If
real estate is prospering, chances are your agent isn't
Most realtors don't make much money in a boom.
By Stephen J. Dubner and Steven D. Levitt | March
5, 2006
It is hard to think of many occupations that garner less
good will these days than the real estate agent.
A great many of these agents and brokers, more than 1.2
million, belong to the National Association of Realtors,
which the Department of Justice accused in a recent lawsuit
of behaving like a cross between a cartel and a mafia, hoarding
access to home-sale databases and harassing competitors
who dared to offer discounted commissions.
Even if you believe all these terrible things about real
estate agents, however, you should try to find in your heart
a bit of sympathy for them. There are two reasons for this.
To examine the first reason, ask this question: Who has
prospered during the recent real-estate boom? Home sellers,
to be sure, along with developers, mortgage brokers -- and
also, you would assume your average real estate agent.
These agents have rung up millions of sales while home
prices have been doubling and even tripling. Since an agent's
commission is usually based on a fixed percentage of the
sale price -- typically 5 percent or 6 percent, of which
about half goes to the listing agent and half to the buyer's
agent -- agents' fees have climbed along with home prices,
even though they probably don't have to work any harder
to sell an $800,000 house than they do a $200,000 house.
A listing agent really only performs four main functions:
setting the price of your home, finding potential buyers,
prepping and showing the house, and handling the negotiations
and contracts.
Just for fun, let's put a value on each of these functions.
Setting a home's asking price requires a few hours of work
at most, studying the house and comparable sales.
Showing the typical home might take 20 or 30 hours, with
negotiations and contracts taking maybe four hours. Attracting
potential buyers is of course the trickiest task -- which
is why, as the Justice Department alleges, realtors have
tried to block access to the databases. But it's now easy
to find independent or discount agents who will list your
house on the Multiple Listing Service for about $750. So
in sum, we are talking about perhaps 40 hours of work. Let's
be generous and say that's worth $100 an hour. Add another
$750 to list the home. That's a total of $4,750, which makes
the 6 percent commission that you would pay on the sale
of a $500,000 house -- $15,000 each to your agent and the
buyer's agent -- look pretty steep.
It would seem obvious that being an agent during a real
estate boom is a great way to earn a good living. As it
turns out, however, most agents don't make very much money
during a boom, because of one simple fact: the boom attracts
way too many of them. Over the past 10 years, membership
in the association has risen more than 75 percent.
And why not? Compared with most professions, becoming a
real estate agent is quick, cheap, and relatively painless.
In economics, this phenomenon is known as free entry.
In a 2003 paper titled ''Can Free Entry Be Inefficient?"
Chang-Tai Hsieh and Enrico Moretti, economists at the University
of California at Berkeley, examined the income of real estate
agents in various markets under various conditions. Relying
on data from the Census of Population and Housing in 1980
and 1990, Hsieh and Moretti compared home sales in 282 metropolitan
areas. But their story can be told using just a pair of
cities: Boston and Minneapolis, which are similar in size
and demographics -- but quite different in the price of
their real estate. In 1990, a typical house in Boston cost
roughly twice as much as a typical house in Minneapolis.
Since commission rates were fixed, an agent would earn twice
as much selling a house in Boston. But the Boston market,
with so much more commission money up for grabs, attracted
many more agents than Minneapolis did -- even though it
turned out that more homes were being sold in Minneapolis.
The result? The typical Minneapolis agent sold twice as
many homes (6.6 per year) as the typical Boston agent (3.3
per year) -- which left the Boston agent, despite the higher
prices in her market, no better off than her Minneapolis
counterpart. What should be a competitive marketplace --
which would inevitably lead to lower prices -- is not, since
the price of the agents' service is essentially fixed.
The association's own figures show the same dynamic at
work today, nationwide. From 2002 to 2004, during one of
the hottest real estate markets in American history, the
median income for realtors actually fell -- to $49,300 from
$52,200.
This is not to say that some agents haven't become rich.
As in most sales professions, whether the product is diamond
rings or crack cocaine, the people at the top of the pyramid
make an awful lot more money than those down below. It's
just that the base of the real estate agent pyramid grows
significantly during a boom.
And because hungry new realtors are discouraged from undercutting
their competitors by lowering their commission, they compete
instead by frantically trying to obtain new listings. This
would explain why your mailbox is jammed with postcards
from realtors exhorting you to sell.
The second reason to feel bad for real estate agents is
even more dire: Their very profession is about to join the
endangered-species list.
Think back for a moment to 1999. Travel agents still roamed
the earth in vast numbers. So did stockbrokers. But their
business models were being blown apart, largely by the Internet.
The new market for do-it-yourself online securities trading
lowered fees so drastically that a full-price stockbroker
could simply no longer earn a living. Travel agents were
shoved aside once the Internet gave customers the ability
to book their own trips -- and when, perhaps more damagingly,
the airlines decided to stop paying the travel agents' commissions.
The Internet is a natural repository for the sort of data
that drive the real estate market. New sites like zillow.com
let anyone try to figure out (if imperfectly) what his home
is worth; sites like craigslist.org allow buyers and sellers
to find each other easily. As those services and ones like
them become more popular, it is hard to imagine that the
market will allow realtors to maintain their hefty commissions.
In addition to discount and flat-fee brokers, one likely
successor is the fee-for-service broker. Cary and Barbara
Chubin, a married couple who just relocated from Chicago
to Oakland, started up this kind of business in Chicago.
They charged $750 to list a home on the Multiple Listing
Service, $50 an hour for showing the home and $250 for negotiations
and closing.
Younger home sellers flocked to the Chubins' pricing model,
but older customers, Cary Chubin recalls, were wary. Chubin
understands.
''People can't believe it could be so much cheaper than
they're used to paying," he says. ''Plus, a home is
the most valuable asset most people have, and you're afraid
to death of making a mistake."
Fear may be a great motivator for maintaining the status
quo, but the Chubins say they believe they have found an
even better one: money. That's how Barbara Chubin plays
the game in her advertising: ''Do you want to go to the
Caribbean? Or would you rather give the money to your real
estate agent?"
Stephen J. Dubner and Steven D. Levitt are the authors
of ''Freakonomics: A Rogue Economist Explores the Hidden
Side of Everything."
© Copyright 2006 Globe Newspaper Company.
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