August 02, 2003

Steve Levitt

Nice New York Times Magazine piece about Steve Levitt:

The Probability That a Real-Estate Agent Is Cheating You (and Other Riddles of Modern Life): While negotiating to buy old houses, he found that the seller's agent often encouraged him, albeit cagily, to underbid.... [T]he key, Levitt determined, lay in the fact that agents ''receive only a small share of the incremental profit when a house sells for a higher value''... an agent was simply looking to make a deal, any deal. So he would push homeowners to sell too fast and too cheap. Now if Levitt could only measure this effect.... Using data from more than 50,000 home sales in Cook County, Ill., [Levitt] compared the figures for homes owned by real-estate agents with those for homes for which they acted only as agents. The agents' homes stayed on the market about 10 days longer and sold for 2 percent more...

You see, the real estate agent is not the agent of the seller, the real estate agent is the agent of the quick hassle-free deal.

Posted by DeLong at August 2, 2003 07:10 PM | TrackBack


This occured to me when I sold my last house The incentive structure certainly encourages the realtors to move the house quickly. Realtors get a percentage of the sale, usually 6% of the sale price. Whether a house sells for $100,000 or $110,000 is almost trivial to the realtor, even though it can be the difference between breaking even or losing money for the seller.

Really, their incentive is to sign as many sellers to contracts as possible in order to maximize their number of commissions. Taking people around to show them houses is a lot of work, an added expense, and, more importantly, time that's not spent signing new clients who are going to give you the 6%.

Posted by: James Joyner on August 2, 2003 07:28 PM

Something else that's know in the business is that holding an "open house" for a home that is being sold often benefits everyone but the seller-host who foots the cost.

Nine out of ten people who show up aren't interested in buying that home but rather in checking out the market for comparable sales when buying, selling or valuing something else, and the would-be seller's agent hands out a business card to every one of them. So if your sales agent recommends that you host an open house ...

Posted by: Jim Glass on August 2, 2003 07:55 PM

Well there you have it: the perils of agency.

Think of it as putting the mean in Gardner and Means.

Posted by: David Lloyd-Jones on August 2, 2003 09:05 PM

Like James Joyner in the first post, this occurred to me too when I was getting estimates about how much our house was worth when we were soliciting agents for it. One incredibly smart, well-informed agent gave a quote that was way below market-value. When I quietly explained how a real estate agent's required effort in selling a house could increase roughly exponentially with increasing house price, while compensation increased linearly, he was almost actively uninterested in the explanation. Otherwise, he was completely attentive. Another agent said that it was a great time to sell because houses were moving so quickly. The local papers were also reporting how houses were moving fast. When I suggested that maybe sellers could get more money for their houses, which would sell at a more normal pace, she seemed completely confused.

Posted by: M. Strowbridge on August 2, 2003 10:22 PM

A lot depends on what the market for housing is like. In a “hot” market, where there are a lot of buyers, an under priced house will usually get bid up, correcting for agent bias. When sellers over-estimate the value of their house, and it fails to sell, the property can become tainted. The seller keeps lowing the price and ends up selling for less that he would have gotten had he priced it properly in the first place. I’ve seen people take their houses off the market and then bring them back on in an attempt to hide the fact that they had troubling selling it. A lot of sellers don’t understand the notion of opportunity cost. I’ve seen them keep an empty house on the market for years waiting for that one magic buyer who will offer what the place is “really worth.” And like the doctors who make bad patients, realtors often make for irrational sellers when they go to sell their own property. I think the situation is a little more complicated then: “agents tend to under value the house to get the deal closed quickly.”

Posted by: A. Zarkov on August 3, 2003 01:19 AM

When we were buying our house, my wife blurted out our maximum price to the seller's agent. I had resigned myself to paying that much, but we got it for $10,000 less than that. I guess the commission on that $10,000 wasn't worth the effort for the agent to try to get.

Posted by: Tim Lambert on August 3, 2003 06:37 AM

If a Wall Street type agent negotiates the sell of a company, isn't he compensated in the same way the housing broker is? And doesn't the same agency problem apply equally? I have heard some business types asking why brokers are not compensated on the incremental value of business deals rather than the transaction price.

Posted by: Harold McClure on August 3, 2003 07:00 AM

Investment bankers wish for the transaction rather than for the "best" price for the party represented. The transaction pays fabulously well for the banker, if not for one of the parties. Remember the IPO price jumps from 1997 on. There was all sorts of money left on the table rather than going to the issuing company. But, there were all sorts of rewards for the deal and for those who would be flipping the shares as quickly as possible.

Why is it that the mutual fund industry does not have a more competitive fee structure? Same analysis would be useful.

Posted by: anne on August 3, 2003 07:48 AM

It'd be interesting to see how prices compare
between deals where buyers and sellers each
are represented by agents, versus deals where
one agent handles it for both.

That is, if buyers have agents who get
3% of the deal, while sellers' agents get
another 3%, is the average higher than in
deals where a single agent takes, maybe,
LESS than 6% for the deal.

The premise is that 5% of $100,000 is more
than 3% of $150,000 ---

Posted by: Melcher on August 3, 2003 10:33 AM

Come, come. The real estate stuff is the least interesting thing in the article (anyone who has ever listed his home for sale already knew it). I liked:

" Levitt had taken exactly one math course as an undergraduate and had forgotten even that. During his first graduate class, he asked the student next to him about a formula on the board: Is there any difference between the derivative sign that's straight up-and-down and the curly one? ''You are in so much trouble,'' he was told."

Posted by: Patrick R. Sullivan on August 3, 2003 10:52 AM

"Levitt had taken exactly one math course as an undergraduate and had forgotten even that."

Just so.

Posted by: jd on August 3, 2003 10:56 AM

My experience as an attorney in real estate lawsuits is that all too often the agent was not representing the buyer nor the seller, but was instead representing the agent's own commission.

Posted by: Gwailo on August 3, 2003 12:16 PM

"Just so."

So I take it that you're not a fan of the mathematization of economics, then?

I find the animus displayed in certain quarters towards mathematically sophisticated economics highly peculiar. One can't help but wonder about the motivations of those who complain about it - is it a matter of the fox and the grapes, of the soft-n-fuzzies griping about the influence of a subject they aren't able to understand?

Mathematics is at its' best a thing of beauty, and if the application of mathematical techniques to the field of economics is able to throw new insight into questions that have seen little by way of resolution to date, I see no reason for dissatisfaction. One can hardly imagine physicists, for instance, advocating the abandonment of representation theory and functional analysis, simply because some of their number find these subjects hard to understand.

Posted by: Abiola Lapite on August 3, 2003 07:35 PM

Um... am I the only person in America who ALWAYS understood that the way realtors make a lot of money is by making a lot of deals, and the best way to do that is to keep their client's asking price low?

It seems to be news to most of you here, and it's always news to folks who tell me "Wow, our house sold in one day!" and are then crestfallen when I explain that that proves they didn't ask enough for it.

Posted by: Mike G on August 3, 2003 08:32 PM

>>I find the animus displayed in certain quarters towards mathematically sophisticated economics highly peculiar. One can't help but wonder about the motivations of those who complain about it - is it a matter of the fox and the grapes, of the soft-n-fuzzies griping about the influence of a subject they aren't able to understand?

No it isn't.

>>One can hardly imagine physicists, for instance, advocating the abandonment of representation theory and functional analysis, simply because some of their number find these subjects hard to understand.

One can certainly imagine them making a whole load of fuss, however, if you showed up there demanding that everything be analysed as a linear partial differential equation and claiming that the only reason anyone might object to that assumption was that they didn't understand PDEs. "Mathematical" economics bores, nine times out of ten, are also hostile to anyone who proposes to use more complicated mathematics than they do.

Check out Barkley Rosser's, or James K Galbraith's website one day if you want to see someone who can clearly hack the mathematics, but doesn't always choose to.

Posted by: dsquared on August 3, 2003 11:14 PM

Levitt's logic holds perfectly if one assumes away the fact that agents have to compete for contracts among sellers and often do so on their ability to extract higher prices from purchasers. He implies that this dynamic has nothing to do with property pricing by ignoring it.

In my area, the ability to secure a higher price is an extremely useful discriminator among agents, and agents who have sought my business have often gone to great lengths to establish their ability to command high prices. If sellers ignore this discriminator, they also are inviting the agent to ignore the price in favor of a quick sale, and we are back to Levitt's argument. But it misconstrues the real incentive structure.

On the mathematics issue, is Levitt a "post-Autistic" type? Cheers for him anyway.

Posted by: Jim Harris on August 4, 2003 05:55 AM

Its not really hard - when I last sold a house 12 years ago I asked the agent what the asking price should be. I then proposed that he get a flat fee for the sale plus a generous percentage of any yield ABOVE that asking price. It worked - the agent put a lot of effort into it, I got a price that I knew (having been one of those open-house tyre-kickers) was very good, and the agent made a good profit; win-win for everyone except the buyer.

The only thing I'd do differently now is try and get some time penalties in, to minimise the risk of the 'market for lemons' effect. In fact, finding the optimal contract given the competing risks might be a nice exercise in PDEs ....

Posted by: derrida derider on August 4, 2003 06:36 AM

Good solution, derrida. I want to remind that selling a house fast has value in itself, especially if the seller is already a buyer of another house. Not only are there costs in having the equity tied up but the reward of acheiving one of the milestones of relocation is probably worth it to some. Many of you seem unaware of the depression you cause people who had just been experiencing elation. No wonder economics is considered the cold science.

Posted by: LowLife on August 4, 2003 08:35 AM

Here's Levitt's paper (rough draft, anyway) on the "black name" controversy:

The results in Table 4 suggest that a woman’s first name is indeed a useful predictor of
the circumstances in which she grow up, which may in turn be correlated with labor productivity.
Comparing columns (1) and (2), the types of information available to employers on a resume
does little to reduce the value of this signal. In columns (2), a woman with a BNI equal to one
(implying a name that no Whites have) is almost 12 percentage points more likely to have been
born to a teenage mother and 9 percentage points more likely to have been born out-of-wedlock
than a Black woman living in the same zip code with the same age and education, but carrying a
name that is equally common among Whites and Blacks. The woman with a Black name is also
more likely to have been born in a Black neighborhood and to herself be unmarried. Thus, while we cannot rule out animus on the part of employers, we find evidence supporting a potential
productivity-related statistical discrimination motive for employers to base interview decisions
on first names.

Posted by: Patrick R. Sullivan on August 4, 2003 03:51 PM

This is urban legend because I can't remember where I saw it: Some physicists ended up looking at the work of some mathematical economists and asked: "Why do you use so much more math than you need?"

The answer: to intimidate people. If you can't read what someone writes, you can't criticize it.

Posted by: zizka on August 4, 2003 05:36 PM

Don't remember from the Levitt article. Is it Levitt or the author who concludes that a lot of economics graduates have the early spark squeezed out of them by the insistence on math, math, math? The other point when it comes to math and economics is the audience. It is fine to do the work however is needed to get it published in a professional journal. It is another thing to convey the results to a wider audience. If there are important policy implications, or something interesting to tell to a wider audience, there is a real advantage to being able to explain what you've done without saying "partial derivative" or "natural log" or "the point at which the marginal this equals the marginal that".

Posted by: K Harris on August 5, 2003 11:21 AM

Maybe the problem is connected to the absence from residential property markets of dealers risking their own capital. Is there a country with tax laws that don’t make the despised activity of ”property speculation” unprofitable? In the UK there’s the absurd situation of long chains of agreed transactions that can’t be completed because the last one is still dangling and no-one has free capital to break the logjam.

Posted by: James Wimberley on August 6, 2003 05:57 AM
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