"Freakonomics" Rebuttal

Do Realtors Really Add Value?

[Note:  Since it appeared more than 3(!) years ago, this post has become one of the all-time most popular on City Lakes Real Estate  — just on the earlier (software) version of this blog.  I’m re-posting it now for the benefit of blog newcomers, and to make it easier for the search engines to find it.   

If you like this post, also check out “SuperFreakonomics on Realtors“; “Realtors, Chauffeurs, and Investment Bankers“; Economists in Glass Houses; and “Freakonomics (Re)Revisited“]

I don’t go to that many cocktail parties, so I’m not really privy to “cocktail party” chatter. However, I think that it’s safe to say that far fewer realtors these days are being button-holed by their friends and neighbors about the latest real estate killing, hot new development, etc.

Instead, what regularly seems to come up is a criticism famously made about realtors in the book “Freakonomics,” by economists Steven Levitt and Stephen Dubner. Suffice to say, neither one is a fan of realtors, or what they do.

In particular, Levitt recounts his dealings with an especially sleazy realtor in Palo Alto, California.

Headed cross-country to a new academic post at Stanford, Levitt hired the realtor to help him house-hunt near the university. In the course of showing him properties, the realtor cautioned that, unfortunately, it was a hot market with an imbalance of prospective buyers like Levitt relative to sellers. As a result, if Levitt wanted to buy anything, he needed to be prepared to pay full price soon after a desirable property hit the market, with little or no negotiation.

Which is apparently what Levitt did.

Just a few months later, Levitt was offered a plum academic post back east, and unexpectedly needed to put his just-purchased home on the market. He called his realtor, who now told him that, due to all the inventory and slow sales, he needed to price his home “realistically” (code for “low”) if he wanted to attract a buyer.

Who wouldn’t be incensed by such treatment? And which client doesn’t wonder, just a teeny bit, whether their realtor is capable of the same?

Truth-Telling

I can’t speak for all realtors, but I doubt that such behavior is representative, for the following three reasons:

One. Lying about market conditions is easily found out. In an era when everyone is online and real estate data is ubiquitous, a realtor who calls “up,” “down,” or “cold,” “hot” is simply not credible. The New York Times, The Wall Street Journal, cable tv, local newspapers and Web sites, real estate Web sites, etc. now threaten to drown today’s housing consumer with data. To mischaracterize that data would destroy a realtor’s credibility, and without credibility there are no clients.

Admittedly, relocation buyers often know little about their new community, and therefore may be more vulnerable initially to an unscrupulous realtor. However, in my experience such clients tend to do more due diligence, not less — frequently with their realtor’s help and encouragement.

Two. Market statistics eventually fade away and what matters is one house — the one the client is interested in buying. At that point, the discussion between realtor and client becomes very concrete and factual: What are the “comp’s” (comparable sold properties)? How do they compare and contrast with the subject property? How long were they on the market, and what did they ultimately sell for?

Twenty minutes into this discussion — if not far earlier — it’s usually apparent whether area homes are selling in multiple offers above their asking price, or languishing on the market and suffering serial price cuts. It seems unlikely that a trained economist such as Levitt wouldn’t be able to tell the difference.

Three. Lying is hard, telling the truth is easy. By definition, every good realtor juggles: multiple clients, dozens of showings, lots of parallel deals at varying stages. It’s hard enough keeping all the details straight and presenting them coherently to your client(s); not tripping yourself up in a web of lies would seem to increase the “difficulty factor” exponentially.

Levitt and Dubner do make some legitimate claims. For example, they cite statistics indicating that realtors selling their own homes tend to wait longer, and get a higher price. While the statistical differences are small, they do appear to be real. The explanation applies to anysales professional paid a commission (vs. an hourly fee): each additional dollar that an item fetches accrues overwhelmingly to the owner. Meanwhile, 100% of the costs (time and actual outlays, for advertising, gas, etc.) associated with longer market time fall on the salesman. Ergo, Levitt and Dubner conclude, realtors have an incentive to sell homes too fast and too cheap.

Once again, Levitt and Dubner ignore that prices are ultimately set by the market, not realtors. Specifically, realtors (and appraisers) establish a price range not in a vacuum but based on the comp’s — typically three similar, nearby properties that have sold in the previous six months (or less). Realtors distort or spin the comp’s at their own peril (see, “lack of credibility” above).

Path of Least Resistance

In my experience, particularly in today’s soft market, it is far more common (and easier) for realtors to accede to clients’ unrealistically high initial asking price, than to insist on a lower but achievable target. Too, realtors can often empathize with clients’ financial needs, and let their emotions (and hope) influence the asking price rather than cold, market logic.

No matter the motivation, in buyers’ markets overpriced homes sit, and the longer they sit the steeper the ultimate discount.

True to their economics background, the Freakonomicsauthors implicitly treat all homes as indistinguishable “widgets,” whose market value is a given. In fact, skilled, conscientious realtors often work with sellers for weeks and even months before a home comes on the market, suggesting strategic repairs and improvements, addressing code compliance and municipal point-of-sale inspection requirements, putting the owner in touch with various contractors, etc. Meanwhile, the realtor is busy networking behind the scenes, building market awareness for the property and identifying prospective buyers.

Perhaps that’s why homes listed with realtors sell for 12%-14% more than “FSBO’s” (for sale by owners). That’s far more than the average realtor’s commission — and a statistic that’s nowhere to be found in Freakonomics.

The public may not like realtors, for some of the reasons identified by Levitt and Dubner, but they avoid dealing with them at their own (financial) peril.