If real estate is prospering, chances are your agent isn't
Most realtors don't make much money in a boom.
It is hard to think of many occupations that garner less good will these days than the real estate agent.
A great many of these agents and brokers, more than 1.2 million, belong to the National Association of Realtors, which the Department of Justice accused in a recent lawsuit of behaving like a cross between a cartel and a mafia, hoarding access to home-sale databases and harassing competitors who dared to offer discounted commissions.
Even if you believe all these terrible things about real estate agents, however, you should try to find in your heart a bit of sympathy for them. There are two reasons for this.
To examine the first reason, ask this question: Who has prospered during the recent real-estate boom? Home sellers, to be sure, along with developers, mortgage brokers -- and also, you would assume, your average real estate agent.
These agents have rung up millions of sales while home prices have been doubling and even tripling. Since an agent's commission is usually based on a fixed percentage of the sale price -- typically 5 percent or 6 percent, of which about half goes to the listing agent and half to the buyer's agent -- agents' fees have climbed along with home prices, even though they probably don't have to work any harder to sell an $800,000 house than they do a $200,000 house.
A listing agent really only performs four main functions: setting the price of your home, finding potential buyers, prepping and showing the house, and handling the negotiations and contracts.
Just for fun, let's put a value on each of these functions. Setting a home's asking price requires a few hours of work at most, studying the house and comparable sales.
Showing the typical home might take 20 or 30 hours, with negotiations and contracts taking maybe four hours.
Attracting potential buyers is of course the trickiest task -- which is why, as the Justice Department alleges, realtors have tried to block access to the databases. But it's now easy to find independent or discount agents who will list your house on the Multiple Listing Service for about $750.
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.
As it turns out, however, most agents don't make very much money during a boom, because of one simple fact: the boom attracts way too many of them. Over the past 10 years, membership in the association has risen more than 75 percent.
And why not? Compared with most professions, becoming a real estate agent is quick, cheap, and relatively painless. In economics, this phenomenon is known as free entry.
In a 2003 paper titled ''Can Free Entry Be Inefficient?" Chang-Tai Hsieh and Enrico Moretti, economists at the University of California at Berkeley, examined the income of real estate agents in various markets under various conditions.
Relying on data from the Census of Population and Housing in 1980 and 1990, Hsieh and Moretti compared home sales in 282 metropolitan areas. But their story can be told using just a pair of cities: Boston and Minneapolis, which are similar in size and demographics -- but quite different in the price of their real estate.
In 1990, a typical house in Boston cost roughly twice as much as a typical house in Minneapolis. Since commission rates were fixed, an agent would earn twice as much selling a house in Boston.
But the Boston market, with so much more commission money up for grabs, attracted many more agents than Minneapolis did -- even though it turned out that more homes were being sold in Minneapolis.
The result? The typical Minneapolis agent sold twice as many homes (6.6 per year) as the typical Boston agent (3.3 per year) -- which left the Boston agent, despite the higher prices in her market, no better off than her Minneapolis counterpart. What should be a competitive marketplace -- which would inevitably lead to lower prices -- is not, since the price of the agents' service is essentially fixed.
The association's own figures show the same dynamic at work today, nationwide. From 2002 to 2004, during one of the hottest real estate markets in American history, the median income for realtors actually fell -- to $49,300 from $52,200.
This is not to say that some agents haven't become rich. As in most sales professions, whether the product is diamond rings or crack cocaine, the people at the top of the pyramid make an awful lot more money than those down below. It's just that the base of the real estate agent pyramid grows significantly during a boom.
And because hungry new realtors are discouraged from undercutting their competitors by lowering their commission, they compete instead by frantically trying to obtain new listings. This would explain why your mailbox is jammed with postcards from realtors exhorting you to sell.
The second reason to feel bad for real estate agents is even more dire: Their very profession is about to join the endangered-species list.
Think back for a moment to 1999. Travel agents still roamed the earth in vast numbers. So did stockbrokers. But their business models were being blown apart, largely by the Internet.
The new market for do-it-yourself online securities trading lowered fees so drastically that a full-price stockbroker could simply no longer earn a living. Travel agents were shoved aside once the Internet gave customers the ability to book their own trips -- and when, perhaps more damagingly, the airlines decided to stop paying the travel agents' commissions.
The Internet is a natural repository for the sort of data that drive the real estate market. New sites like zillow.com let anyone try to figure out (if imperfectly) what his home is worth; sites like craigslist.org allow buyers and sellers to find each other easily. As those services and ones like them become more popular, it is hard to imagine that the market will allow realtors to maintain their hefty commissions.
In addition to discount and flat-fee brokers, one likely successor is the fee-for-service broker. Cary and Barbara Chubin, a married couple who just relocated from Chicago to Oakland, started up this kind of business in Chicago. They charged $750 to list a home on the Multiple Listing Service, $50 an hour for showing the home and $250 for negotiations and closing.
Younger home sellers flocked to the Chubins' pricing model, but older customers, Cary Chubin recalls, were wary. Chubin understands.
''People can't believe it could be so much cheaper than they're used to paying," he says. ''Plus, a home is the most valuable asset most people have, and you're afraid to death of making a mistake."
Fear may be a great motivator for maintaining the status quo, but the Chubins say they believe they have found an even better one: money. That's how Barbara Chubin plays the game in her advertising: ''Do you want to go to the Caribbean? Or would you rather give the money to your real estate agent?"
Stephen J. Dubner and Steven D. Levitt are the authors of ''Freakonomics: A Rogue Economist Explores the Hidden Side of Everything."