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Monday, March 06, 2006

Freakonomics on Real Estate

There was a very interesting article in the New York Times Magazine today by Steven Levitt and Stephen Dubner, authors of the best-selling book "Freakonomics". The premise of the article was that residential real estate brokers are overpaid and that the current system of percentage commissions is going away.

Considering that Levitt is an economics professor at the famed University of Chicago Economics department, I was stunned by the faulty assumptions and lack of intellectual rigor in this article. I should first preface this post by saying that while my license is currently inactive, I have previously been licensed to practice real estate, though I was primarily involved in commercial real estate as opposed to residential real estate.

Levitt starts by describing the work that residential realtors do and what it is worth:
"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."
Of course he forgets to mention that both agents have to split their commission with the firm they work for. So this may then leave them with $7,500 before taxes. And that is also before subjecting any expenses related to the sale such as marketing.

Later in the article Levitt references a study that examined in income of real estate agents in various markets. The study showed that while home prices were less in Minneapolis, agents sold more homes at a rate of 6.6 per year. At that rate, an agent would make just under $50,000 per year. While that is a decent living, this number doesn't really jive with Levitt's opening remark:
"It is hard to think of an occupation that garners less goodwill these days than the real-estate agent. More often than not, agents are portrayed as hustlers or sharks, unimaginative opportunists who, for not all that much effort, pocket a significant chunk of the sale price of your home."
Yeah, those residential brokers are rolling in it Steven.

Are there a lot of bad residential brokers out there? Of course there are. Are they overpaid? No more so that any incompetent workers in any company, which most of you will recognize as being a large number.

But a good residential brokers is easily worth that amount of money. A good brokers does much more than just determine a selling price, find buyers, conduct showings, and handle negotiations. A good brokers should get a higher price or sell a house quicker.

My wife and I were in the position of having to sell a home to move across the country. And we had to put in on the market two weeks after 9/11. Talk about bad timing. But we found a great broker. Contrary to this article and popular opinion, brokers will negotiate the commission. Ours agreed to drop by one point. And he ended up getting us a great price on an offer within two weeks.

How did he do this? By knowing the market cold. This guy had been on the buying or selling side of almost 75% of the homes in our neighborhood. I couldn't have paid the amount of commission comensurate with that sort of experience. Levitt doesn't know what he is talking about when he says:
"Setting a home's asking price requires a few hours of work at most, studying the house and the data on comparable sales."
Levitts ends the article by predicting the demise of commissioned real estate agents. While there is no doubt that real estate agents are going to be paid in different manners, Levitt makes a faulty assumption about the nature of real estate. Unlike other industries or products that have seen a downward spiral in the use of brokers, real estate is not an easily comparable commodity. As anyone who has ever taken a real estate class knows, no two pieces of real estate are alike. As long as this remains true, there will always be a need for good real estate agents.

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