As always, also on my blog with footnotes

Today I'll show why it is a big mistake to hire a real estate agent if you are selling your house (in the current market).

In common practice, the real estate agent takes a percentage cut from the sales price. In exchange they help you sell your house.

People intuitively think that the seller will pay the agent's fees, through a higher price. For instance, if you planned to sell your $100k you might sell it for $106k to cover the agent's 6% fees.

Is this really the case? First, we need a detour through the economics of cost incidence.

Cost Incidence

We've known for a long time that the financial burden of a cost rarely falls where you think it will.

For example, if the government implements a tax on corporations, the incidence might fall on the employees, customers or shareholders[footnote]Not the corporation. Despite what people will tell you, the corporation isn't a person. A person will end up paying the tax[/footnote]. Who ends up paying it is generally the result of the web of bargaining power relationships between each economic agent.

You can visualize bargaining power as a gradient from monopsony (one buyer) to monopoly (one seller)

For instance, in microeconomics 101 we'll tell you that a worker's wage (W) is equal to their marginal product of labor (MPL):

W = MPL

This equation makes no sense to anyone who's ever worked - if I produce $250k worth of value for my employer, surely I'm paid less than that. A better model of wages would be this:

W = θ * MPL

Where θ is the bargaining power parameter between 0 and 1 we've seen above. Example where θ ~ 0 would be volunteer work, where the worker is so happy to do the work they do away with wages entirely.

You can find instances where θ ~ 1 in certain CEOs holding a stranglehold over a company. One example would be Adam Neumann, who cost $1.7B to fire as CEO. Another would be Elon Musk, who leads a postmodern pseudo-cult. Which means Elon's company, Tesla, can save on marketing costs and have a hilariously overvalued stock. But these only happen because of Elon specifically - he has θ = 1 against Tesla. Elon can capture all the economic value created from his cult of personality and put it in his pocket.

As a sidenote, low worker θ is currently a huge, society-wide problem. The term to look for is monopsony in the labor market. It's the consensus from labor economics researchers that firms are maintaining monopsonies (either naturally or by cooperating to suppress worker wages) and lower worker bargaining power for profit.

Bargaining Power in a Home Sale

It's easy to apply bargaining power analysis to a home sale. If there are few people selling their homes and many looking to buy, then θ is high (monopoly). In the reverse case, θ will be low (monopsony).

The concept of economic surplus now comes into play. A seller has a price where they're indifferent between selling or not at this price. This is sometimes called a reserve price. Any price above that is a "surplus", which makes the seller happy.

Same thing for a buyer - they have a maximum reserve price, and buying below that is surplus for the buyer.

If θ=1 there is only one seller, and a near infinity of potential buyers. In a bidding war, the buyer will often be told "you should bid something you won't regret if you lose" which is human-speak for "bid your reserve price". In this case, the sales price would be close to the highest buyer reserve price of the market. The buying market is "tapped out".

Conversely, if there was one buyer and many sellers then the sales price would be the lowest seller's reservation price.

What does this have to do with agent fees?

In a "hot" market, where θ ~ 1, the richest buyer is already paying their maximum possible price. The real estate agent's fees are built into that maximized price, so they can only be deducting from the seller's economic surplus.

Conversely, in a market where θ ~ 0, the poorest seller is selling for their minimum possible price, so the real estate agent fees end up actually being paid by the buyer.

Takeaway:

In very hot housing markets, the seller pays most the real estate agent's economic cost. In cold markets, the buyer ends up paying more of the cost.

Why you shouldn't hire an agent

Now we've established that in a hot housing market (like today), the seller is bearing the economic cost of the real estate agent.

It's somehow a contentious issue that real estate agents are of any help to the seller hiring them. It shouldn't be. In a market where sellers have the bargaining power, the seller outright loses heaps of money by hiring an agent.

There's this famous freakonomics chapter making the claim that agents are incentivized to sell the house fast, rather than for a high price . We don't need to speculate on the effect: there are studies on the matter and they show the seller clearly losing value. Losing 6% of your house's sale price is a lot of money! For most people this is the equivalent of months of work.

Let the auction do the work for you

Despite the data showing that agents don't help the seller get a better price, you may argue that perhaps arranging the final sales price is a difficult job. A job so complex that only a veteran real estate agent can do it for you.

Nonsense.

In a hot market, the price is simply set by a first price auction. In the current housing market in Montreal, it's common to for agents show a house for a week, and ask for all offers to be made blindly by a specific date.

There isn't much to do here! The first price auction will lead to buyers bidding up to their comfort level given the amount of competition they expect to run into in the bidding war. You simply don't need an agent to ask for people to submit a bid by a certain date.

Real Estate Agent Fee Bargaining Power

Real estate agents are harmful to their clientele. Moreover, showing houses and making sure buyers and sellers are signing the correct pre-prepared paperwork isn't rocket surgery.

In a perfect world, competition would enter to ensure that real estate agents' bargaining power against home buyers and sellers get close to θ ~ 0. They shouldn't be able to suck much money out of the economy and buy their Mercedes with.

But clearly agents are buying overpriced German sedans. Then, why isn't the agent's cut driven to zero?

...

Because real estate agents are unionized!

Unions are a great way to increase your θ. They create a pseudo-monopoly where there normally wouldn't be one by aggregating many economic agents into a single one.

In my province (Quebec), agents literally have a union. It of course does occupational licensing, the thing all good economists hate. They also somehow managed to win a court case letting agents have exclusive access to sales price data, permanently harming housing market researchers. Look at them being mad at self-listing services

ppl r dumb lol

Its clear than in a hot market, sellers should not be hiring an agent. If you hate money so much, please just give it to charity instead.

Even worse, it seems that sellers somehow pay agents at a price point of θ > 1 - Since agents lose money to their client, their wage is above their marginal product of labor. This means θ > 1!!

This is crazy. It shows why predicting economic behavior is difficult -- people are very very dumb.

I couldn't easily access to self-listing versus agent-listed data, but in Quebec the two are easily segregated into two websites: centris.ca (agent) and duproprio.com (self-listing). An agent told me around 97% of homes were sold through agents. This checks out with google trends data on the two listing platforms:

What's impressive here is that self-listing popularity did not increase as the Canadian housing market went through its hottest period in history! Home sellers are completely inelastic in their listing strategy to the market conditions, even if it costs them very large sums of money.