Do Real Estate Agents Exploit their Information Advantage?

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The finding that agent-owned homes are on the market longer and sell for more suggests that agents do deploy their specialized knowledge to maximize their profits rather than those of the homeowners they represent.

Like physicians, automobile mechanics, and attorneys, realtors know more about their area of expertise than the people paying them for advice. In the absence of properly structured incentives, experts can use their specialized knowledge to further their own interests at the expense of those who hire them. Car mechanics can recommend more expensive repairs than are really necessary, attorneys can charge high fees for services that reasonably intelligent consumers could perform themselves, and realtors can give sales advice that maximizes their profit rather than that of the homeowner.

Real-estate agents bear substantial marketing costs when selling a typical home. They are paid on commission, usually 6 percent of the sale price, split equally between the agent representing the buyer and the agent representing the seller. Each agent pays about half of the 3 percent fee to his firm. The selling agent keeps just 1.5 percent of the final sale price.

In Market Distortions When Agents are Better Informed: The Value of Information in Real Estate Transactions (NBER Working Paper No.11053), authors Steven Levitt and Chad Syverson examine data on 98,000 suburban Chicago home sales from the Multiple Listing Service of Northern Illinois -- roughly 3,300 of the homes were owned by real-estate agents. The authors find that agents selling their own homes behave differently. After controlling for location, characteristics, and condition, the agent-owned houses stay on the market almost 10 days longer and sell for about 3.7 percent more than comparable houses owned by the people who hire real-estate agents to represent them.

A 3.7 percent price increase on a $300,000 house generates an additional $11,100. If a higher priced offer were certain to materialize by waiting an extra week, then the homeowner would realize an additional $10,434 at standard commission rates, while the. The real-estate agent representing the seller would only net an additional $167. Unless the costs for an additional week of listing the home are less than $167, the agent has an incentive to urge the homeowner to forgo waiting for what could be a substantially higher offer the extra $10,434 for a quick sale at a lower price. Agents selling their own homes capture both their commission and the homeowner's share. Given the commission structure, the finding that agent-owned homes are on the market longer and sell for more suggests that agents do deploy their specialized knowledge to maximize their profits rather than those of the homeowners they represent. Levitt and Syverson also show that the gaps in sales outcomes are too large to be caused by different discount rates across agents and non-agents.

Further evidence for such profit maximization comes from the fact that the sales price difference between agent-owned homes and other homes was highest in areas with heterogeneous housing. In neighborhoods with nearly identical houses, past home sales are good indicators of likely selling prices. Heterogeneous neighborhoods had a 4.3 percent agent-owned premium. In homogeneous neighborhoods where sellers presumably had more information, the premium on agent-owned homes was 2.3 percent.

In recent years, the Internet has made it easier for sellers to track house prices. In theory, this would decrease the value of the real-estate agent's specialized knowledge. Indeed, the authors find that when the public was beginning to use the Internet, from 1992 to 1995, the premium on agent-owned homes was 4.9 percent. By 1996 to 1999, as Internet usage was becoming widespread, the premium dropped to 3.2 percent.

Given that their results suggest that real-estate agents exploit their informational advantage at the expense of their clients, Levitt and Syverson ask why "a contractual form that so badly misaligns agent and home-seller incentives arose and persists." They examine alternative contracting methods, finding flaws in each of them. They caution that it may be the case that agents "provide a bundle of services besides just valuation information, and that these services are worth the commission cost despite the distortions highlighted" in their report.

-- Linda Gorman