Endangered Species

Published: March 5, 2006

The Boston-Minneapolis Hypothesis

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Illustration by Giampietro+Smith

It is hard to think of an occupation that garners less goodwill these days than the real-estate agent. More often than not, agents are portrayed as hustlers or sharks, unimaginative opportunists who, for not all that much effort, pocket a significant chunk of the sale price of your home. A great many of these agents and brokers, more than 1.2 million, belong to the National Association of Realtors, which the Department of Justice accused in a recent lawsuit of behaving like a cross between a cartel and a mafia, hoarding access to home-sale databases and harassing competitors who dared to offer discounted commissions.

Even if you believe all these terrible things about real-estate agents, however, you should try to find in your heart a bit of sympathy for them. There are two reasons for this.

To examine the first reason, ask this question: Who has prospered during the recent real-estate boom? Home sellers, to be sure, along with developers, mortgage brokers — and also, you would assume, your average real-estate agent. These agents have rung up millions of sales while home prices have been doubling and even tripling. Since an agent's commission is usually based on a fixed percentage of the sale price — typically 5 or 6 percent, of which about half goes to the listing agent and half to the buyer's agent — agents' fees have climbed along with home prices, even though they probably don't have to work any harder to sell an $800,000 house than they do a $200,000 house.

A listing agent really only performs four main functions: setting the price of your home, finding potential buyers, prepping and showing them the house and handling the negotiations and contracts. Just for fun, let's put a value on each of these functions. Setting a home's asking price requires a few hours of work at most, studying the house and the data on comparable sales. Showing the typical home might take 20 or 30 hours, with negotiations and contracts taking maybe four hours. Attracting potential buyers is of course the trickiest task — which is why, as the Justice Department alleges, Realtors have tried to block access to the for-sale databases. But it's now easy to find independent or discount agents who will list your house on the Multiple Listing Service for a fee of about $750.

So in sum, we are talking about perhaps 40 hours of work. Let's be generous and say that's worth $100 an hour. Add another $750 to list the home. That's a total of $4,750, which makes the 6 percent commission that you would pay on the sale of a $500,000 house — $15,000 each to your agent and the buyer's agent — look pretty steep. It would seem obvious that being an agent during a real-estate boom is a great way to earn a good living.

As it turns out, however, most agents don't make very much money during a boom, because of one simple fact: the boom attracts way too many of them. Over the past 10 years, membership in the N.A.R. has risen by more than 75 percent. And why not? Compared with most professions, becoming a real-estate agent is quick, cheap and relatively painless. In economics, this phenomenon is known as free entry.

In a 2003 paper titled "Can Free Entry Be Inefficient?" Chang-Tai Hsieh and Enrico Moretti, economists at the University of California, Berkeley, examined the income of real-estate agents in various markets under various conditions. Relying on data from the Census of Population and Housing in 1980 and 1990, Hsieh and Moretti compared home sales in 282 metropolitan areas. But their story can be told using just a pair of cities: Boston and Minneapolis, which are similar in size and demographics — but quite different in the price of their real estate.

In 1990, a typical house in Boston cost roughly twice as much as a typical house in Minneapolis. Since commission rates were fixed, an agent would earn twice as much selling a house in Boston. But the Boston market, with so much more commission money up for grabs, attracted many more agents than Minneapolis did — even though it turned out that more homes were actually being sold in Minneapolis.

The result? The typical Minneapolis agent sold twice as many homes (6.6 per year) as the typical Boston agent (3.3 per year) — which left the Boston agent, despite the higher prices in her market, no better off than her Minneapolis counterpart. What should be a competitive marketplace — which would inevitably lead to lower prices — is not, since the price of the agents' service is essentially fixed in place.