Why We Hire Real Estate Agents
Human beings are not particularly rational animals. Some people jog at 6 in the morning in the winter. Others adopt more cats than they can easily care for. Some even cheer for the Kansas City Royals. The examples are everywhere, and yet economists always seem surprised.
Practically every piece of economic research rests upon the singular flawed assumption of the rational actor: that people will, when properly educated, act to maximize their benefits, minimize their costs and pay only what something is really worth. But out in the real world, there is an inverse relationship between money and rationality: the more money is involved, the more unpredictably we behave. Nowhere is it more starkly obvious than in the booming world of REAL ESTATE.
The relative worth of real estate agents is well-travelled territory, both in academic circles and the mass media. Real estate industry groups have commissioned volumes of research over the years, all of which come to the same career-affirming conclusion for realtors: people who sell property with the help of an agent get a higher price than those who don't. But there are obvious holes in all that research - for one thing, the industry has marketed itself so effectively over the years that few people even try to sell their homes privately anymore, and those who do tend to have less valuable houses.
And so, we still wonder: what exactly do agents offer to justify commissions of five per cent or more on the sale of a home?
Turns out, not much, according to a new study from Stanford University. To answer the question definitively, researchers B. Douglas Bernheim and Jonathan Meer needed to examine years of data, covering a particular set of houses, all roughly similar and in a single neighbourhood, where buyers and sellers all fit into a roughly uniform demographic group. And this place would have to have a relatively large number of deals, split between people selling their homes privately and those employing an agent. The lab they were looking for was right outside their office windows. The Stanford campus, with its roughly 800 homes, provided the perfect economic petri dish to put the real estate industry to the test.
The study looked at 680 home sales between the start of 1980 and the end of 2005, 95 of which involved agents. (In earlier years, private sales were the norm on campus, but in the past decade brokered sales have come to represent about half the transactions.) The average commission paid in these sales was six per cent, or US$34,000, a hefty chunk of change, especially considering the results. "We find no evidence that the use of a broker significantly affects either the selling price or the initial asking price, though it does lead to a more rapid sale," the authors write. So in the end, you're paying more than thirty grand to save a little time. Not rational.
Mind you, none of this should come as a huge surprise. The bestselling 2005 book Freakonomics by Steven Levitt and Stephen Dubner dedicated part of a chapter to exposing some of the central myths of real estate brokerage. What becomes abundantly clear is that in the real estate business, it is not about wringing every last cent out of your home, and it's not about helping you find the perfect new place for the best possible price. The name of the game is speed - closing many deals as quickly as possible, and moving on to the next. It's a volume business, disguised as a service. But that dynamic changes when agents are selling their own homes. Levitt showed that homes owned by real estate agents stay on the market significantly longer, and sell for significantly higher prices than those owned by the rest of us.
The vexing question, then, is - why? Why do we still hire real estate agents and pay them huge amounts of money to do a simple job that really adds no financial value? Why is it that, even after reading all this, you and I will still hire a real estate agent next time we buy or sell a house?
Well, there are the practical concerns, of course - getting a listing on MLS, help with the paperwork and advertising - but all of those things combined are worth no more than a thousand bucks. No, the real reason we hire realtors lies in something that can't be easily captured in an economic model. Economists do very well examining greed because, on some deep level we don't like to admit, greed is logical. But economists struggle with that other fundamental human emotion, fear, because it often isn't rational at all. And fear is where real estate agents make their money.
Realtors - like financial planners, childbirth doulas and fortune tellers - bring the reassuring illusion of expertise to an inherently terrifying experience. As you embark on what will likely be the biggest financial decision of your life, they pat you on the back, tell you everything is going to be okay, and show you where to sign. As Marjorie Garber pointed out in her 2007 book Sex And Real Estate, "realtors and house agents often find themselves functioning as therapists, psychologists, and marriage counsellors." And they charge accordingly.
It's easy for economists to look at the dollars and cents of real estate deals and conclude that the broker industry, and its US$61 billion in commissions collected in the U.S. last year alone, is nothing but flim-flam - a case of effective marketing trumping financial wisdom. Doing their best impression of Mr. Spock, they would describe emotion as an "externality," a foreign force getting in the way of the efficient operation of the market, creating an unneccessary drag on the system. In fact, it's just the opposite.
In a market operated by emotional, erratic humans, the most rational thing in the world is to seek someone capable of helping us cope with our fears and get the deal done. By doing so, they actually grease the wheels of commerce, and help the system run far more efficiently than if every homeowner were an agent unto themselves.
Is that service really worth $15,000 on the sale of a $300,000 house? That all depends. Irrational humans do a lot of crazier things to keep fear in check.
Maclean's March 17, 2008