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Realtor Cartel Update: Massachusetts April 25, 2012

Posted by federalist in Real Estate.
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One way that people have gotten around the Realtor Cartel is by nominally joining it. Indeed, when the barriers to entry are only a few thousand dollars of test and licensing fees it can make sense to join the cartel (i.e., become a “Realtor”) just to save on the costs of a single property sale.

The Massachusetts cartel moved in 1999 to raise its barriers with a “continuing education” requirement. This had the intended effect: The number of licensed agents fell 58%. The justification for the requirement was that it would improve the cartel’s service to the public. A study just released by Benjamin Powell and Evgeny Vorotnikov concludes this was a sham:

The study found no evidence that either the volume of complaints, or those requiring a response from the board, decreased after mandating the continuing education courses.

In other words, full-time agents changed the law to limit their competition from part-timers and enhanced their own incomes in the process. Sadly, the much-touted benefit to consumers has yet to be seen.

QOTD: Make Consumers Buy Their Own Insurance February 21, 2008

Posted by federalist in Judiciary, Markets, Real Estate.
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You can buy insurance against various misfortunes that might befall you.  You can also play our “jackpot justice” system and try to cash in on someone else’s insurance.  The problem with the latter option is that it is fraught with moral hazards.

Corey Cohen offers an excellent solution that extends a proven concept:

Title insurance is little more then a mandated malpractice policy for lawyers that is purchased, in most cases in its entirety, by the homeowner. If a “title defect” occurs, the title insurance completely indemnifies the lawyer who performed the contracted service. In those states that don’t require title insurance, a form must be completed that releases the lawyer from responsibility for forged or poorly performed searches. Either way, the potential injured party, the borrower, is responsible for the cost.

I don’t understand why other providers of goods and services aren’t allowed to mandate upfront indemnification. I’m sure that if given the chance, large retailers like Wal-Mart, which face expensive lawsuits related to in-store injuries, would love a chance for “pay-as-you-go” legal coverage. They could collect a dollar at the door from customers to cover any injury that might occur in the store, or have them sign a waiver releasing the corporation from any injuries that occur from things other then falling prices.

As an emergency physician I would welcome the ability to request payment for individual indemnification on a patient-to-patient basis like the government-mandated, consumer-purchased “malpractice” policy that protects my brethren in the legal profession.

I.e., at least make customers pay for their lottery ticket if they want the right to sue.  And give people like me who don’t want to pay these jackpots a chance to opt out.

Don’t Give Your Rebate To Your Realtor October 10, 2007

Posted by federalist in Real Estate.

I have written before about grotesque inefficiencies in the market for real estate brokerage. Rent exhaustion, illegal cartels, unethical behavior and conflicts of interest. All of these industry features have only grown with the explosion in real estate values.

On my other blog I outline a solution to the hazards facing consumers that fits almost entirely within the present paradigm of the brokerage industry.

Homeownership Myth August 22, 2007

Posted by federalist in Finance, Real Estate.

For a long time Homeownership has enjoyed the status of Unconditional Social Good, right alongside such metrics as Employment or Life Expectancy.  Witness the degree of government intervention to foster home ownership — personal tax breaks (the mortgage interest deduction) as well as government-backed loans and loan subsidies.

Today Holman Jenkins explains that not every American should be buying a home:

A typical low-income household might spend half the family income on mortgage costs, leaving less money for a rainy day or investing in education. Their less-marketable homes apparently also tended to tie them down, making them less likely to relocate for a job.

Bottom line: Homeownership likely has had an exceedingly poor payoff for millions of low-income purchasers, perhaps even blighting the prospects of what might otherwise be upwardly mobile families.

I would point out that even wealthy individuals should not blindly assume that homeownership is right for them.

People often get hung up on the fact that renters don’t “build equity” the way homeowners paying off principle on a mortgage do.  Home equity has historically appreciated, but so have many other assets in which one could invest spare cash.  No money manager, looking at a home as simply another investment, would advise an individual to put a significant portion of his portfolio in a single house.

It is true that owning a home can sometimes be cheaper than renting, but that is a function of cyclical and regional market conditions.  Sometimes renting is cheaper — especially when one considers the illiquidity of individual real estate.

Feds Call Out the Realtor Cartel May 9, 2007

Posted by federalist in Real Estate.

“Realtors” have long colluded with state legislatures and regulators to maintain their cartel at the expense of consumers.  The U.S. Department of Justice together with the Federal Trade Commission issued a report, “Competition in the Real Estate Brokerage Industry.”  As summarized in their press release:

The review by the Department and the FTC suggests that, although the real estate industry has undergone a number of substantial changes in recent years — particularly as a result of technological advances such as the Internet — competition in the industry has been hindered as a result of actions taken by some real estate brokers acting through multiple listing services and the National Association of Realtors, state legislatures, and state real estate commissions.

The report is particularly critical of “three types of restraints imposed by state laws and regulations that are likely to reduce competition and consumer choice in the real estate brokerage industry: anti-rebate laws and regulations; minimum-service requirements; and overly broad licensing requirements.”

Rent Exhaustion in Real Estate Brokerage May 4, 2007

Posted by federalist in Real Estate.
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“Rent exhaustion” refers to a situation where opportunities for large windfalls attract many competitors, who by massing around it essentially destroy the value of the windfall.  Tim Harford gives one classic example:

Rent exhaustion is no economists’ fantasy – go to any place with rich tourists and poor locals (Dar es Salaam, the first African city I visited, fits the description nicely), and you’ll see lots of people waiting for the one generous tip or overpriced taxi fare. If the tourists become more generous or gullible, the local guides don’t get richer, they just multiply. The bigger paydays become less frequent.

Like beggars, Realtors have driven the cartel rents of the real estate brokerage industry to the point of exhaustion.  The cartel has largely maintained the tradition of a 6% sales fee per house transaction.  With houses routinely selling for seven figures there are enormous windfalls — a good year’s salary — to be had from selling even one house.  An article in the Feb 7 WSJ explains,

Although it is difficult to make a good living as an agent, many stay active in the business at least part time, handling transactions for friends and family or hoping to hit the jackpot with one big transaction.

In a normal market price competition would drive the sales fees down to more reasonable levels.  But in this case the cartel has held its grip on the market and, predictably, hordes of salesmen have flocked to the industry, overwhelming the opportunities and wasting a lot of time that would more productively be spent elsewhere.

Though finally, the WSJ reports, “The long-awaited shakeout among real-estate agents is finally happening — much to the relief of those who are sticking with the business and prefer a bit less competition. … Even before sales slowed, people in the industry said far too many agents were chasing too few deals.”

Consumers would have benefited much more if sales fees had come down, instead of rent exhaustion driving out competing salesmen.

Making Real Estate More Liquid November 29, 2006

Posted by federalist in Finance, Real Estate.

Real estate typically combines two distinct and risky financial assets.  One is the underlying property, whose value can fluctuate widely in response to interest rates and localized demand.  The other is the cashflow of the property, which consists of income from rents and costs from taxes, insurance, maintenance, etc.

Compounding the risks of these real estate components is that fact that neither is very liquid: Securing rental income for a property requires finding and maintaining renters.  Properties themselves can typically only be liquidated in “units” that start in 6 figures, and the transaction costs associated with buying or selling property can run upwards of 10%.  (Dot-com entrepreneurs take note: We’re still waiting for the internet to work its magic on this market!)

Finally, there is no way to buy insurance against property or rental declines.  In contrast to equity and fixed income, you can’t really sell short, buy puts, or otherwise hedge a long exposure to a particular real estate investment.  (You can, however, hedge the risks of appreciation using long-term leases.)

Granted, it is possible to buy diversified real estate exposure in a liquid fashion, through REITs (Real Estate Investment Trusts) and other real-estate-intensive companies.  But most people will still end up locked into a single, often highly-leveraged piece of real estate: their home.

If you are a property owner and you want to hedge against a decline in your property value, your options are neither extensive nor palatable:

  1. Sell, and become a renter instead.
  2. Sell, and move to a different region where you believe there is less risk of a decline in values.

Individual real estate is clearly a market ripe for innovations in liquidity.  Due to the size of the market, any entrepreneur who introduces practical liquidity mechanisms stands to make an enormous fortune.

Likely innovations would:

  • Separate the cashflow component of real estate from the underlying property component.
  • Subdivide the property component into more tradable parcels.
  • Allow owners to hedge against declines in both cashflow and property value.

Today a venture called Rexx Index was announced that’s making steps in this last area, albeit only for commercial real estate.

More Real Estate Agent Conflicts of Interest November 9, 2006

Posted by federalist in Real Estate, Special Interests.

One of the biggest problems with the American real-estate sales cartel (which is enforced primarily by the National Association of Realtors) is the contradictory incentives for “Buyer Agents.”  In principle a Buyer’s Agent is retained to ensure that a real estate Buyer has his interests fully represented in finding and buying property.  I.e., a Buyer’s Agent is supposed to be a licensed professional who is duty-bound to ensure that the Buyer (who may be familiar with neither the area nor the local market) is fully informed of inventory that might meet his criteria.  The Agent is then supposed to apply his expertise to ensure that the Buyer can purchase his desired property as expeditiously and cheaply as possible.

In reality Buyer’s Agents are typically nothing more than glorified chauffeurs, whose only interest is getting a Buyer into a property as quickly as possible.  Why?  Because they get paid for closing a transaction.  And, in fact, the more you spend the more they get paid.  Granted, their commission is traditionally paid by the Seller.  But this is an odd and counterproductive tradition.

In this age of broadband internet and consumer navigation systems there is really no need for a traditional Buyer’s Agent.  The problem is that the Realtor cartel is keeping incentives for Buyers to use them: If you buy a house without an agent, you don’t get a rebate.  If you buy it with an agent, the Seller pays double the commission — and the Buyer’s Agent gets half of it!  As a Buyer, why wouldn’t you use an Agent, when the cost to you is essentially nothing?

The answer is that Buyer’s Agents have incentives that are somewhat at odds with the interests of Buyers.  Both parties want to see the Buyer buy a property.  But the Buyer wants to find the best possible property at the best possible price.  The Agent — whose entire compensation comes as a percentage of a closed deal — wants the Buyer to end up in the most expensive possible property as quickly as possible.

At times the incentives may be even more opposed, as The Wall Street Journal highlights in today’s article, “Do Real-Estate Agents Have a Secret Agenda?

Real-estate agents increasingly have lucrative incentives to push one home over another.  Slow sales have prompted builders and some individual sellers to offer unusually generous incentives to agents whose clients buy a home. Sellers normally pay the buyer’s agent 2% to 3% of the home’s price. Now many are offering thousands of dollars or other rewards, such as travel vouchers, on top of the normal commission.

The problem with agent incentives is that consumers may not know their agents have a potential conflict of interest when they show and discuss certain properties. Of course, agents can’t make buyers want to buy an unsuitable home, and most buyers have strong ideas of their own. But agents can have a big influence on which homes consumers see. And agents’ influence can be particularly strong with newcomers to an area who don’t know which builders are considered most reliable and which neighborhoods most appealing.

The obvious solutions to the myriad problems surrounding Buyer’s Agents:

  • Buyers should pay a lawyer or licensed real-estate professional directly (by the hour, or by the job) for helping them to negotiate or close a deal.  That is the only way to ensure that the Buyer’s interests are represented.

  • Buyers should require that any additional compensation accrued by their Agent in the course of a transaction be given to the Buyer.  I.e., there is no reason for the Agent to enjoy an undisclosed kickback in the course of his employment for a Buyer.

  • If Buyers need the “search” services provided by the traditional Chauffeur Agent, they should agree to compensate the Chauffeur for his services but should require that any excess commission the Chauffeur earns from steering the Buyer to a deal should be returned to the Buyer.