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Part 2: If a monkey can sell a $1M home for $950K, does he deserve 3%?

October 17th, 2006 · 3 Comments

I’ve done a bit more thinking on my previous post

The “base-plus-commission” compensation model is attractive in many ways, but as Nadal correctly points out, the key difficulty may be in getting the seller and her listing agent to agree on what the “target” price is.

That may be because both parties are fixated on a fixed price instead of a range, and realistically, nobody really knows in advance what exact price a home is worth. So how about if we tweak the compensation model to reflect a price range?

Back to our hypothetical $1M home…we don’t know in advance whether the home is really worth $970,000 or $990,000 or $1,015,000. What we do know, however, is that the highest price at which it would sell pretty quickly and with minimal effort (the price that a monkey posing as a Realtor could get) is roughly $950,000.

So here’s how we do it: If the agent only gets the “monkey price”, she only gets monkey pay — let’s call it $2000. Her incentive commission is on a sliding scale, based on the final price she gets, along the following lines:

She gets 20% of every additional dollar she gets for the home between $950,000 and $975,000 and 40% of every additional dollar between $975,000 and $1,000,000 and 60% of every additional dollar thereafter.

To spare you getting out your calculator, here’s what the final compensation looks like:


With this scheme, the Realtor’s compensation is directly tied to her success. Notice how quickly her overall compensation climbs above that arbitrary holy grail of a 3% commission. If she can indeed get 15% ($150,000) more than what we roughly believe the home to be worth, she gets a cool 9.3% commission.

The lynchpin in this whole scheme remains the base price, and though reasonable people could certainly come to an agreement on this, Greg Swann points out how an unscrupulous agent could certainly fleece an unsuspecting victim.

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Tags: Disintermediation · For sellers · Freakonomics · Mark Nadel · Real estate

If a monkey can sell a $1M home for $950K, does he deserve 3%?

October 17th, 2006 · 3 Comments

Mark Nadel’s recent paper has certainly provided a lot of blogger fodder!
While much of the excitement generated by his paper has been about buyers’ agents’monkey-and-house.jpg commissions, there’s a hidden nugget on the listing agents’ side. Nadel suggests that instead of the traditional 3%-of-price-per-side fee, how about using a base-plus-incentive model?

It would work something like this…a seller and her agent would agree on what the baseline value of the home is — say, $1M — and what the baseline commission will be — say, $10,000 — if the agent sells the home for that $1M. For every dollar above $1M that the agent gets, she pockets a large percentage, like 50%.

So if the agent is particularly talented (or lucky!) (or both!) and sells the home for $1,050,000, she would get a total commission of $35,000: the $10,000 base plus 50% of the additional $50,000.

Now the incentives are indeed truly aligned. Should the agent spend $2000 to stage the property? Only if she thinks that will increased its value by more than $4000. Should the agent recommend her client accept an offer of $1,005,000 on day 3? Only if she really thinks there’s nothing she can do to increase the offer.

Nadel acknowledges one very sticky point: how to get the seller and her agent to agree on what the baseline is. Get an independent appraisal? Zillow the property?

There’s one other sticky point he doesn’t mention: there isn’t a large broker in the country that would allow any of its agents to try something like this…which doesn’t at all mean somebody shouldn’t try it!

I propose a further twist to really align the incentives: let’s make the 50% deal go in both directions, up and down. So if the agent only gets $990,000 for the $1M home, her total commission would only be $5000: the $10,000 base less 50% of the $10,000 below $1M.

Any takers?

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Tags: Disintermediation · For sellers · Freakonomics · Mark Nadel · Real estate

For Realtors who don’t look past the end of their noses, the Freakonomists just might be right

October 17th, 2006 · 2 Comments

As I continue to dissect Mark Nadel’s tome, he reiterates a favorite point of the Freakonomists: the current commission-based fee structure makes Realtors do things that might not be in their clients’ best interest.big-nose-dude.jpg

An example of this mis-alignment of interests is that while a homeowner would certainly love his Realtor to spend an extra 20 hours to get an extra $10,000 for his home, a Realtor’s not likely to do so because the extra income from those 20 hours is paltry — $10.50/hr by Nadel’s calculations. (Nadel may need to check his math on this one; using his same assumptions, I get $4.50 an hour. Either way, the Realtor might as well be flipping burgers.)

For those Realtors who don’t look past the end of their noses and regard each transaction as simply a one-off deal, this is indeed a pretty damning indictment.

Successful agents, however, know that a solid business is built on long-term relationships with satisfied clients. If a past client indeed thought his Realtor had left $10,000 on the table, that would be the end of that relationship. No more future deals, and no more future referrals.

For agents who think long-term, however, the math goes something like this:

20 extra hours of work =
75% greater chance of doing another transaction with that same client in 5 years
75% greater chance of getting 1 referral a year for the next 10 years from that client.

No matter how you slice that one, that’s a lot of money the Realtor is leaving on the table by being shortsighted.
Ultimately it comes down to this…there are two kinds of incentives: short-term and long-term. If you emphasize the short-term ones, then, yes, a Realtor will look after himself every time. If you think long-term, however, a Realtor’s best interest will indeed be the same as the client’s.

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Tags: Disintermediation · For sellers · Freakonomics · Mark Nadel · Real estate

I like the way this man thinks!

October 10th, 2006 · No Comments

When you think you have something compelling to say to the world, better say it fast before somebody else beats you to it, and says it better than you could.

I have a lot of strong thoughts about how we currently do business and how the Internet is changing that. As it stands now, much of what we do, especially our rules about what we can and can’t do with MLS data, absolutely do not benefit the consumer, for the most part do not benefit us in the industry.

Todd Tarson beat me to the punch with a well-written, analogy-based explanation of many of these changes. I’ll chime in later with more thoughts, but for now feast on what he has to say.

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Tags: Disintermediation · Freakonomics · Mark Nadel · Real estate

AEI weighs in on ABM’s in RE

October 9th, 2006 · 1 Comment

2006-10-09_15-39-48-234.pngWeighing in at an impressive 77 pages and 394 footnotes, Mark S. Nadel’s recent tome on real estate commissions is not for the faint of heart. Since I’m skeptical about anything written about real estate by the Freakonomics economists I decided to ignore their advice and read Nadel’s piece about alternative business models (ABM’s) in real estate (RE) anyway.

I often find it best to use a grain of salt when digesting content from any potentially biased source — be it the conservative American Enterprise Institute-Brookings Joint Center (which hosts, and presumably sponsors, Nadel’s research) or the liberal Center for American Progress.

While Nadel is quite critical of NAR itself, he has a refreshing absence of the extreme anti-Realtor vitriol so common in writings of this type. His proposed solution to the problems he sees with today’s real estate industry is not, as one might expect of a conservative commentator, simply “let the market take care of it.” On the other hand, he does not propose, say, nationalizing the industry.
In all, it’s a good read when you’ve got some time on your hands. Starting here, I’ll post some thoughts on what he has to say.

Nadel’s hypothesis is pretty straightforward:

The traditional, straight percentage-of-sale residential real estate brokerage commission does not serve the interests of either home buyers or sellers.

His solution leads me to suspect he’s been reading Greg Swann’s blog:

The foundation of a new fee structure should have buyer’s brokers setting their own fees or negotiating with buyers, not relying on standard, default commissions set by sellers’ brokers in the MLS.

More thoughts later…

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Tags: Alternative business models · Commissions · Disintermediation · For sellers · Freakonomics · Mark Nadel · Real estate