There is a dark side to real estate agents

Selling a house is one of the biggest financial decisions that an individual makes during the course of his lifetime. And after having made a decision to sell, the first thing to do is to get hold of a real estate agent.

As Steven D. Levitt and Stephen J. Dubner write in Freakonomics, A Rogue Economist Explores the Hidden Side of Everything, "It is a quintessential blend of commerce and camaraderie: you hire a real-estate agent to sell your home".

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As they further point out, "Aside from the fact that selling a house is typically the largest financial transaction in your life, and that you probably have scant experience in real estate, and that you may have an enormous emotional attachment to your house, there are at least two pressing fears: that you will sell the house for far less than it is worth and that you will not be able to sell it all".

Given these fears, one hires a real estate agent to help sell the house. "A real estate agent is a different breed of expert than a criminologist, but she is every bit the expert. That is, she knows her field far better than the layman on whose behalf she is acting. She is better informed about the house's value, the state of the housing market, even the buyer's frame of mind. You depend on her for this information. That, in fact, is why you hired an expert".

Nevertheless, does the real estate agent really work to the benefit of the individual who hires him to sell the house? "It would be lovely to think so. But experts are human, and humans respond to incentives. How any given expert treats you, therefore, will depend on how that expert's incentives are set up" Levitt and Dubner point out.

The authors take an example of a house to prove how incentives have a huge impact on the way real estate agents behave. "But as incentives go, commissions are tricky. First of all, a 6% real-estate commission is typically split between the seller's agent and the buyer's. Each agent then kicks back half her take to the agency.

Which means that only 1.5% goes directly into the agent's pocket. So on a sale of your house $300,000 house, her personal take of the $18,000 commission is $4,500. Still not bad, you say.

But what if the house was actually worth more than $300,000? What if, with a little more effort and patience and a few more newspaper ads, she could have sold it for $310,000? After the commission, that puts an additional $9,400 into your pocket. But the agent's additional share - her personal 1.5 per cent of the extra $10,000 - is a mere $150.

If you earn $9,400 while she earns only $150, maybe your incentives aren't aligned after all".

The point being made here is that the agent will not try hard enough to sell a house for $310,000 when she can easily sell it for $300,000 because the incremental commission is not worth the effort involved at her end.

What proves this even more is some data coming out of suburban Chicago.

"A recent set of data covering the sale of nearly 100,000 houses in suburban Chicago shows that more than 3,000 of those houses were owned by the agents themselves….The study found that an agent keeps her own house on the market an average ten extra days, waiting for a better offer, and sells it for over 3%more than your house - or $10,000 on the sale of a $300,000 house.

That's $10,000 going into her pocket that does not go into yours, a nifty profit, produced by the abuse of information and a keen understanding of incentives.

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