A year ago last month, I bought my condo. The biggest purchase of my life was one I could not have made on my own. I turned to trusted people to help me through the process. My parents provided guidance, having bought homes in the past. My mortgage banker, a work friend of my father, walked me through some of the steps in closing my first mortgage. Last, but certainly not least, my realtor, a family friend, helped me find my home and get the best price possible. Allegedly.
In many situations, we trust people who have an informational advantage over us to perform a service for us. I recently trusted a plumber to fix my toilet. I trust a mechanic to fix my car. I trust a doctor with my health.
It is not because these people are necessarily smarter than me, though they may be, it is because they are an expert in something that I am not.
Just as I go to a plumber to fix my drain, he may come to me for help with his finances. I might not be smarter than him, but I know a lot more about banking and investment as that is my specialty and I am well educated in that area.
In our lives, we all respond to incentives. They may be financial or they may not. I am incentivized to go to work because they pay me. I am incentivized to make the company a bigger profit because I get a bigger bonus, raise, and a potential promotion.
Just the same, a real estate agent is incentivized to help you with a real estate transaction. Most real estate agents are compensated with a commission. That commission is usually split between the buyer’s and seller’s agent and the agent shares the fee with their firm. After all is said and done, a realtor takes home about 1.5% of the purchase price, before taxes.
On a home sale of $100,000, the real estate agent takes home $1,500. But most homes do not sell for $1,500. The median home price is closer to $300,000. On that transaction, a realtor takes home $4,500. Not a bad payday.
When you are buying a home, your agent is charged with finding you the best home for you and helping you negotiate the best price possible. But is that always what happens?
For a realtor, their pay is based on the home price. So a higher selling price is actually better for your realtor. Your goals are at odds with each other, and the realtor may not be forthcoming in helping you find a home at a lower price if it costs them money.
On the flip side, a seller’s agent’s goals are aligned with those of a seller. Selling for the highest price is better for both parties. But is that always what happens?
Real Estate in Real Life
While reading a great book, Freakonomics, I learned some of the details of a study of real estate transactions in Chicago. To make a long story short, in 3,000 similar home sales in that market, realtors sold their homes, on average, for $10,000 more than their customers. They also sat on the market an average of 10 days longer.
Why is that? If a realtor is incentivized to sell your home for more, as they make more as well, you would think that each realtor would work just as hard to sell your home as their home.
But do your incentives really line up?
If a home sells for $10,000 more, that is a lot of money in your pocket; but for a realtor, it is only $150. To keep your house on the market longer distracts the realtor from other sales, which could be another $4,500 in their pocket. It also takes more work and could cost more. Even if it is better for you, the realtor might encourage you to take a lower offer to move on to work on other deals.
If you bought or sold a house, this may have happened to you. But maybe not. Many realtors are hard working and honest and help you where the can, but, at least in Chicago, that is not the case the majority of the time.
Use Information to Your Advantage and To Cut Theirs
Why can a doctor suggest an expensive procedure, a mechanic charge a fortune for a car repair, and a plumber charge me $340 to fix a clogged drain? The same reason I could create a profitable loan for a bank and a realtor can sell your home for $10,000 less than it may be worth: informational advantage.
To save money and trouble in your life, use information to your advantage. Don’t blindly trust salespeople or other “experts” blindly. Do everything you can to gain information and make an informed decision.
I shopped around for the best loan rates when I got my mortgage. I used Zillow and other real estate tools to find and value my home. Of course, I had trusted experts by my side, but I did not follow them blindly.
The next time you are faced with a big decision where you have an informational disadvantage, try to close that gap. Do your own research. Find second opinions. Learn all you can make a better decision and avoid being taken advantage of by “experts” who are out to help themselves more than you.
Did an Expert Lead You The Wrong Way, or the Right Way?
Do you have any stories where you were ripped off by someone who knew more than you? Did a trustworthy expert come through and help you when you needed it? Please share your story in the comments.
Image by Images_of_Money / flickr