The Probability That a Real-Estate Agent Is Cheating You (and Other Riddles of Modern Life) profiles an interesting character:

Steven Levitt tends to see things differently than the average person. Differently, too, than the average economist. This is either a wonderful trait or a troubling one, depending on how you feel about economists. The average economist is known to wax oracularly about any and all monetary issues. But if you were to ask Levitt his opinion of some standard economic matter, he would probably swipe the hair from his eyes and plead ignorance. ”I gave up a long time ago pretending that I knew stuff I didn’t know,” he says. ”I mean, I just — I just don’t know very much about the field of economics. I’m not good at math, I don’t know a lot of econometrics, and I also don’t know how to do theory. If you ask me about whether the stock market’s going to go up or down, if you ask me whether the economy’s going to grow or shrink, if you ask me whether deflation’s good or bad, if you ask me about taxes — I mean, it would be total fakery if I said I knew anything about any of those things.”

In Levitt’s view, economics is a science with excellent tools for gaining answers but a serious shortage of interesting questions. His particular gift is the ability to ask such questions. For instance: If drug dealers make so much money, why do they still live with their mothers? Which is more dangerous, a gun or a swimming pool? What really caused crime rates to plunge during the past decade? Do real-estate agents have their clients’ best interests at heart? Why do black parents give their children names that may hurt their career prospects? Do schoolteachers cheat to meet high-stakes testing standards? Is sumo wrestling corrupt?

As the title suggests, one topic that interests Levitt is the real estate business:

While negotiating to buy old houses, he found that the seller’s agent often encouraged him, albeit cagily, to underbid. This seemed odd: didn’t the agent represent the seller’s best interest? Then he thought more about the agent’s role. Like many other ”experts” (auto mechanics and stockbrokers come to mind), a real-estate agent is thought to know his field far better than a lay person. A homeowner is encouraged to trust the agent’s information. So if the agent brings in a low offer and says it might just be the best the homeowner can expect, the homeowner tends to believe him. But the key, Levitt determined, lay in the fact that agents ”receive only a small share of the incremental profit when a house sells for a higher value.” Like a stockbroker churning commissions or a bookie grabbing his vig, an agent was simply looking to make a deal, any deal. So he would push homeowners to sell too fast and too cheap.

This occured to me when I sold my last house The incentive structure certainly encourages the realtors to move the house quickly. Realtors get a percentage of the sale, usually 6% of the sale price. Whether a house sells for $100,000 or $110,000 is almost trivial to the realtor, even though it can be the difference between breaking even or losing money for the seller.

Really, their incentive is to sign as many sellers to contracts as possible in order to maximize their number of commissions. Taking people around to show them houses is a lot of work, an added expense, and, more importantly, time that’s not spent signing new clients who are going to give you the 6%.

(Hat tip: Brad DeLong)

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James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College. He's a former Army officer and Desert Storm veteran. Views expressed here are his own. Follow James on Twitter @DrJJoyner.


  1. Kevin says:

    It’s worse than that… The 6% is split among the listing agent (%1) and the buying and selling agent (2.5% each). This is from memory, and I’m not a broker so the splits could be different. But I do know that the 6% pays everyone, so the incremental incentive is even lower…

  2. John Lemon says:

    There are some other issues that are at play here beyond commission (or just trying to sell fast to maximize monthly commissions).

    The other main issue I am thinking about is pricing a fairly large (“big ticket”) item that is unique. Unlike cars where there are a number of comparisons that one could make (after accounting for tastes), houses have many intangibles (view, neighbors’ houses, etc.), thus pricing is filled with a great deal of uncertainty.

    Because of that, there isn’t as much information contained within the price of a house as with other items. Therefore, in looking for information about the quality of the house you look to another market signal — time on market. (The same is true for an academic pricing his services right out of grad school.) If a house is on the market for a month or two (or longer than the average sale), it signals to buyers that there is something wrong with the house. Fewer people are likely to view the house because they can assume a month’s worth of shoppers have looked at it and rejected it. Some realtors will take a house off the market if it has been on too long, and then re-list it a month later, but you still can get info on this.

    Thus, in order to avoid sending a poor market signal about the quality of the house, there is an incentive to underprice the house. This happened to us as we basically sold our (extremely unique and romantic) house in just two days (in a market where average sale was about 30). We kicked ourselves for doing this, but we did make a heap of money and avoided a few weeks of stress. Alternatively, “friends” of ours ignored their realtor’s advice and priced high and ended up carrying two mortgages for several months. Ha!

  3. John Lemon says:

    I guess the short point is that the market works much better than most people think. Capitalism, while fueled by profit-seekers, actually creates incentive structures for “playing nice.”

    One should also remember that the future credibility of the realtor relies upon good word-of-mouth and you don’t get that by screwing somebody. Most realtors are incredibly nice people (and you would be amazed by the number of highly religious people that go into this field.)

    Read: Dennis Mueller’s “Capitalism, Democracy and Ralph’s Pretty Good Grocery.”

  4. James Joyner says:

    Kevin: That’s true, too, depending on the situation. Smaller firms often have the listing agent also act as the selling agent but they also put it into the multi-agent listing. When my house sold, the listing agent got 3% and the selling agent (from another firm) got 3%.

    John: You make some valid points. The trouble is that good word of mouth mainly depends on personality issues since, as you say, it’s really difficult to know whether you got screwed because there are so many variables and there is no commodity pricing. I’m not saying that realtors are ripping people off by trying to convince people to take the first offer, even if it’s bad, just that they don’t have much incentive to maximize. For the seller, especially in a small market, an extra $5000 on the price of the home can be significant. It’s not worth the aggravation for the realtor.

  5. John Lemon says:

    Nor is the extra $5000 worth the aggravation for the seller either, in many cases. Remember the seller is not only trying to maximize price of the house, but also trying to minimize the anxiety of selling a house (which can be quite huge).

    And I do think people figure out if they’ve been screwed after a few months in a new house, or keeping an eye on the sales market after they’ve sold. And knowing many realtors personally, I can vouch that this all factors in to word of mouth about the realtor. And word of mouth reputation is HUGE for realtors.

  6. John Lemon says:

    My basic and “grandiose” point is that free markets create incentives for good social behavior overall, even if there may be a few cheats here and there.

  7. James Joyner says:


    Some of that makes sense. The value of $5000 depends largely on one’s market, I guess. In a major Metro area, where houses start at $400,000, that’s nothing. In areas where a nice house can be had for $100,000, it matters quite a bit–especially if you’ve only been in the house a short time. That 6% commission can wind up putting the seller in a position where the outstanding debt can’t even been paid.

  8. John Lemon says:

    I do understand that, but the other element you are forgetting is the price of the seller’s anxiety. 5K on a 100K house may be a big chunk of the outstanding debt, but it may also be tolerable for someone hihgly worried about carrying two mortgages or needs to unload fast for a variety of other reasons.

    The irony is that the less wealthy are more likely to have greater anxiety about selling quickly (since they don’t have other liquid assets to dip into), and hence will be more tolerant of lowballing the sale price.