Tuesday, February 5, 2008

Housing Markets - 5

We have already seen that the Internet can be a good source of this type of information. There are also house listings in newspapers and both of those sources are frequently consulted by buyers even if they have a realtor. For some homes on the market there will be "open houses" which allow potential buyers to take a look see. These help buyers not just to gauge that particular home but also to serve as a benchmark for other alternatives.

If the information can be found elsewhere, then why use an agent or broker? This question is relevant not just to the real estate market. Web sites as automated brokers have clearly made inroads into the travel business (e.g., expedia.com and travelocity.com) and the stock market investing business (e.g., ameritrade.com and estocktrading.net). So one should distinguish a buyer who would know which alternative to choose if the information on alternatives was available, from a different buyer who would need help to process that information and match it to some more abstract categories that are guiding the buyer's choice. The former type of buyer is more likely to use the online service. The latter is more likely to go with an agent or broker and in that sense the agent's job is as much educational as it is to simply provide information. Some buyer's in the former category may nevertheless go to an agent either because the agent might have information that is not available from other sources, or because the agent can get the information more readily.

BLS Real Estate Agent/Broker Job Description

An interesting issue is whether the agents/brokers have an affect on the transaction price. To consider why this may occur, let us look at two types of incentives that are at work on the agent. The first comes from within the transaction. Frequently, the agent's compensation is calculated as a percentage of the selling price (and frequently the rate is 3%). So for example, if the seller got $100,000, the agent for the seller would get $3,000, as would the agent for the buyer, and the buyer would pay $106,000 to cover that expenditure. If both agents get paid on this percentage basis then both have incentive to get the highest price possible that will close the deal. But there is an offsetting incentive in that the agent for the buyer also has to be concerned with generating additional business and to the extent that new business comes from referrals, the agent will want the current buyer to be happy with the transaction price. Likewise, the buyer will choose an agent in part based on the agent's good reputation.

A paper that argues the broker effect is not on price, but rather on time to closure.

Since you may not have experience as a home buyer and may not have dealt with real estate agents (but if you've rented an apartment the experience may have been similar) let's try to personalize this issue of agent "moral hazard" by focusing on a different case that you should be familiar with. Moral hazard means the agent works in his own self-interest first and foremost. We'll ask if the student-advisor relationship has moral hazard. Consider your relationship with your academic advisor, either at present or in the past. In suggesting courses or instructors for you to take, do you think your advisor helped you find the best alternatives? Do you think the quality of that advice depends on you knowing your advisor well?

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