Real (Estate) Rent Seeking

The Justice Department may file suit against the National Association of Realtors (NAR) to prevent them from excluding discount brokers from access to the regional MLS systems.  I’m hardly a fan of antitrust but the market for realtors is a racket.  Six percent to sell a house?  Outrageous!

Putting aside the outrage the market for realtors is terribly wasteful.  Consider, house prices are much higher in California than in Idaho but commissions are stable at around six percent.  Thus, even though the realtor’s job, brokering a deal, is the same in California as in Idaho, a realtor in California will make much more per-house.  As a result, there are far too many realtors in California and many of them will spend an entire year selling only a handful of houses.  Indeed, many realtor’s spend most of their time prospecting for clients rather than actually selling houses – this is a huge waste of resources. 

The same relationship holds over time as over space.  That is, when house prices go up we don’t see a fall in commission rates.  Instead, we see more entry.  Since the same number of houses are being bought and sold, the extra realtors don’t make the buyer or seller better off and sadly the realtors aren’t better off either – instead the excess return is siphoned off in wasteful prospecting for clients.

Unfortunately, no one really understands why commissions are stable.  The answer is not monopoly.  It’s very easy to enter the market for realtors.  So why don’t commissions fall?  One can certainly point to some restrictive practices by the NAR but I don’t think that is the whole or even the major part of the story.

A clue to the puzzle is that we also see stable commission rates in law (contingency fees) and in services (tipping).  Why is the appropriate tip 15% at an expensive restaurant and at a cheap restaurant?  Does the tuxedoed waiter really have a harder job than the diner waitress?  Maybe (indeed, I have argued along these lines elsewhere) but the commonality across these very different markets tells me something else is going on.

Is it signaling?  Would you distrust a realtor offering lower commissions?  Again, maybe, but it’s hard to believe that with so much money at stake there aren’t enough people willing to take a risk on a discount realtor for long enough for reputations to be established.  I think part of the problem in the realtor market is that other realtors can easily discriminate against discount brokers by pushing their clients one way or the other – that says the antitrust actions will probably not be very effective.  But this doesn’t explain stable commissions in law or waiting.

It’s a puzzle and one worth solving.  Comments are open.

Comments

WRT realtors, I think you've nailed it. Waitresses? Call it rational ignorence. I don't want to think about how much to tip, I just want to do the safe thing and leave. Lawyers? That's signaling. Lawyers are competitive, and the stakes are always high. Nobody wants a discount lawyer any more than they want a discount army.

If one real estate agency lowers their commission rate, the others will have to match it, and they will all hate the first agency to cut the rates.

Somebody needs to be the hero (to the buyers of homes, not their agents) and start the process. Everyone will follow.

I think a lot of it is just uneducated consumers. Commissions are negotiable. However, the Realtors spend a lot of money promoting the idea that buying or selling a house is a complicated procedure that requires the assistance of a licensed agent. They have been using aggressive marketing for years to artificially inflate prices. It happens in other industries too, but the Realtors as a group have been very successful at it.

I think Michael H is on to something above. It's like those "we'll beat any price in town by 10%" deals that electronics stores have. Well, every store has the deal, so nobody cuts prices.

Or, the people who see the value of 3% go to Foxtons, which in my neighborhood (NJ) advertises their 3% commissions extensively, and seems to have plenty of clients.

Not to mention that not everyone pays 6% even for full service. I recently sold my house and paid 4.5% to an excellent full service realtor. Part of the difference may be that informally-connected clients can get better rates than those who just walk in off the street, so to speak; my realtor is a local specialist and I was referred to him by neighbors who'd been happy with him when selling their house. Part of it may also be the effect of Foxtons in the area, though.

When we were haggling over a certain house, the broker offered to sacrifice part of his commission to bring the price down. Alas for him, we decided that even the reduced price wasn't worth dealing with the problems the inspector had found in the house.

It's a lot easier for a broker to make this kind of offer when he's starting from a 6% commission.

WRT tipping in restaurants: I have noticed that many waiters/waitresses working in expensive restaurants make a living out of their job, while the same is not true for those who work in many "inexpensive" restaurants (could it be a self fulfilling prophecy: On the one hand, inexpensive restaurants might not support the (tipping-) income required to support oneself; hence, waiters/waitresses working in these restaurants cant make a living out of their job. On the other hand, one could argue that the lower per customer (tipping-) income earned in inexpensive restaurants would be compensated by the increased traffic in these restaurants, thereby providing (tipping-) income similar to that of expensive restaurants on a total income basis. Yes, increased traffic equals more work!!!). Given my observation, and since the waiters/waitresses make the bulk of their wages from the tips they receive, I tend to tip more than 15% when I dine in expensive restaurants. Should I change my strategy?

First: in the US generally, real-estate commissions are split between the seller's agent and the buyer's agent, and are paid by the seller out of the proceeds of the sale.

In the San Francisco Bay Area, 5% (total) and even occasional 4% commissions are becoming more common on properties over $700,000; 6% is rare on houses over $1,000,000. That's a pretty big chunk of the market in several counties here. So there's some price fall.

In the current market, the seller's agent is making an inordinate amount of money for the work they do, as all that really needs to be done is to draw up some standard forms, list the house on the MLS for less than one thinks it will go for, set out a lockbox key, hold an open house or two, and choose from multiple offers.

The buyer's agent, on the other hand, even if they don't offer chauffer services to look at houses, will still have to visit several houses to gain entry (using the lockbox left by the seller's agent), likely prepare several offers before one is accepted, and obtain entry for the buyer or buyer's inspectors during the (rather short) inspection process.

The quality of real-estate agents vary widely. In my housebuying experience, and working woth my girlfriend who's buying an investment property, I've met a number of agents, maybe one in four of whom seemed reasonably competent and informed. Quite frequently, the agent showing a house at an open house is not the listing agent, but a junior agent at the brokerage, prospecting for buyers. A good agent might actually deserve their 3%, but there are some who should pay for the privilege of representing me.

As to waiters, the fixed tip creates a career ladder: one starts working in cheap restaurants, and as one is ready to move up, one gets a job with a more expensive, and thus better-tipped, restaurant. In theory, the more expensive restaurants have more attentive and better service; in practice, they have more consistently good service, and better-looking servers.

As noted above the buyer has no incentive to shop around for lower commisions, so the question is why don't sellers haggle for lower commisions. I think that the answer is since selling a house is something that a person does rarely, but involves a large amount of money, they want to feel that they are getting the best. If a good agent could get you an extra 10 grand for your house, your not going to begrudge them a couple of grand in commissions. Since it is hard to judge how good an agent is unless you sell a good amount of homes, going with the full commission agent seems like the safe bet. After all, if the discount agent is so good, why is he charging so little?

I usually tip >20% at cheap restaurants (eg. Thai, Chinese, Chili's) and rarely more than 16% at expensive ones, even less if I get wine. I feel especially bad for the recent immigrants that probably get to serve 3 or 4 tables an hour at these tiny places sprinkled all over L.A.

I agree that real estate agents are infuriating. Hopefully it will become more commonplace to negotiate rates - there's certainly no lack of supply!

The average real estate commission, nationwide, was 5.1% in 2003. It's been below 6% for more than a decade, and dropped appreciably as the housing market heated up. Furthermore, in the higher end of the market, commissions have always been lower, fee-for-service is more common, and many listings are nonexclusive, just as is the standard in the commercial market.

I think signalling is the main problem, both here and in a very large number of economic situations. Price signalling is probably the main cause of inefficiency in service/information economics, and appears to me to be a VERY serious barrier to the real economic growth in wealthy nations.

The figure does not include either FSBOs or flat-fee services. It is an accounting of commissions charged by brokers in those transactions where the seller is represented by a broker who charges commissions. And it is from REAL Trends, which gathers data for real estate firms. I'd link directly to the data, but their products are now all subscription only. The figures are, however, widely reported in the real estate trade press, if you wanted to do a search for them.

When I bought a house in US I was shocked by the 7% commission the seller's agent was getting. Living in the Netherlands, I was used to commissions around 1 to 2%, although both sellers and buyers pay them. If you know what house you want to buy, you can often negiotate them down to below 1%. When it comes to selling my house in the US, I'll certainly be negotiating the commission down myself.

Asymetrical information on the part of buyers and sellers? A gentleman's agreement? Brokers who violate the custom and charge lower prices are harshly punished by other brokers (who maybe refuse to deal with them or even send them death threats)?

As an investor, one has to love the way the internet has brought down brokerage commissions.

Can we please dispense with the silly notion that "The seller pays the commission"? The price is endogenous, folks.

I recall from my basic econ classes that there are two types of markets that end up with competitors charging the same price. One is collusion, which I can tell you as a REALTOR is not happening in the real estate industry. The other is perfect competition. What's the mystery?

I'll agree that good agents deserve the money they make (on a "normal" sales price), but the problem (at least in the California market) is that the industry has been flooded with people looking to make an "easy buck" and who more or less do not know what they are doing, just plain not good at their job and/or don't care enough to put forth the proper effort. With little or no training or certification needed to become an agent, and commission only pay structures (encouraging brokers to hire just about anyone), it is not hard to get into the business.

In a residential real estate transaction there are three parties of interest: buyer, seller and agent. The agent has the least to lose and the most to gain. Given a 6 percent commission, if a $500,000 house sells for $450,000, the agent's commission drops from $30,000 to $27,000 and the agent has no risk. It's in the agent's best interest to complete a transaction. If you paid an agent $100 an hour, the agent would have to work more than seven weeks to earn $30,000. I realize there is overhead involved here but the value just isn't there.

Yes, yes, thank you, Steve Levitt. While I don't disagree with his contention that incentives for listing agents to maximize home prices would be more powerful if they were more clearly value-added (perhaps a 1% commission on the home's last fair market appraisal, combined with a 50% commission on dollar one above that) the notion that the current incentive system is especially perverse is, I think, a little weak.

For one thing, the argument makes it sound like the difference between selling 12 listings and selling 10 is somehow a factor of how much time, love, and tenderness went into each one, and that's just not the case. Realtors don't WAIT to get their next listing until after they've sold their last one. You could have 12 listings at once, followed by months with no listings at all. Most of the drudgery goes into the procuring of new listings, and you will likely sell every one you get. Advertising costs are borne by the broker, not the agent, so that's not a concern, and as long as the home is in the MLS, there will be swarms of agents -- both from within and without your agency -- who will bring in potential buyers. If a seller wanted to sell his home at $410k, then even if the listing agent thought it would sell more quickly at $390k, it requires no real extra effort to put it on the market at the higher price, sit back, and see what happens.

So, really, while the listing agent may not have an especially strong incentive to get the maximum possible price, nor does he have an especially strong incentive to sell a property quickly. On the other hand, sellers often DO have incentive for a quick sale. Most sellers are also BUYERS, and they usually want to coordinate the sale of their own home with the purchase of another. Levitt's study showing that realtors are more likely to leave their homes on the market longer, it seems to me, strongly suggests that realtors are more likely to bring a patient and disciplined approach to the process. Most sellers do not.

I had a personal experience with the "non-collusion" of realtors. Tried to sell our house ourselves, got it listed on the MLS, and had a parade of realtors come through... without clients. Three months pass, we get it listed with a realtor-- who did absolutely nothing-- and the same realtors came through with clients. Other FSBOs have shared this experience. In spite of guaranteeing a commission to the buyers' agent, there was no desire on the part of the realtors to give business to the FSBO.

Many of the realtors, of course, tried to sell me their services. I asked what value they would add. More than one cited the many customers they were helping find a home(none of who they were bringing by-- collusion, anyone?). One spent a long time pointing out that she would also help find a new home. I pointed out that by not showing her current customers all the available properties (e.g., mine), she was demonstrating that she didn't look out for her customers' best interests.

It's a slimy industry. I would never accuse every member of being slimy, but I met enough who lied to my face about their business that it left me with a horrible taste in my mouth.

The model for commissions should be sellers' agents getting a much larger percentage of the amount above the assessment. Maybe 15% of the sales price above assessment. And the buyers' agents should get a flat fee based on the assessment (or perhaps even a decreasing percentage).

Thank goodness the auto sales industry has evolved. Last purchase, I used several buyers' services and ample online info to find the best deal in our region. Then I took that price down the street and said "the sale is yours if you can meet this price." Answer: "yes." Total research: maybe 1/2 hour. Total haggling: 3 seconds.

"In spite of guaranteeing a commission to the buyers' agent..."

I'm not sure just how you'd do that. The buyer's agent only gets a commission if he makes the sale, but the listing agent gets a guaranteed commission IF the house sells. And, typically those listings are good for only a defined period of time. You can have your listing expire if the asking price is too high.

Your story is consistent with a competitive market, more than a collusive one. You didn't sell your house in the first three months because you put out poor incentives.

"Competitive entry" looks easy because "agents" enter easily. But at least around here (Seattle) agents mostly affiliate with brokerages, of which there are only 5 or 6 big ones, all of which take a fixed portion of agents' commissions. It may be hard for hundreds of agents to collude, but the small number of powerful brokerages form a cartel just fine.

Make what you will of this:
I've purchased three homes in the past 15 year. Each time I represented myself (I an not an agent.) In each case there was a bidding war. In each case the party I was bidding against had an agent. Each time the seller's agent steered the seller to me, there by avoiding a split commission. Coincidnce? I think not.

If an agent sells a $500,000 home for 5 percent commission ($25,000) that equates to more than six weeks (assuming a 40-hour work week) at $100 an hour. Does anyone believe that -- even after overhead is deducted -- the services of agents in general is worth that level of compensation?

If it's efficienct you want, a Craig's List type of MLS is the way to go and let each party hire the apporpriate professional assistence needed to perform the due diligence.

Hi Patrick,

The 6% commission doesn't make a real estate agent's annual income higher -- it makes the income per transaction higher. But there's (mostly) free entry. So many real estate agents spend much time and money trying to find new clients, rather than, y'know, doing what those clients hire them to do. Like lobbyists, it's completely rational behavior, but it's also inefficient. I get at least two postcards a month from agents asking me if I'm thinking about moving.

The real stumper is why the 'competitive' fee for services is straight 6% commission, since much of the actual time/effort spent seems orthogonal to the size of the deal. Are the incentive problems that great -- wouldn't a flat fee plus 1% align incentives sufficiently? Particularly on the buyer's agent's side -- it's not at all clear why that person's on commission.

Battlepanda,

You are wondering why this country charges more than others? What is your profession and how much are you paid? I guarantee it's more than any other country. This country pays it's people more than any other country in the world. The poverty line for this country is above the average wage for the rest of the world combined.

Could some one enlighten me as to what is the higest commission a Real Estate Agent has made in any one given year from 1980 to say 2005? I dont want to know names...just in terms of achievement what could one make? And what would those Salespersons say would have been their magic formula for success? Please respond....thanks....

Any help would be welcome!

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The comments I've read so far are absolutely mind-boggling. First of all, people who are not in real estate think that all realtors are alike. This is ridiculous. The realtors Experience, skills, education, support systems, etc. are all different. So, why do you lump them all into one group. An experienced teacher gets paid more than one who is not tenured yet. The best doctors and lawyers all get paid more than others in their field. The question is not whether realtors are worth 6%, but did the homeowner selling their house interview correctly. A truly professional realtor can easily get a homeowner much more money through increased marketing exposure and superior negotiating skills. A poorly trained realtor could end up making mistakes to cost a homeowner thousands of dollars. Is a realtor worth 6%? Absolutely yes if you hire the right one. No, if you hire the wrong one. When a realtor does a listing presentation, it is actually a job interview. Most homeowners do not know how to conduct a proper interview and ask the right questions. Don't you think someone with 20 years experience and who sucessfully sells thirty homes a year is better equipped and worth more than the part time salesperson who just came into the business to see if they could make a quick buck and has never even sold a house yet? It's the same in any other industry. The best get paid better because they are worth it to the person hiring them. Also, if you think technology should bring down the cost of commissions, then how come investment in technology has actually raised the expenses in many industries and has resulted in a higher cost of products and services? Another point is that lowering costs virtuall always costs in services. There has been a great deal of pressure on the airline industry over recent years to cut prices. If you flew 25 years ago, you knew that there were more airlines to choose from and competition forced them to bring up their level of service. By cutting airline fees so much, a lot of major airlines went out of business and today, flying is a not nearly as pleasant as it was years ago, with all the services cut out. You must realize that Better is Better and Cheaper is Cheaper. You can't have both. There are numerous discount real estate companies out there to choose from. If that is what you want, then fine. However, don't expect to get the same level of service or the best sales price. There are two ways to get a higher net out of your sale. Reduce commissions or sell for a higher price. Which company do you think you have a better chance of selling for a higher price through? The discount broker or the full service one? I find it amazing that people who have never been in the real estate industry claim to be experts in that field. There are numerous so-called experts that write columns about realtors getting paid far too much. Perhaps you should get paid by your column, regardless of your credentials, education or experience. I think 5 cents a sentance seems fair. How about you?

Dear Ma/Sir,

My name is MARK HENNESY and I am constrained to write you this letter
after various enquiries I have made regarding sending out part of my
savings to acquire a property in your country and also in financing
directly some of my importation from Asia without
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I have at hand, a total amount of $11Millon and would want to solicit
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I spoke to my attorney on numerous possibilities, and he came up with
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I have discussed with my wife, and we decided to write you for
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we will transfer the funds in bits to your Home Equity Line of Credit
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Please notify us if you can be of assistance, provided you have a HELOC
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