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[Boston Fed] Calibrating Real Estate Broker Commissions

An interesting study from an economist at the Boston Fed that discusses the relationship between a seller and the real estate broker hired to sell in the property. What’s interesting to me is that the conflict of interest is measured by the costs associated with the delay in selling the property. That’s a clever way to quantify.

Real Estate Brokers and Commission: Theory and Calibrations [1]
by Oz Shy (What a cool name!)

The conclusion of the 6% model:

The findings suggest that while the pressure brokers exert on sellers to reduce prices generates faster sales and hence improves social welfare, the usual commission rate of 6 percent exceeds the seller’s value‐maximizing rate if the sale is handled by a single agent. On the other hand, if several agents (such as the buyer’s and seller’s brokers and the agencies that employ these realtors) split the commission, then a 6 percent commission rate may be required to motivate the broker to sell at a high price.

On the plus side…

Two-sided market and network effects: Real estate brokers are connected via computerized networks that expose them to a large variety of houses for sale. Buyers are aware of that and will therefore hire an agent who is also connected to the same network. Sellers know that buyers tend to hire agents who are also on this network, which induces more sellers to enlist. This “snowball” effect can potentially magnify until all sellers and buyers connect via agents to the same network of realtors.

When I went to sell my last house, I toyed with doing it myself, but rationalized that I would receive less exposure and the my net would end up being more than if I sold it myself, before I figured in the hassle/time factor and my fear of screwing up my biggest investment.

On the down side…

Conflicting interests: Agents may provide sellers with certain information on the housing mar- ket in order to lead them to settle on a lower price compared with the price that would maximize sellers’ expected gain. Lower prices would increase the probability of finding a buyer and would also shorten brokers’ expected waiting time until the transaction takes place, allowing them to collect their commission sooner.

There seems to be a lot of weight given to the idea that real estate brokers want the price as low as possible to lift transaction volume.

While I agree there is a structural conflict, I think the premise as presented is overly simplistic. Yes, if the price is lowballed, the property will move quickly.

In my 23 years of interacting with brokers in my appraisal work, in a number of housing markets, I have found that the sellers generally hold sway over the brokers. The idea that the seller simply accepts the broker’s price recommendation is not real world. Of course there are good agents and bad agents just like any profession.

In fact, the sellers are armed with a lot more information than ever before – a lot of it is incorrect or misleading and in my experience, causing sellers to be less reliant on the agent’s initial advice.

There are all sorts of models out there trying to find an alternative to the traditional brokerage model or fit in as an alternative to the traditional model. Some ideas will be successful and some won’t, but to date, there hasn’t been an “ah-ha” model to arrive.

So until the industry will remain conflicted.