Matthew Ferrara, Philosopher
 

Why the Economist is Wrong about REALTORS

The Economist magazine thinks American consumers are cartel-ridden suckers when it comes to housing. Really?

In a recent article called American Property: The great rip-off we get once again a fine example of sensationalism passing itself off as journalism. Or worse, as journalism about economics. We aren’t too surprised. It’s always been easy to pick on real estate agents. So, when times are tough and nobody’s paying your advertisers, pick a scapegoat and start kicking.

Read the article for yourself, but it boils down to three claims: First, American real estate agents charge double what British ones do, so there must be something nefarious at work. Second, real estate agents are crooks: why else use a picture and reference to Glengarry Glen Ross? Third, economists somewhere are baffled as to how the industry still gets away with it, especially after years of the all-powerful internet cutting out middlemen. Thus, there must be a rip-off happening somewhere.

The argument turns on a single – and massively – mistaken claim: That real estate agents are simple middlemen.

“Economists are baffled. The internet has squelched inefficient middlemen in other industries, from insurance brokers to travel agents. Why not American realtors?” After all, the quoted economist claims American brokers cause “social waste” of about $8 billion dollars in “overcharging and inefficiency.”

Yet somehow, nobody has noticed all this evil-doing, especially American regulators, who love to charge companies with all sorts of wrongdoing. (Remember the famous antitrust lawsuit against Microsoft for making its internet browser free?)  Regulators have somehow missed this perennial boondoggle of defenseless homeowners. It’s possible, they argue, that the “industry has captured its regulators.” That would mean fifty state regulators, industry watchdogs, the U.S. Department of Justice and perhaps the most lawyers per-capita on the planet are all in on the deal. Makes sense to us.

Oh, there are theories, says the Economist, in a kind of Monty Python wink-wink nod-nod sort of way. American consumers might just be suckers (how did we knew PT Barnum would somehow be referenced?). Possibly the industry is hugely inefficient and magically resistant to power of the internet. The first part is often true, but for all industries. But the idea that real estate is impervious to innovation dismisses a record of twenty years of technology, sales and marketing innovations.

From an economics standpoint, the article fails to mention how quickly and efficiently the U.S. industry purges inefficient agents and brokers. From our experience working with brokers since 1991, nearly 60% of new agents don’t last a year in the business. Nearly 90% don’t make it past five years. Seems like a fairly good track record for getting rid of waste and incompetence quickly.

So, the article settles upon the cartel theory, a perennial favorite catch-all justification. The massive waste and high costs occur because American brokers are in collusion with each other. Interdependent, is the word they use, but you can read between the lines. Since it’s common for all parties to be represented by a broker, the brokers have designed a system to pay each other off with fees from both sides of the deal. In fact, they won’t work with each other unless there’s a fee to be had, a system of discrimination which the Economist claims exists but is hard to prove. How convenient.

Ironically, the article makes note that most brokers get business from their personal sphere of influence. So, reputation is a critical component to the business. Just how long does the Economist think a broker’s reputation would last if she refused to show clients certain homes (which they saw on the internet beforehand, of course) because the other broker wasn’t offering them a fee? Clearly, the Economist hasn’t really talked to any buyers’ brokers here in the States.

Likewise, the Economist overlooks the essentials of the free market system. Nobody is required to use a broker. Consumers can try to sell on their own; about 10% do each year. Most choose to work with a broker. In any case, all payments are entirely voluntarily. Is the Economist arguing that Americans choose to waste their own money? 

It might surprise the Economist to learn that American brokers don’t just get a fee for doing nothing. 

Then again, the Economist doesn’t bother to examine what brokers actually do – on either side of the pond. We’re simply supposed to take their word that it’s equal, and not worth more than 2 or 3% of a property’s value. Without an honest comparison of the kinds, degree and level of services that brokers in different countries provide, the claim of overcharging rings hollow. American consumers demand very high levels of service, especially marketing, including professional photography, video, internet marketing and print media. All of these drive up costs, at the consumer’s own choosing, perhaps higher than the expectations or demands of consumers in other countries. The Economist would have done a greater service had they examined the cost-of-production factors that go into fees, such as training, marketing, technology, management, data systems and trade associations. It’s silly to argue that Mercedes Benz owners in London were “duped” into paying more, or there’s some sort of auto-cartel at work, because Indian consumers can buy an inexpensive Tata, even though both are “cars.”

There’s even the possibility that British consumers are getting less service because their brokers don’t (for whatever reason, perhaps regulatory) charge higher fees.  Maybe the cost to be a broker in Britain is less than the cost to be one in America. Doesn’t the Economist regularly remind us how expensive American health care is compared to theirs? There’s often a non-nefarious economic reason behind the fees that entrepreneurs charge to make a living in any country.

It’s also simply more expensive because – gasp! – there are more brokers in America and therefore more competition for consumers!

But then, you really wouldn’t have a news story, would you, if it were all costs and margins?

We fully admit that we’re only armchair economists. But we believe that American consumers – the people who put those travel agents, book sellers and insurance brokers out of business, by the way – are quite able to Google-up a discount if they really want one. In fact, buyers and sellers negotiate their commission all the time.

Don’t get us wrong: There are plenty of places where the U.S. industry could be more efficient and create cost savings for consumers. Plenty of brokers are focused on doing just that. The housing market is huge, diversified and very cost sensitive. And it’s filled with plenty of hardworking, dedicated and value-oriented agents who would take serious offense at being compared to Glen Ross.

Often stone throwers fail to notice their own windows.The Economist might want to ask why it hasn’t lowered the fee for their magazine, despite the internet challenging news middleman. Last time we looked, a copy of the Economist was about $7. For some reason we still paid for it. Maybe that argues for Americans being suckers after all. Or maybe there are times when consumers are willing to pay a little more if they seek something more than discounted value… a claim we might have to re-examine ourselves, if the Economist keeps churning out articles like this one.

 

  • This is appreciated.  Thanks.

  • Jeff Gingerich

    Well said Matt. You get what you pay for. The system in the United Kingdom is ridiculously inefficient.

  • Good response Matthew and thanks for posting this! One of the main premises of the article is wrong from the beginning, when comparing insurance brokers to travel agents with regard to eliminating the middlemen. My company also has an Insurance Division, and the internet has certainly not squashed our business.  In fact, in the last 5 years, that Division has grown every year. Yes the internet companies have caught on to a degree, a la Geico, but once something goes wrong, consumers can’t go online to report a claim or when they need advice. They need to talk to a professional, and that’s where the Geico’s of the world are defficient, and that is the point that we use to distinguish ourselves from Geico. 

    If you read the comments following the original article, it is clear that we have a long way to go to repair our reputation as Real Estate professionals.

  • Paul

    Interesting post (as always). I read the Economist article and found it to be substandard to most of their work. Dunno why they chose to run this silly and uninformed piece. I worked through all the reader comments and found the ravings of one particular reader to mimic the writers bias. Nonetheless, I thought your post was good, but seriously, you paid $7 for a print copy. I have had the Economist delivered to my inbox for years and still don’t pay an up-charge for the subscriptions…

  • Agi Anderson

    Matt, your powerful command of the written word speaks volumes in this post. Glad you paint a more accurate picture.

  • Thanks, Agi.

    I was simply astonished that such a (usually) credible news source would post something so puerile as this article. I hope you share it with your sphere of influence, because there’s no reason for this kind of journalism when the housing market is struggling to do its best every day in tough conditions.
    — Matthew

  • I could pay for a high priced hotel or a low rent hostel. I could travel coast to coast on a Greyhound or fly first class. I could try to sell my house (and all the other tasks that accompany it) by myself or I could hire a professional Realtor. That’s the neat thng about being a resident of the United States of America. I have a choice.

    Nice rebuttal Matthew.

  • Great points! The existence of higher priced offerings in a market does not necessarily mean dumb customers, nefarious collusion or even inefficiency. It means usually that there is market demand for it.
    Thanks for your comments.
    – Matthew

    Matthew Ferrara & Co.
    (w) matthewferrara.com
    (t) 978-291-1250
    (cell) 508-878-6223
    (f) facebook.com/mfcompany

  • Ed Godbois

    Consider using a rel=nofollow attribute when formatting a link like this in the future. The Economist shouldn’t receive any SEO mojo for this. Excellent response!

  • Thanks for the suggestion, Ed! Forgot about that in my haste to write it! Will do it when we release the video. – Matthew

    Matthew Ferrara & Co.
    (w) matthewferrara.com
    (t) 978-291-1250
    (cell) 508-878-6223
    (f) facebook.com/mfcompany

  • Basil Burwell

    Great job Matthew, to the point without excessive bashing of a flawed article by a misguided author.

  • Deb

    When I visited friends in England a few years ago who were selling their home, I discovered that the model there is very different from ours. Real Estate Agents get about 2%, but the sellers pay for everything- photo shoot, brochures, ads, etc. The agent basically gives advice only, and has no upfront costs or potential losses should a listing not sell.

    I’m surprised that the Economist didn’t do a better job of research. Their articles are usually very good, and this is going to hurt agents here.

  • Well stated, Matt, and insightful.  A powerful and informed response for sure.  I appreciate you taking a stand on behalf of REALTORS and our indudstry. 

  • Epstein’s Mother

    “From our experience working with brokers since 1991, nearly 60% of new agents don’t last a year in the business. Nearly 90% don’t make it past five years. Seems like a fairly good track record for getting rid of waste and incompetence quickly.”

    Actually, your statement runs the other way — since the vast majority of entrants into the field don’t last, those who do get the bulk of business and are in a position to collude on prices. That, after all, is what we see in other industries where few new entrants last.

    The “waste” the Economist is talking about is economic waste. That is, money being paid to brokers above the value they actually add to the transaction.

  • I’m not sure if you know how the real estate industry works but even the largest company in any market only had a small percentage of sales. In very market the sales are distributed amongst so many companies and agents that collusion would be nearly impossible. There would always be a company who would immediately undermine the price agreement to capture market share. Collusion only works when people don’t want to compete and have a legal monopoly. Because the market is wide open to entrants on a moments notice (licensure takes mere days or weeks) the likelihood of price fixing is nearly impossible.

  • Epstein’s Mother

    If there is no collusion, then why is that 6% commission so universal? Not higher, not lower, just 6%. Truly competitive industries see lots of fluctuations, with cheaper products with cheaper rates, more services provided for higher rates, etc. Not 6% all around. Not 6% for a $100K house, and 6% for a $1 million house. Not 6% Wichita, Kansas and 6% for a Potomac, Maryland.

    Please. The only other industry that sees a consistent 6% commission is investment bank underwriting. And next you’re going to tell me that there is plenty of competition between investment banks, too?

  • I’m afraid you really do not know what you are talking about. There is no universal 6% fee. I just sold my house for less than that. And I work with brokers all over America – some who charge as little as 2% and some who charge as high as 10%. You, just like the Economist, are working from pure cliche and lack of knowledge. Commission rates in every state, and with every broker, are negotiable and vary greatly according to company policy, individual client, and market conditions. And brokers definitely compete with each other on the basis of their (commission) price.

    I’m curious: have you ever actually bought or sold a house in the United States?

  • Epstein’s Mother

    Yes, I bought a house in Wisconsin, where the commission was 6%. Just sold that house, where the commission again was 6%. Also bought another house in Maryland — 6%.

    So you’re saying that this widespread view that 6% is the commission is just false? Someone just made up this number? And I just happened to hit on it 3 times out of sheer chance?

    Come on. You can tell that to your choir, but you’re not convincing anyone else.

  • No, it just means you didn’t negotiate a better rate.
    There are 5 million transactions a year. You had three of many at 6%. That doesn’t mean they were all 6%. If you want to have a serious discussion about the industry feel free to reply. If you just want to troll the blogs and throw around inaccurate claims, please move on.
    – Matthew

  • Epstein’s Mother

    I always enjoy how some people describe someone who offers counterarguments as “trolling”. I usually take that to mean that they’ve run out of arguments themselves.

    But you do make a point. Maybe I’m a bad negotiator. And I had only 3 transactions out of millions.

    However, as I suspect you know, the US Government Accountability Office reviewed these millions of transactions back in 2005 and 2006, and the GAO seems to suggest that my experience is the norm.

    Or is the GAO report wrong, too?

    http://www.gao.gov/new.items/d05947.pdf

    And, of course, I assume you are aware of the relatively recent academic study by Douglas Bernheim and Jonathan Meer of all home sales over a 27 year period in an 800-house neighborhood where they found that those sellers who used real estate brokers lost 5.9-7.7% on the transaction, versus those who sold the homes themselves?

    http://econweb.tamu.edu/jmeer/Bernheim_Meer_Brokers_EI.pdf

    I’ll agree with you that, at the individual realtor level, there is competition, just as the GAO report argues. It’s just not on price — which is what happens in markets where there is collusion on price, as individual actors try to skirt the “rule” on price by offering different services. And the academic literature on the subject suggests that that collusion occurs via the National Association of Realtors.

  • Rodrigo

    There are a few things you fail to mention. One, what the heck do brokers actually do? So they don’t inspect the house (house inspector does that), they don’t check for termites (termite inspector), they don’t appraise it (house appraiser). So, I’m paying the brokers 5% of my house for what? To walk me over there and show me the place? I got ripped off. I figured in the end my broker put in about 35 hours into my home purchase (mostly just going with me to houses which they were mostly redundant for. I actually would find the house first online and ask them to show it to me always wondering “why were they there?”) and they walk away with 2.5% of my home purchase which works out to $15,000. $15,000!!!!! I’m sorry, the cost does not justify the work. Realtors are a rip off, and moreover, they are unnecessary. All they do is the paperwork, and I’ll pay a real estate attorney a couple thousand to write up the documents thanks. Fact is, realtors don’t do anything. Folks, think hard. What are you paying thousands and thousands of dollars for? A fool and his money are soon parted. Ask them, what do they actually do. Ask them to see a timesheet of the hours and labor they spent on your house (fair request for someone providing a service right?) You’ll see, it’s hardly worth thousands of dollars. Anybody making that much money off that little work is definitely going to make their job seems as indispensable as possible. And they do. The system makes it seem like you absolutely can’t buy unless someone is representing you. They’re protecting their job and the economist hit the nail on the head. Their absolute middlemen; there could be no better term for them.
    I highly encourage everybody to be wise with their money. If you are going to pay thousands, then get thousands of dollars of work in return. Find out what this exorbitant fee is for. Protect your money; you worked hard for it.