We sold our house this summer and bought a new home. The experience has led me to reflect on homes and home-buying in America.
As in any industry, there are good and bad incentives at work in real estate. A home seller would like to get the highest price for their house and sell it in a reasonable period of time. The industry operates on a commission system so that the agent seeks to sell the house at a higher price. This incentive works, but only to a point.
Consider the impact of $5000 on the seller vs. the agent. Six percent of $5000 is $300. After the realty company and purchasing agent take their cut, the agent isn't left with much. A $5000 difference in the price of the house means little to the agent, but a lot to the home owner. Does an agent become successful by getting the highest price or by turning over lots of houses? The answer is obvious. An agent's ideal world is not one where people get exactly the right price for their homes, it is a world where everyone is wildy motivated to buy and sell, turning over lots of houses quickly and thus frequently depositing money in the agent's pockets.
The MLS is the industry's insider listing of homes. Many or most agents will not bring a buyer to a non-MLS home. In the age of open information, the MLS will eventually crumble. In the meantime home buyers must agree to large commissions or fees just to get their home on this insider list. So much for an open market.
That's not the only information access problem in the real estate world. Agents are reluctant to show homes in foreclosure. (Who wants a commission on a heavily discounted property?)
If the industry was really interested in setting the correct value for homes, why aren't there standard rating systems for the electrical system, the windows, the drainage, insulation, plumbing, etc.? An agent is likely to tell you "that's what a home inspector is for". Indeed. I'd rather tour homes with an inspector than with an agent.
The home inspection is an example of another incentive problem: the agent will tend to discount the importance of anything that does not affect their commission. Let's say a buyer asks the seller to pay closing costs and also, after the home inspection, lays out a long list of expensive demands for repair. Both demands are expensive for the seller, but cost the seller's agent nothing. The agent cannot advise the seller well unless they feel some of that pain.
Agents are good people and some of the hardest working salespeople you will meet. But like everyone, they respond to the incentives that are built into the system. Let the buyer (and seller) beware.
Judging from the homes on the market, there are some screwy incentives in home-building as well. How do you incentivize a builder to spend more on quality and sacrifice the large square footage or flashiness that catches a buyer's attention? How do you incentivize a home-owner to update the energy efficiency of the house (windows, furnace, insulation) rather than just the kitchen and bathroom? How do you incentivize a builder to spend extra money to add flexibility to a home design, so future owners can more easily move a wall, enlarge a window, or upgrade the electrical? Why can't anyone build a basement that stays dry? How can we incentivize people to live closer to where they work? I certainly don't know the answers to these questions. But they have me wondering. A home is the biggest purchase most people ever make. Why is it so hard to get quality for those huge sums of money?
As in any industry, there are good and bad incentives at work in real estate. A home seller would like to get the highest price for their house and sell it in a reasonable period of time. The industry operates on a commission system so that the agent seeks to sell the house at a higher price. This incentive works, but only to a point.
Consider the impact of $5000 on the seller vs. the agent. Six percent of $5000 is $300. After the realty company and purchasing agent take their cut, the agent isn't left with much. A $5000 difference in the price of the house means little to the agent, but a lot to the home owner. Does an agent become successful by getting the highest price or by turning over lots of houses? The answer is obvious. An agent's ideal world is not one where people get exactly the right price for their homes, it is a world where everyone is wildy motivated to buy and sell, turning over lots of houses quickly and thus frequently depositing money in the agent's pockets.
The MLS is the industry's insider listing of homes. Many or most agents will not bring a buyer to a non-MLS home. In the age of open information, the MLS will eventually crumble. In the meantime home buyers must agree to large commissions or fees just to get their home on this insider list. So much for an open market.
That's not the only information access problem in the real estate world. Agents are reluctant to show homes in foreclosure. (Who wants a commission on a heavily discounted property?)
If the industry was really interested in setting the correct value for homes, why aren't there standard rating systems for the electrical system, the windows, the drainage, insulation, plumbing, etc.? An agent is likely to tell you "that's what a home inspector is for". Indeed. I'd rather tour homes with an inspector than with an agent.
The home inspection is an example of another incentive problem: the agent will tend to discount the importance of anything that does not affect their commission. Let's say a buyer asks the seller to pay closing costs and also, after the home inspection, lays out a long list of expensive demands for repair. Both demands are expensive for the seller, but cost the seller's agent nothing. The agent cannot advise the seller well unless they feel some of that pain.
Agents are good people and some of the hardest working salespeople you will meet. But like everyone, they respond to the incentives that are built into the system. Let the buyer (and seller) beware.
Judging from the homes on the market, there are some screwy incentives in home-building as well. How do you incentivize a builder to spend more on quality and sacrifice the large square footage or flashiness that catches a buyer's attention? How do you incentivize a home-owner to update the energy efficiency of the house (windows, furnace, insulation) rather than just the kitchen and bathroom? How do you incentivize a builder to spend extra money to add flexibility to a home design, so future owners can more easily move a wall, enlarge a window, or upgrade the electrical? Why can't anyone build a basement that stays dry? How can we incentivize people to live closer to where they work? I certainly don't know the answers to these questions. But they have me wondering. A home is the biggest purchase most people ever make. Why is it so hard to get quality for those huge sums of money?
Comments
Interesting article. I agree with your points and your logic behind them.
An interesting chain of thought is to consider local government's role in the process. My belief is that local property codes provide insight into why people live so far from where they work.
As you are aware, zoning will regulate set-back, and the minimum distance a building can be from a property line. Also the residential code will declare a property to be single family or multiple family.
Now we have single family residences that provide fire protection for the neighborhood but this causes homes to be spaced further apart.
When the property is declared multi-family the developer/land owner gets higher prices for his property. However, multi-family neighborhoods due to the lack of incentive for the resident tend to becomes run-down and shabby, also the property owner has little incentive to make repairs until there is a danger or code violation.
All this interacts to cause several things, single family neighborhoods start to have larger propertiies, and multi-family neighborhoods become more run down.
Local government here tends to be very friendly to develpers that will put up houses (good fo the tax base) and large apartment complexes (Also good for the tax base).
So everything becomes more spread out and urban sprawl is the result. The only way for the resident to get almost anything done is to drive. Groceries - drive. Hardware - drive. Entertainment - drive.
If local government would become incentivized (I can't believe I used that word) to create smaller, more compact neighborhoods then there is a chance of reducing our dependance on automobiles. Multi-use neighborhoods provde groceries and hardware stores in the neighborhood.
Also a compact neighborhood becomes more efficient for mass transit.
An owner might live upstairs from his business. Its the model most older downtown's were built upon.
However, Americans value their privacy and are poor close neighboors. We want to play our stereo loudly at any time of the day or night. We also don't want to hear the neighbor play his stereo ever, especially since he has such poor taste in music.
Also, us Americans deal poorly with our neighbors. We have little concern as we don't socialize with our neighbors we socialize with our church congregation or our co-workers. That's why we have no trouble running our leaf blower at 7:00 am on Saturday. We don't care if we wake the neighbor, we don't know him, he had a loud party last night and fixes his car in the driveway leaving engine parts on his lawn.
Ultimately there would need to be a fundamental shift in personal responsibility and community thought.