Tuesday, April 10, 2012

Real Estate - Stuck Firmly in the 20th Century

There's something that has bugged me a while about real estate agents. Actually, there are several things, but structurally I keep wondering - why do we still have them? Why haven't they vanished from the earth?

One analogy - at least, it seems analogous to me - is travel agents. There used to be lots of travel agents. Once upon a time they performed a basic but important task - they gathered and consolidated a lot of information about airline flights and presented it to buyers. In so doing, they took a small cut of the transaction, basically as market makers.

While this operated, it made sense for buyers - it was much easier to call a travel agent than to call every airline and get their flight schedules and prices for flights from A to B. Travel agencies even built a special, proprietary database of flights, and that product gave them value in the market.

Of course along came the internet, and with it Expedia and Travelocity and silly commercials starring William Shatner, and suddenly travel agents largely vanished. Because the internet is an outstanding means of transmitting information between sellers (airlines) and buyers (us). Yes, travel websites do some consolidation for us, for which they take a small cut (usually about $5 per transaction or ticket). But they have, essentially, replaced travel agents - for a much lower cost.

Along the way, airlines learned that it's cheaper to sell us tickets online, so they've benefited too. Technology cut out the middle man, and the rest of us are better off for it.

So a part of me wonders - why haven't real estate agents followed travel agents into oblivion? The function is essentially the same - RE agents act as information transmitters between sellers and buyers. In the realm of information transmission, the internet is vastly superior to relying on an agent as a consolidator. Even the proprietary database agents have (the MLS system) is now available, at least to buyers, for free.

To be fair, RE agents do perform a few other functions - they have a system that allows access to houses (via lock boxes) to permit secure showings, they (supposedly) negotiate on behalf of their clients, and they run some of the paperwork involved in the transaction. They have the 'keys' to putting your house on the MLS in the first place. These things do have value.

But it is very difficult to see how this value amounts to the 6-7% - thousands of dollars - they usually take out of the transaction. Individually, many of these services can be bought from other providers for a fraction of the cost. A lawyer will draw up a purchase contract for you for a couple hundred bucks - and it's likely to be a contract more suited to your interests than the "standard" form that RE agencies use. For a couple hundred bucks more, the lawyer will even negotiate on your behalf. And websites like Zillow provide as much information - sometimes more - as any MLS listing, for free.

About the only thing that's not replaceable is the lock box system - but surely there's a less costly way of running that service as well. So what keeps RE agents in business?

I think there are three things that stand in the way of the logic of the marketplace here. First, agents have cleverly structured that 6-7% cut so that it appears to come only from the seller. This allows them to advertise what we all know in other contexts to be nonsense: that there is such a thing as a free lunch, because the "services" of the "buyer's agent" are "free to the buyer".

Economists know that free lunches are really illusions, and in this case the slight-of-hand is easy to see. The buyer's agent is paid their slice out of the seller's proceeds. But the seller's proceeds come directly from the buyer. If the seller has to pay a buyer's agent $5000, that simply adds $5000 to the price of the house, which comes back out of the buyer's pocket. All of a sudden that "free" service costs you a pretty penny - but you will never get a RE agent to admit this. (I've tried. Many just don't get it.)

Second, RE agents have managed to make the MLS database system indispensable - and they control access to it. Airlines (the sellers of flights) have direct access to put their flights and prices into databases or websites that buyers can see; house sellers can't do the same with the MLS. You the seller need somebody to put your house into that database, and absent a low-cost alternative you're stuck with RE agents.

I am a little surprised that someone hasn't set up a discount seller's RE service - we'll put your house on the MLS and hang a lock box on it, and that's it. Such a business would be cheap to run, and wouldn't need to take thousands from each transaction. But despite the economic logic, such businesses haven't taken off.

The third factor - the barrier to developing that low-cost alternative - lies in two perceptions. The first is the perception that a seller's agent can actually do something, other than listing a house on the MLS, that will increase the probability of a sale on your house. This is, to a substantial degree, a fiction: seller's agents have about as much ability to affect the market as day traders have to move stock indexes up or down. The market is going to do what it does; buyers who are likely to buy a particular house are either there or they're not. If they find the house, it won't be because of anything the seller's agent did - other than post the house on the MLS database.

The second perception is the "free lunch" fallacy above. Because buyers think that "their" agent is free, most will get one. And so it is buyer's agents who have the ability to influence what buyers do - which houses they see and, to a small degree, how those houses are presented.

This suggests that a low-cost seller's service would be problematic, not because it isn't efficient but because buyer's agents (who are generally drawn from the same pool as seller's agents; many are both) are likely to see such a service as a threat, and steer buyers away from those houses. In other words, RE agents have enough control over the perceptions of buyers and sellers to continue to dominate the market, even though there ought to be better economic alternatives.

Ultimately, none of this is that surprising. For all that we like to praise the "hidden hand of the market", the market is often filled with inefficiencies that keep it from acting in the nice, rational, efficient manner that economists tell us it should. People will do things - perpetuate myths, manipulate others' behavior - that advance their own individual interests, even if the result is inefficiency. Nor is there much of an argument here for outside intervention to "fix" the market - government intrusion would likely be even worse, because buying homes is a highly individual decision not easily reduced to common denominators.

There is a hidden lesson in here about the housing market. Basic economics tells us that the higher the transaction costs of an activity, the less of it you will get. For most folks, the transaction cost of buying and selling a home is higher than just about any other purchase - both in absolute dollars and as a percentage. This is an enormous inefficiency - essentially, a hidden tax that produces few public goods - that clearly hampers a recovery in the real estate market. And it's unlikely to go away anytime soon.

So the next time you're listing the villains of the real estate bust - banks, mortgage brokers, Fannie, Freddie, etc. - don't forget to throw in RE agents. They deserve their fair share, after all.

1 comment:

  1. I see your points, but don't entirely agree. Markets are not efficient, there is lots of hidden information, even with the internet (which is not always known to purvey truth). We tend to use our realtors to the max--getting heaps of advice not just on how to market our house but also on who are the reliable contractors, how to find a doctor (a real problem in Quebec and even in Ontario), and so on.

    Sure, it is easy to pay them since it comes from imaginary money (the value of the house), but we listened to our realtor, did what she said and our house sold quite quickly. On the other end, the realtor didn't really find the house we bought (I found it via mls), but did find us heaps of resource type people, including inspectors that were terrific.

    Maybe 6% is high or 3% for each side of the transaction, but this time out I cannot complain.