The relationship between home sellers and their realtors represents a classic principal/agent problem. Realtors are engaged in many activities related to selling the property such as photographing it, listing it, coordinating with home buyers' agents, holding open houses, and so on. Since realtors have traditionally earned a 6% commission on sales they have an incentive to engage in these costly activities. But realtors know much more about how the market is likely to shake out than do their clients. All else equal, they would recommend dropping the price so that the house will sell faster and without all that effort since 94% of the lower sales price is born by their clients. What happens when they bear the full 100%?
Levitt and Syverson showed that when realtors sell their own homes, on average, they keep them on the market longer and sell them for higher prices.
So maybe a 6% commission is not enough to eliminate shirking. How do you provide stronger incentives without giving away too much?
Alina Dizik at the WSJ reports that owners of high priced houses are getting creative.
[Mr. Mahller's] agent would earn a 2% commission, and the buyer's agent would get a 2.5% commission on the home's sale price. The sweetener: Mr. Mahller's agent also pocketed an extra 5% commission on the difference between the asking price of $2.7 million and the final sale price, which was $2.85 million.
Non-Standard Real Estate Commissions: Moral Hazzard and Shirking
ReplyDeleteThe problem of moral hazard in real estate commissions is changing how sellers negotiate broker fees. According to Levitt and Syverson “real estate agents have an incentive to convince clients to sell their houses too cheaply and too quickly” (Levitt and Syverson, 2008). The traditional 6% broker fee is usually split between the buyer’s and seller’s brokers, each getting 3%. Often what happens is that brokers convince sellers to drop their price so they can get their commission quickly and move on to the next sale. Often this is not in the best interest of the seller they are supposed to be working to help and results in a lower price for the seller this is counter intuitive and hence the moral hazard.
In the Wall Street Journal Alina Dizik shows how the creativity in commissions can benefit the seller in a specific example of how Ari Mahller who owned a very large home in Rancho Park, CA, convinced his real estate agent to accept a change in the commission structure. He actually incentivized his broker. Instead of the 6% split Mr. Mahller offered his agent a 2% commission, and the buyer’s agent would get a 2.5% on the sale price of the home. The incentive was Mr. Mahller’s agent would receive an additional 5% commission on the “difference between the asking price of $2.7 million and the final sale price, which was $2.85 million” (Dizik, 2017) resulting in a greater sale price of which the real estate agent would get and additional 5% for the sale.
The example does not discuss shirking where it is possible that without being incentivized the real estate agent may have not worked as hard if his or her commission were lower (Froeb et al., 2016, p. 266). “The effort that it takes to sell a $4 million apartment is not necessarily double the effort that it takes to sell a $2 million apartment,” says Philip Lang, co-founder of TripleMint, a New York-based real-estate startup with 55 agents” (Dizik, 2017) so the expense in the real estate market may not necessarily require an additional expense for the real estate agent or a disincentive to work harder.
References
Dizik, A. (2017, June 14). Home sellers get creative with commissions. The Wall Street Journal. Retrieved on December 10, 2017 from https://www.wsj.com/articles/home-sellers-get-creative-with-commissions-1497449236?mod=djem_jiewr_EC_domainid
Froeb, L. M., McCann, B. T., Shor, M & Ward, M. R. (2016). Managerial economics: A problem solving approach. (4th ed.). Boston: Cengage Learning.
Levitt, S. D. & Syverson. (2008, October 17). Market distortions when agents are better informed: The value of information in real estate transactions. The MIT Press Journals. Retrieved on December 10, 2017 from http://www.mitpressjournals.org/doi/abs/10.1162/rest.90.4.599
Ward, M. (2017, August 10). Non-standard real estate commissions. Managerial Economics Blog Spot. Retrieved on December 10, 2017 from
Additionally So long as the price of the home is competitive with comparable homes, buyers would be willing to purchase a home in this simple price structure. A buyer would want to pay 2.5% rather than 3% commission so the commission pricing structure may encourage a buyer to choose the less expense agent.
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