Full Price is for the Lazy, or Stop Financing Their Marketing

hard-work-pays-offIn life as in business, if you are willing to invest effort into something, you will do better – a lot better – than average. Today’s story is about a real-estate purchase – and how doing your homework makes a 10x price difference for services.

Did you notice that you just paid your agent $1000/hour?

Basic dynamics of a real-estate transaction: when you buy a $500k home, 3% of the purchase price goes to the sellers’ agent; 3%, or $15k, goes to your (buyer’s) agent. What exactly are you paying for?

  • Touring homes
  • Negotiation advice
  • Access to boilerplate real estate transaction forms
  • Administrative services (shepherding the paperwork)

I was unable to find hard data about the average number of homes that buyers look at these days  and the average number of offers that people make before making a purchase, but anecdotal evidence (one, twothree) suggests that: consumers tour 5-10 homes before making a purchase and make 1-2 offers before reaching mutual agreement.

If you convert that to the number of hours that your real estate agent spends with you, you are looking at about 10-20 hours of work. Dividing their fee by the number of hours, you are paying your agent $750 to $1500 an hour. That’s more than what you’re paying your lawyer – heck, that’s more than what your brain surgeon charges.

There are better real-estate firms out there: Redfin, for example – I love Glenn Kelman and I’m thrilled that he’s working to disrupt this industry. For example, Redfin’s field agents that give you home tours have no incentives to sell you those homes. But what Redfin charges is still far too much: on a 500k home, they charge you (3% – $5000 rebate), which still turns out to be about $500/hour. You might argue that Redfin value prop is a lot higher: they enable the consumer to make better decisions through data on their very awesome site. Unfortunately, this is all but commoditized today (every real estate site does it) – and a savvy consumer has no incentive to subsidize software development efforts behind the self-service site.

Finally, if you look hard enough, you can find flat-fee firms: real estate firms that are specifically designed for savvy buyers – those that simply need help with the paperwork. I just worked with Shop Prop, a flat-fee agent in Seattle area. Shop Prop took several thousand dollars for the transaction and refunded the rest of the buyer’s commission back to me. I paid an order of magnitude less per hour than I would have paid an “old-school” agent. Why? Because I was willing to invest time into finding the right deal.

The craziest part: most consumers are irrational and the rebate is not the reason people go with Redfin. Glenn, the Redfin CEO, writes:

.. commission rebates that Redfin offers home sellers and home buyers dramatically lower our profits margins and there is no evidence that they drives more revenue… [We have] given away $100 million [in rebates]”

What’s behind this?

  • Lots of Emotions: the buyer is making a life-changing decision for his/her family. They want to know they’re getting a good deal, which is difficult to judge since they haven’t done many deals like this before. They want to go with a professional – social proof here (“my neighbor did business with this great agent”) is very important.
  • Apples and Oranges Marketplace: even though all houses are out there for consumers to review and evaluate, it’s hard to develop a quantitative sense for “this place is 200 sq ft less but has a remodeled bathroom… does it mean it should be similarly priced?”
  • Competition: real estate market is in the state of frenzy in Seattle area, with lots of international investors making cash-based offers; many homes get 5+ competing offers. Buyers think they need the help of a professional to win in such a market.

Problems with so-called “professionals” that are paid ~3% of the transaction, beyond their exorbitant fees:

  • Incentive Misalignment. There is no incentive for your agent to help you get a good deal on a house. He/she just needs you to buy any house as soon as possible, so they can get their commission and move on to the next client.
  • No Meaningful Expertise. Real estate agents require no meaningful training to practice their profession; the only actual requirement is a vast network to generate demand or supply. Buyers and sellers take 100% of the risk; moreover, as a buyer, if you end up closing on a place, you are so far in the weeds that your “commitment bias” (sunk cost) makes you so convinced that you got a good deal that you will biased to resist any evidence of the contrary – thus convincing you that you had a good real estate agent.

438110523b4cba59613c4dba6d34a734That is, most consumers would rather take $10-20k of their hard-earned money and gift it to a stranger for no meaningful reason – instead of spending it on vacation, their loved ones, or charity. A rational consumer – that’s not afraid to do research, that understands built-in irrational biases inside their mind – will fair an order of magnitude better.

Do you have an example from your life or work where careful research and effort have paid off handsomely? 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s