Freakonomics: Problem solved

Todd Miller: Hello and welcome to Todd Miller TV. Thank you for tuning in. Yesterday I was talking about Freakonomics, analysis of the book, by a couple of PhD economist types and they’ve done an analysis of real estate agents and how the real estate agent’s compensation was not well tied to a homeowner. And I wanted to go over that because they did a really good job explaining what didn’t work but they never once suggested something that would work. So what I want to do is I want to take a real world look at this and actually suggest something that you as a seller or you as an agent can propose to the other party as a form of compensation because compensation is all negotiable.

So in the book what they talk about is a seller has a house that they’re selling for $300,000 and 3% which is traditionally what the listing side gets which is the market rate, in some markets it’s more in some it’s less, it’s about $9000. That’s the total commission paid to the company. Of course the agent doesn’t get all that, it gets split out and everything, right? So what they argued in the book was that if the house sells for $10,000 more, I mean if this agent negotiates really well and markets it and gets $10,000more, they only get $600 total to the company and of that $600 – that’s actually not right – they’re only going to get $300 because they’re only get 3%, $600 would be the total commission. They probably would only get $150 of that. So they’re only going to get 3% and if they negotiate it down $10,000, down to $290,000 they’re only going to loose $300. So the point they make in the book is real estate agents don’t have a really strong incentive because it’s only $300 to them for $10,000 whereas they’re getting close to $9000 either way. They’re good – well they did a great job of showing that but they never really showed an alternative model. I want to propose one that I think is very well tied together. So let’s take the same model where there’s a $300,000 sale – if that’s about what the house is worth – it could be worth more or less.
The agent company gets paid $9000, just the listing side not the agent who works with the buyer. What you do then is you take that as a base and you say anything over that you’re going to get a 20% incentive. So it’s like being on an 80-20 split on the upside. What that does is it incentivizes the agent to negotiate harder because they sell the house for $300,000 — they get a $9000 commission. However, if you get $10,000 more, if the agent’s really good, they market the house, they negotiate the deal out, they’ll get $11,000 or $2000 more than up here – there’s only $200 – so there’s a very strong incentive. Now there’s a backside of that and this is the backside: if they don’t do a good job they only get $7000, they loose the $2000 commission because they didn’t negotiate very hard or whatever where here they only loose $300. So their incentive is more tied to getting a better deal for the buyer, just think about it – for the seller because if you think at $320,000 and if they’re doing all these things then they’ll get even more money and if they’re lazy and they’re pushing the seller to take this deal for $280,000 well they’re only going to get $5000 – that’s not in their best interest to do that. So this is a perspective model, you can break this up any way that you want, as long as it’s legal in your jurisdiction and everything. All commissions should be negotiable, there are no set rates, but this is a model that would work. It would be interesting to see the Freakonomics guys, talk about this, and maybe have their own proposal for how this could be structured in such a way where it’s good for the seller, it’s good for the agent, and then we could sort of move beyond the – well the agent’s not acting in the seller’s best interest. I think this is a good model. It would be interesting to see if some people out there employ this and what result they have. Anyway, that is my update for today, thanks for tuning in.