What do real estate agents do when they sell their own homes and is it different from what happens with their clients? Two University of Chicago professors, Steven D. Levitt and Chad Syverson, published a well-cited study in 2008 that quantifies how much better agents do for themselves than their clients. In Market distortions when agents are better informed: the value of real information in real estate transactions, the authors paint a disturbing picture of information asymmetry, compromised motivations, and another proof point that it is hard for homeowners to win if they work with a traditional real estate agent. [Disclosure: Syverson is an advisor at Surefield.]
The study examines the claim that listing agents typically present their compensation incentives as being perfectly aligned with the seller’s motivation, as a higher selling price will command a higher commission. While this is true, the incentive for the agent to sell the house quickly at a sub-optimal price outweighs the extra income generated by a higher selling point. They can make a higher return on their time by spending it finding new clients and closing more deals, rather than putting more time and effort marketing a given home for a higher price. And, when it comes to their own houses, the Chicago professors found that agents don’t mind waiting for the right buyer at the right price: homes owned by real estate agents sell for 3.7% more and take an additional 9.5 days to sell. This is not an isolated finding either – in 2005, Rutherford, Springer and Yavas found a similar result noting that agents sold their homes at a premium of 4.5% over similar, client-owned homes.
This is another classic example of the principal-agent problem that characterizes the relationship between the typical homeowner and real estate agent. Real estate agents are supposed to work with the best interest of the homeowner in mind, but in practice they are rational beings who respond to economic incentives. And the incentives around a high commission based on a closed sale price leads agents to act in ways that are contrary to the best interest of homeowners.
So what can you, the homeowner, do about this sordid state of affairs?
1. Understand the relationship dynamics before you transact. Most people don’t sell or buy real estate very frequently, perhaps a couple times in their lifetime. That means you will likely need some help from an expert when you do. But, if you are going to use an expert, it is imperative that you understand when your interests and the experts are not aligned when such matters involve large amounts of money. Key divergences include the initial listing price, when to accept any incoming offers, and when to lower the price. On all other topics, your agent is probably a reasonable resource to help you out, but on these matters question everything!
2. Consider the alternatives to traditional agents. While a traditional agent will charge you 6% in commissions and provide you with wrong information that will cause you to sell for 6% less (a loss to your asset value of 12% or more), most U.S. cities have brokerages that do things differently. For example, Redfin charges it’s clients 4.5% to sell a home (1.5% cheaper than a traditional agent) and uses salaried agents that avoid many of the principal-agent problems inherent in traditional brokerage. FSBO (aka for-sale-by-owner) MLS options typically cost homeowners around 3% plus $500 due to the fact that their model requires a hefty buyer’s agent commission to sell. This saves you 3% compared to a traditional agent, but you do all the work as a home seller and have very little guidance when it comes to negotiation or legal aspects of your deal. Next, if you live in Seattle, you can sell your house the same way that they do in the rest of the world for only 1.5% total commission with Surefield, saving you 4.5% compared to a traditional agent, but with 100% full representation through the entire deal. For the truly brave, you can join the 10% of U.S. homeowners that are selling their properties outside of the local MLS monopolies using services like craigslist or increasingly Zillow.
3. Have a friendly conversation with your friend. A lot of people end up listing their house for sale with their friend who lives in the neighborhood and happens to have their agent’s license. Most listings happen this way and it can be hard to be economically rational in these situations. However, there is nothing friendly about high commissions and misaligned incentives. Instead, try to reframe the friendship in a way that is not so one-sided. For example, you can offer to pay your friend an hourly rate to help you sell the home. Even if you pay your friend $500 an hour, it is unlikely they would be able to bill you for more than 3% of the house value! In another framework, you can agree to split profits above a certain price or to not pay any commissions below a certain price – this puts your friend’s skin in the game and eliminates incentive misalignment.