Richard Green shares the ins and outs of the real estate agent compensation in this Forbes.com article.
Real Estate agents are valuable–if they weren’t, we wouldn’t have them. The three times in my life I have sold a house, I thought the agent earned his/her commission.
But the commission structure –the agent gets a fixed percentage of the sale price of the house–makes no sense. (Steven Levitt pointed this out some time ago). There is a price at which anyone could sell a house without an agent–let’s call it 80 percent of market value (it may be more or less). So for the first 80 percent of the sales price of a house, the agent is adding no value.
But now let’s say it takes real effort to sell a house for more than 80 percent of market value. This means for every dollar the seller receives above 80 percent, the agent is producing more value than the typical commission percentage they currently receive.
This produces a perverse set of incentives. Agents have reason to sell the house quickly, but not at the highest possible price, because they don’t get rewarded for their effort. A compensation structure that would align everyone’s interest would be more like a consignment structure–one where the agent would get no compensation for any sale of less than an agreed to amount, but would get a large fraction of any proceeds above the agreed to amount. This would likely produce higher prices for the seller and higher compensation for the agent.
I understand that agents face upfront costs to marketing a house–it would be reasonable for them to charge a fee to recover those costs, regardless of outcomes. But we don’t observe that either.
This Clarence Butt blog site contains articles related to finance.
