Freakanomics Friendly


I was at a party the other night, speaking with someone I just met about the North Berkeley real estate market, and whether houses were still selling quickly and with multiple offers. I stated that while general headlines are reporting on a market decline, North Berkeley is, with some exceptions, still doing very well. When the conversation came to the prospect of selling his house, he casually stated that if he did sell, he’d keep his house on the market longer and would get 10% more than everyone else. I had to chuckle-I immediately recognized this as a reference to the book Freakanomics, by Steven Levitt and Stephen Dubner, where the authors state that research shows that when a Realtor sells her own home, it stays on the market longer and sells for 10% more than her client’s homes.

I don’t have the book in front of me so I can’t check what “research” actually shows this. But I most certainly take exception. I’ve sold a few of my own homes and can not brag any such thing.

A house will sell over its asking price if the asking price is artificially low and it is sufficiently marketed. Deliberate underpricing is a very easy way to warp statistics to benefit the agent. Up until recently, this practice was practically epidemic (see “The Underpricing Epidemic”). It allows the agent to brag “my marketing efforts and negotiating skill produced multiple offers and a sales price 25% over asking.” Most people don’t seem to realize that, on its face, this is completely meaningless. Any idiot who underprices a house when demand is high will get the same result. The more interesting question is what would have happened if the agent priced the house at the number she really thought it was worth.

The authors big beef with Realtors seems to be around the notion of information asymmetry. We know more than the buyers/sellers and use this information solely to enrich ourselves, not our clients. They see the ever increasing availability of information on the internet as the beginning of the end of real estate brokerage as we know it. They even go as far as to equate the demise of the Ku Klux Clan with what will happen to Realtors.

Back to the party I was attending. My new friend was clearly impressed that I knew to what he was referring. It then gave me a chance to talk about how my real estate brokerage practice was different from most, and that I would not only sell his house for the absolute highest price the market would bear, but also charge him many thousands of dollars less in commissions.

He asked for my business card, but alas, after searching around in my wallet, I told him I’d have to got out to my car to get one. He said no problem-he’d take a walk with me. I guess I made a good impression.

A Company Doesn’t Sell a House

An Agent Does

The Emperor Has No Clothes!

Does the name of the “For Sale” sign in front of a house make any difference in its sale price? The truthful answer is, of course, no. A company doesn’t sell a house – an agent does. And there are good agents and not-so-good agents and any given company is going to have some of both. But the fact remains that there are some sellers who make their choice of who to list with based on the company name.

I guess it boils down to the mystique of “branding.” On any objective basis, there often is no qualitative difference between one product and another. In fact, in some cases two differently branded products come from the same factory, produced to the same exact specifications. The only difference is the name on the label, and a 500% difference in price! It never ceases to amaze me that some people will pay such premiums, not for any assurance of inherent quality, but simply for the snob appeal of a name.

In real estate, a similar phenomenon occurs. Some companies spend millions of dollars to brand themselves as the Gucci of companies. List your house with us, they say, because our name is synonymous with high class, and high class will attract a higher paying buyer. Newsflash: the emperor has no clothes! Houses aren’t sold this way. The majority of times, a buyer is represented by an agent from a different office. The buyer could care less who the listing agency is.

The best service comes from the best agent, period. Everything else is simply smoke and mirrors, or to borrow from Macbeth, “sound and fury, signifying nothing.”

No Pre-Inspections

While the current home sale market is considerably cooler than in the recent past, there still remain many pockets of under-supply and over-demand. North Berkeley is a good example, where homes are still receiving multiple offers and large overbids. When a house for sale is vacant, one of the ways buyers make their offers more competitive, aside from price, is to have the property “pre-inspected” by a professional home inspector, with the idea to make an offer without an inspection contingency. While it can seem very attractive to a seller to receive a non-inspection contingent offer, there are larger issues at stake that make me recommend to my sellers that I expressly prohibit a buyer from pre-inspecting.

What’s wrong with allowing pre-inspections? It’s not really fair, for one thing. In effect, the seller is asking buyers to spend somewhere $500-$700 for an inspection on the speculation that their offer will be accepted. Well, only one offer will be accepted, leaving every other buyer with a useless report and a lighter pocket. Now repeat this process several times with several properties and you can see how a buyer might get more than a bit annoyed. So even when the buyer finally does get into contract, he is predisposed to being unhappy. This is usually not a good recipe for living happily ever after.

For another thing, allowing pre-inspections creates a logistical pain-in-the-ass. There have been many occasions where several groups of buyers, their agents, and their inspectors are all at the house at the same time. I can assure you, the only people happy with this scenario are the inspectors.

The remedy of all this is simple: allowing for a few possible exceptions (major fixer uppers, for instance), listing agents should prohibit buyer pre-inspections. Assure buyer’s agents that a reasonable inspection contingency period in an offer will not be held against them. This way, buyers can compete strictly on price and other terms.

This isn’t just touchy-feely stuff. It is my experience that when a buyer feels fairly treated, they will offer more.

The listing practice of not allowing buyer pre-inspections should go hand-in-hand with the seller providing a very good disclosure package. I’ll discuss this in my next posting.

Optionee Remorse

You’ve probably heard about buyer remorse, where at some point in the purchase of a home the buyer regrets their decision to either buy, or not buy. Optionee remorse is similar, but drawn out over a much longer time frame.

An optionee, in this discussion, is a person who has negotiated a purchase price today for a purchase they will make sometime in the future, say, a year from now. In an appreciating market, setting a price today can potentially mean you will be buying below the then-market value, assuming the market continues to go up. In a declining market, negotiating a price today, trying to take into account what might happen in the future is an obviously risky thing. How risky depends on the terms of the option.
Last year in August, I negotiated a $2.3m home purchase to take place one year later, now in mid Aug 2007. During this yearlong period, my client would rent the house, with 100% of the rent ($9k/mo x 12 months) applied towards the eventual purchase. There was also an up-front payment to the seller of $48k, also to be applied to the purchase.

Now, by definition, an option to purchase is just that, an option. The buyer can choose not to go through with the deal (i.e. not exercise the option). But in this case, not exercising the option meant the buyer would walk away from a total of $161,000 in credits towards the purchase (all the rent, plus a $5k security deposit, plus the $48k option money).

Of course, walking away from $161,000 in purchase credit is no small thing. But it might make sense if the market has gone down during the period of the option. $161,000 divided by the $2,300,000 purchase price is 7%. Has the market for luxury homes in this neighborhood gone down at least 7% in the last year? This was a hard question to answer, namely due to the paucity of similar inventory. Intuitively, it seemed like it had, so the price negotiated a year ago seemed too high for today’s market. The buyers felt like they would be significantly overpaying for the house, and rightly worried whether they could get their money out if they had to sell within a few years.

Oh, another wrinkle: the jumbo mortgage market was melting down. Luckily, the buyers had locked in a great loan rate for the option house, but if they purchased any other property, the interest rate would have been several percentage points higher.

Given all these market changes that had occurred over the last 12 months, the buyers felt like they had a good argument to make asking the seller to lower his price, to $2,100,000. Unfortunately, the seller wasn’t as pessimistic about the market as the buyers were. We were told to exercise the option on its original terms, or walk away.

You start to see the buyer’s conundrum, and the cause for remorse. Should they exercise their option to purchase (they do love the house, by the way), or go back into the marketplace and hope to make up the $161k loss by finding a comparable house at today’s lower prices? This amounted to the perfect storm of anxiety for the buyers.

What happened? Over a period of several weeks, the buyers looked at every other house on the market, none of which sufficiently appealed to them. So they decided to stay put, exercise the option, and hopefully not have to sell the house anytime soon.

This entry was posted in Buyers