy to take questions as they pertain to real estate on Title V, Radon, Termites, Sump Pumps, Roofs, Foundations, Wells, Septic Systems, Cash-Flow, Staging, and a host of other housing issues. As a Vanderbilt University alumnus, he is proud to serve his local community.
*All information is posted in good faith and is assumed to be reliable, but may rely on third party information sources.
