Whether you are a home buyer or a home seller, when you work with a residential real estate agent, you are subjected to two conflicts of interest. One of these is inherent in the relationship itself, while the other is borne out of the customs and traditions in the real estate industry. And if you are not aware of them, and you do not know how to deal with them, it could cost you thousands of dollars.
The first of these conflicts of interest, which is inherent in any relationship where you rely on a professional for advice, is called the Principal-Agent Problem. This problem is just as prevalent with medical doctors and plumbers as it is with real estate agents. The conflict basically comes down to this: when an expert (i.e., the agent) gives you advice, is it in your best interest or their best interest? When a doctor tells you to take a prescription, is it the best course of action for you or is it helping them meet their quota for that drug? When a plumber tells you that you need to have you main line cleaned, is that really true, or does it just pad their bill? And when a real estate agent tells you to lower your home price or take the first offer, is it sage advice, or are they just looking to get a quick commission?
How do you combat the Principal-Agent Problem? There is only one way: education. You have to be (almost) as smart as the agent giving you the advice. And while becoming an expert in any field is unfeasible, the wealth of information available today certainly makes it easier to close the gap. For some issues, like medical and plumbing, you can also seek a second opinion. But this is not really feasible with real estate. That is why, when it comes to buying or selling a home, you must get your own education—especially with regards to home prices—and not rely completely on your agent. It is not that your agent is bad and will intentionally mislead you, it is that they are human and very susceptible to the Principal-Agent Problem.
The other conflict of interest, which is the real estate industry’s own doing, is the all-or-nothing lottery structure of real estate compensation. If your home does not sell as a seller (or you fail to buy a home as a buyer), the agent makes nothing, regardless of how much money they have spent and how much work they have done. But if your home does sell (or you do buy), then they get compensated with a lottery-size payout, which is disproportionately large for the work they have actually done on that particular deal. Of course the agents do need these lottery-size payouts to compensate them for all the work they have done for free with buyers that didn’t buy and sellers that didn’t sell. It does seem unfair that serious, motivated home buyers and sellers end up subsidizing those buyers and sellers that were not really committed.
How do you combat the all-or-nothing conflict of interest? Make it all-or-something. When an agent does work for you as a buyer or seller, they should get paid something whether you go through with the deal or not. Not only does it reduce the conflict of interest, but it is also fair. Nobody should have to work for free.
How would this all-or-something compensation work? Home sellers could offer to pay a non-refundable portion of the commission (perhaps 25%) after the home has been on the market for one week. This would be money the agent keeps whether the home sells or not. If the home ultimately sells, this approach costs the home seller nothing, as it was just a portion of the commission they agreed to pay anyway. But if the home does not sell, then at least the agent made something for their time and money (most of which is spent in the first week).
Home buyers could offer to pay a nominal, refundable payment (perhaps $1000) to buyers agents to show them homes. If they ultimately buy a home through the agent, it costs them nothing as they will get this money back at closing. But if they fail to buy a home, the agent keeps the money (and the buyer is out the money), and in so doing avoids working for free.
The all-or-something approach to agent compensation is not only fair, but it actually reduces the Principal-Agent Problem by getting the agent’s goals more in line with the those of the buyer or seller that has already paid them some money.
Will this all-or-something technique ever take hold? Not if it is left up to the real estate industry. The industry makes too much money the way things are. The only ones who can make this happen are the buyers and the sellers. And that will not happen until they see the benefit in doing it.
To see how ReaListing saves home sellers thousands using the all-or-something technique, click here.