Prof. Jonathan Meer & The (Famous) Stanford Study...
... addresses an issue at the very heart of the challenges that the residential real estate industry currently faces: too many agents, chasing too few deals, low barriers to entry, misalignment of interests between agent and client, and a vastly different technology landscape that is reshaping the way in which buyers and sellers of homes acquire, consume, and use information. Gone are the days when the agent was the gatekeeper to market data and the tools needed to advertise and sell a home; or when a home buyer needed an agent to discover what was on the market to be able to make informed decision about pricing, value, and competitive homes and options.
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What Value Does the Real Estate Agent Bring?
If you have used Surefield or Zillow or other industry disrupting websites to either look for or list your home, the Stanford Study will reinforce what you already knew or suspected about agent performance. If you are an agent, now is the time to embrace technology and to adapt accordingly to changing times. Keep in mind the Darwinian idea that, it is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.
The question that Jonathan Meer and his co-author Douglas Bernheim set out to answer was, what value does the broker add to a residential real estate transaction? One of the challenges in researching this is that the listing services that an agent provides are generally bundled so it is difficult to separate them out to be able to analyze them independently of each other. These services include listing the property on the MLS, taking photographs, staging advice, listing prices, paperwork, showings, handling other brokers and such like. It is a large bundle of services, but what is strange, when you think about it, is the percentage payment model for the services provided. Why is the value of all these bundled services, that might only total a few hundred or at most a couple thousand dollars, result in a commission cost that could be ten times or more as much as the actual cost of the of the services themselves? Not only is this somewhat strange from a financial perspective, but it sets up a classic case of what is known as the principal-agent problem.*
*The principal agent problem occurs when one person, the principal, hires another, the agent, to act on their behalf in some manner, but where there is imperfect monitoring of the agent’s performance. This creates a dilemma whereby the agents are motivated to act in their own best interests, which are contrary to those of their principals.
Real Estate Agency Unpacked
The classic example of the principal-agent problem is the auto-mechanic who knows a lot more than you do, and where you have to trust them to do the work properly and advise you accordingly, but where the incentives for both agent and principal might not be aligned. The same applies to the real estate agent who does not capture a meaningfully significant extra amount of commission for significant amount of additional effort they must put in to extracting the best price for a client. For example, working to get an additional $10,000 from a home sale, might be of significant value to the homeowner, but to the sales agent, the amount of additional commission is too small to warrant the extra effort it would require in getting it. The incentives are not aligned between the principal, who would like the extra $10,000, and the agent, from whom getting the extra money for the principal, is not worth the extra effort it would take.
The objective of the Stanford study was to unpack the broker expertise services – showing the home, advising on pricing, negotiations – from the value of listing the home on the MLS, and the paperwork services which can be readily calibrated in terms of their actual costs. The Stanford University faculty staff market provided a ‘usefully unusual’ market in which the unpacking of services could be studied, and served as the foundation upon which the analysis was conducted. The university has an office called ‘The Faculty Staff Housing Office’ which acts as a multiple listing service because the university retains ownership of the land and limits who is eligible to purchase homes. So many of the real estate agent’s functions are subsumed by this office. The office lists the homes for sale and provides all necessary paperwork to consummate a transaction in the 800 or so homes on the Stanford campus – the equivalent of about 40 blocks in a typical metropolitan area.
Using an Agent Reduced Sales Price by 6-7%
In the late 1990’s, and though not required, there was a sudden uptick in the number of home sellers in this neighborhood using a broker to sell their home, going from none in some years to up to 60% of sales by the mid-2000’s. This came about because of some aggressive marketing on the part of local agents to use their services. Looking at the impact of the arrival of agents into the market, the study allowed for differences in house characteristics, size, number of bedrooms, features etc. They were also able to identify those homes that were sold multiple times over the course of the 30 years of the study and to compare those that sold with an agent against those that sold without an agent.
Finding: The same home sold with the aid of a real estate agent sold for 6% - 7% less than when sold without the aid of an agent.
This provides ‘evidence of very, very strong agency costs, that is the real estate agents’ incentives are aligned differently. They would like to sell the home relatively quickly and if they sell the home two weeks earlier for $10,000 less that means that they are essentially giving up $200 in order to put in maybe 10-20 fewer hours of work into the sale of the house which when you work out the hourly rate of that is not a crazy decision to be making.’
Listed at Lower Prices, Homes Sold Faster
The Stanford study also found that homes listed by agents were likely to sell significantly quicker when listed by an agent, which reinforced the idea that agents were motivated to sell for a lower price in a shorter time. These findings were very similar to another famous study by Chad Syverson and Steve Levitt (of Freakanomics fame), where they looked at the Chicago market and compared sales by an agent of client homes, and compared them to sales by that same agent selling his or her own home. They found that when selling their own home, agents take longer to sell, and sell for more. [Dr.G: I will be covering this study in a future episode]. Syverson and Levitt took this to be evidence of the agent-principal problem - which is supportive of the findings of the Stanford study.
The Stanford study also noticed that homes listed with an agent typically listed at a lower initial asking price than those homes listed without, further pointing to the principal-agent conflict where the agent just wants to sell the home for a good price quickly, but not necessarily for the maximum price and to take the time doing so.
While this study is restricted to a unique real estate market, it is nevertheless of a decent size, being a reasonable equivalent in scale to a city neighborhood, and has been replicated in some regards to far larger, more generic real estate markets by other studies – such as the Syverson and Levitt study in Chicago.
- The internet has begun to make some of the listing services increasingly obsolete.
- It is important that the individual decides independently whether the services of an agent are in their best financial interests
- It is important that in making this decision that the homeowner is aware of the principal-agent conflict and that the agent is likely operating from a different set of incentives.
- The pressure to unbundle services is likely to become more prevalent: buying an MLS listing, or photography for a home as separate and distinct services versus paying 5-6% of the sales price of a home for those same services for example.
- The market forces that are driving this unbundling of services could drive the real estate agent to obsolescence the same way as it did, most notably, with the travel agent.
- As millennials who are more comfortable with using technology to do pretty much everything in their lives comes on stream to start buying and selling homes, they are also likely to be increasingly uncomfortable with the current bundled services model that comes with a high commission based pricing structure.