Real Estate Incentives
Financial advisors sometimes get a bad reputation for not having their client’s best interest in mind. Many continue to earn commissions even if their client’s portfolio is losing money. But what about real estate agents? Their compensation structure is also heavily based on commissions. They often earn a percentage from the final sale of a home. For a homeowner looking to sell, the ideal situation is to sell his house for the highest price possible. So at first glance it would appear that both a homeowner and a real estate agent would have the same financial incentive; to get the best possible deal for the seller. 🙂
But further investigation reveals that maybe that’s not really true. Let’s say a homeowner sells his house for $500,000 with the help of a real estate agent on a fixed 2% commission. This means the realtor earns $10,000 and the homeowner keeps the remaining $490,000. To keep it simple we’ll ignore taxes and other costs.
But maybe with some additional advertising, negotiations, and patience, the house could actually be sold for $510,000. But this is when the incentive structures begin to diverge. As the homeowner selling the house, an extra $10,000 from the sale price means adding $9,800 more to the bank. 😀 Most sellers would like to see that money, even if it means waiting an extra couple of weeks to find the right buyer. But a realtor would only make $200 off the extra $10,000. For most real estate agents, putting in the extra time and effort (and sometimes even money for ads) isn’t worth the extra commission. So if the homeowner stands to gain $9,800 while the agent would only receive $200, then clearly their incentives do not align very well anymore.
When realtors sell homes for other people, they encourage them to take the first reasonable offer so they can move onto other listings. But when realtors they sell their own homes, they behave more like an owner (which of course they are) and hold out for the best offer. A study of this phenomenon was done on nearly 100,000 homes in Chicago, Illinois. According to the data realtors on average keep their own homes on the market for 10 days longer, and sell them for 3% higher in price than selling homes for their clients. The study controlled for variables such as location, age and quality of the house, aesthetics, primary residence vs investment property, etc.
So commission based incentives can be tricky, but interesting. Even if the broker and client’s incentives appear to be aligned, it may only be true up to a certain extent. 🙂 Similar parallels can be drawn for car dealers, stock brokers, and other types of commission based jobs. I have nothing against realtors or financial advisors. I respect them for helping even the most financially challenged people make really big life changing decisions. That’s a lot of pressure. Imagine being a realtor; you may not think a couple is financially ready to buy their first home, but as their agent, how could you turn them down? It’s human nature to pursue personal profit. So if we meet professionals that insist they somehow have our best interest in mind, it’s perfectly healthy to have a bit of scepticism.
Random Useless Fact:
People generally want better treatment of others, but not if it directly affect themselves. The two polls below were taken in Great Britain.