Real-Estate Agents... Beneficial?

Consider a transaction that wouldn't seem, on the surface, to create much fear: selling your house. What's so scary about that? Aside from the fact that selling a house is typically the largest financial transaction in your life, and that you probably have scant experience in real estate, and that you may have an enormous emotional attachment to your house, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it at all.

In the first case, you fear setting the price too low; in the second, you fear setting the price too high. It is the job of your real-estate agent, of course, to find the golden mean. She is the one with all the information: the inventory of similar houses, the recent sales trends, the tremors of the mortgage market, perhaps even a lead on an interested buy. You feel fortunate to have such a knowledgeable expert as an ally in this most confounding enterprise. It is the quintessential blend of commerce and camaraderie: you hire a real-estate agent to sell your home.

She sizes up its charms, snaps some pictures, sets the price, writes a seductive ad, shows the house aggressively, negotiates the offers, and sees the deal through to its end. Sure, it's a lot of work, but she's getting a nice cut. On the sale of a $300,000 house, a typical 6 percent agent fee yields $18,000. Eighteen thousand dollars, you say to yourself: that's a lot of money. But you also tell yourself that you never could have sold the house for $300,000 on your own. The agent knew how to- what's that phrase she used?- "maximize the house's value." She got you top dollar, right?

Right?

A real-estate agent is a different breed of expert than a criminologist, but she is every bit the expert. That is, she knows her field far better than the layman on whose behalf she is acting. She is better informed about the house's value, the state of the housing market, even the buyer's frame of mind. You depend on her for this information. That, in fact, is why you hired an expert.

As the world has grown more specialized, countless such experts have made themselves similarly indispensable. Doctors, lawyers, contractors, stockbrokers, auto mechanics, mortgage brokers, financial planners: they all enjoy a gigantic informational advantage. And they use that advantage to help you, the person who hired them, get exactly what they want for the best price.

Right?

It would be lovely to think so. But experts are humans, and humans respond to incentives. How any given expert treats you, therefore, will depend on how that expert's incentives are set up. Sometimes his incentives may work in your favor. For instance: a study of California auto mechanics found they often passed up a small repair bill by letting failing cars pass emissions inspections- the reason being that lenient mechanics are rewarded with repeat business. But in a different case, an expert's incentives may work against you. In a medical study, it turned out that obstetricians in areas with declining birth rates are much more likely to perform cesarean-section deliveries than obstetricians in growing areas- suggesting that, when business is tough, doctors try to ring up more expensive procedures.

It is one thing to muse about experts' abusing their position and another to prove it. The best way to do so would be to measure how an expert treats you versus how he performs the same service for himself. Unfortunately a surgeon doesn't operate on himself. Nor is his medical file a matter of public record; neither is an auto mechanic's repair log for his own car.

Real-estate sales, however, ARE a matter of public record. And real-estate agents often do sell their own homes. A recent set of data covering the sale of a nearly 100.000 houses in suburban Chicago shows that more than 3,000 of those houses were owned by the agents themselves.

Before plunging into the data, it helps to ask a question: what is the real-estate agent's incentive when she is selling her own home? Simple: to make the best deal possible. Presumably this is also your incentive when you are selling your home. And so your incentive and the real-estate agent's incentive would seem to be nicely aligned. Her commision, after all, is based on the sale price.

But as incentives go, commissions are tricky. First of all, a 6 percent real-estate commision is typically split between the seller's agent and the buyer's. Each agent then kicks back half of her take to the agency. Which means that only 1.5 percent of the purchase price goes directly into your agent's pocket.

So on the sale of your $300,000 house, her personal take of the $18,000 commission is $4.500. Still not bad, you say. But what if the house was actually worth more than $300,000? What if, with a little more effort and patience and a few more newspaper ads, she could have sold it for $310,000? After the commission, that puts an additional $9,400 in your pocket. But the agent's additional share- her personal 1.5 percent of the extra $10,000- is a mere $150. If you earn $9,400 while she earns only $150, maybe your incentives aren't aligned after all. (Especially when she's the one paying for the ads and doing all the work.) Is the agent willing to put out all that extra time, money, and energy for just $150?

There's one way to find out: measure the difference between the sales data for houses that belong to real-estate agents themselves and the houses the sold on behalf of clients. Using the data from the sales of those 100,000 Chicago homes, and controlling for any number of variables- location, age and quality of the house, aesthetics, and so on- it turns out that a real-estate agent keeps her own home on the market an average of ten days longer and sells it for an extra 3-plus percent, or $10,000 on a $300,000 house. When she sells her own house, an agent hold out for the best offer; when she sells yours, she pushes you to take the first decent offer that comes along. Like a stockbroker churning commisions, she wants to make deals and make them fast. Why not? Her share of a better off- $150- is too puny an incentive to encourage her to do otherwise.

This can be tricky. The agent does not want to come right out and call you a fool. So she merely implies it- perhaps by telling you about the much bigger, nicer, newer house down the bloc that has sat unsold for six months. Here is the agent's main weapon: the conversion of information into fear. Consider this true story, told by John Donahue, a law professor who in 2001 was teaching at Stanford University: "I was just about to buy a house on the Stanford campus," he recalls, "and the seller's agent kept telling me what a good deal I was getting because the market was about to zoom. As soon as I signed the purchase contract, he asked me if I would need an agent to sell my previous Stanford house. I told him that I would probably try to sell without an agent, and he replied, 'John, that might work under normal conditions, but with the market tanking now, you really need the help of a broker.' "

Within five minutes, a zooming market had tanked. Such are the marvels that can be conjured by an agent in search of the next deal.

Consider now another true story of a rea-estate agent's information abuse. The take involves C., a close friend of mine. C. wanted to buy a house that was listed as $469,000. He was prepared to offer $450,000 but he first called the seller's agent and asked her to name the lowest price that she thought the homeowner might accept. The agent promptly scolded C. "You ought to be ashamed of yourself," she said. "That is clearly a violation of real-estate eithcs."

C. apologized. The conversation turned to other, more mundane issues. After ten minutes, as the conversation was ending, the agent told C., "Let me say one last thing. My client is willing to sell his house for a lot less than you might think."

Based on this conversation, C. then offered $425,000 for the house instead of the $450,000 he had planned to offer. In the end, the seller accepted $430,000. Thanks to HIS OWN AGENT'S intervention, the seller lost at least $20,000. The agent, meanwhile, only lost $300- a small price to pay to ensure that she would quickly and easily lock up the sale, which netted her a commission of $6,450.

So a big part of a real-estate agent's job, it would seem, is to persuade the homeowner to sell for less than he would like while at the same time letting potential buyers know that a house can be bought for less than its listing price. To be sure, there are more subtle means of doing so than coming right out and telling the buyer to bid low. The study of real-estate agents above also includes data that reveals how agents convey information through the for-sale ads they write. A phrase like "well maintained," for instance, means that a house is old but not quite falling down. A savvy buyer will know this (or find out for himself once he sees the house), but to the sixty-five-year-old retiree who is selling the house, "well maintained" might sound like a compliment, which is just what the agent intends.

An analysis of the language used in real-estate ads shows that certain worlds are powerfully correlated with the final sale price of a house. This doesn't necessarily mean that labeling a house "well maintained" CAUSES it to sell for less than an equivalent house. It does, however, indicate that when a real-estate agent labels a house "well maintained," she is subtly encouraging a buyer to bid low.

Listed below are ten terms commonly used in real-estate ads. Five of them have a srtong positive correlation to the ultimate sales price, and five have a strong negative correlation. Guess which are which.

Ten Common Real-Estate Ad Terms

Fantastic
Granite
Spacious
State-of-the-Art
!
Corian
Charming
Maple
Great Neighborhood
Gourmet

A "fantastic" house is surely fantastic enough to warrant a high price, isn't it? What about a "charming" and "spacious" house in a "great neighborhood!"? No, no, no, and no. Here's the breakdown:

Five Terms Correlated to a Higher Sales Price

Granite
State-of-the-Art
Corian
Maple
Gourmet

Five Terms Correlated to a Lower Sales Price

Fantastic
Spacious
!
Charming
Great Neighborhood

Three of the five terms correlated with a higher sales price are physical descriptions of the house itself: granite, Corian, and maple. A information goes, such terms are specific and straightforward- and therefore pretty useful. If you like granite, you might like the house; but even if you don't, "granite" creatingly doesn't connote a fixer-upper. Nor does "gourmet" or "state-of-the-art." both of which seem to tell a buyer that a house is, on some level, truly fantastic.

"Fantastic," meanwhile, is a dangerously ambiguous adjective, as is "charming." Both these words seem to be real-estate agent code for a house that doesn't have many specific attributes worth describing. "Spacious" homes, meanwhile, are often decrepit or impractical. "Great neighborhood" signals a buyer that, well, THIS house isn't very nice but others nearby may be. And an exclamation point in a real-estate ad is bad news for sure, a bid to paper over real shortcomings with false enthusiasm.

If you study the words in the ad for a real-estate agent's OWN home, you see that she indeed emphasizes descriptive terms (especially "new," "granite," "maple," and "move-in condition") and avoids empty adjectives (including "wonderful," "immaculate," and the telltale "!"). Then she patiently waits for the best buyer to come along. She might tell this buyer about a house nearby that just sold for $25,000 ABOVE the asking price, or another house that is currently the subject of a bidding war. She is careful to exercise every advantage of the information asymmetry she enjoys.

But like most other professions, the real-estate agent has also seen her advantage eroded by the Internet. After all, anyone selling a home can now get online and gether her own information about sales trends and housing inventory and mortgage rates. The information has been set loose. And recent data show the results. Real-estate agents still get a higher price for their own homes than comparable homes owned by their clients, but since the proliferation of real-estate websites, the gap between the two prices has shrunk by a third... More on the Internet later...