Economic incentives: real state transactions

“People respond to incentives.”

Steve Levitt

A few months ago, I decided to sell my house. While, in theory, it is a straightforward task, it isn’t clear. I received a couple of evaluations with a difference between them of 25%: for some agents, my house values X, and for others, it values X + 25% more. Plus pandemic, plus changes in the behavior of the people about where they want to live. So, understanding what could be a fair price is anything except a simple task.

And at that moment come to my mind a concept expressed by Stephen Levitt in his book “Freaknomics”: economic incentives.

He expresses that incentives could explain all human behaviors. Levitt’s original book outlines three different incentives: economic incentives, social incentives, and moral incentives. He suggests that all human behavior and any change in the economic world can be explained by one or more of these incentives.

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What is an incentive?

In plain language, an incentive is a carrot that moves you for something: doing exercise every day to be fit, study more to get a better salary, start the day earlier to maximize your time. Also, it could be a stick, for instance, the doctor’s recommendation to avoid certain kinds of food. In a less informal definition, an incentive is a concession to stimulate greater output. According to Levitt, there are three incentives: economic, social, and moral.

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The Value of Information in Real Estate Transactions

Levitt and Syverson, in their paper, “Market Distortions when Agents are Better Informed: The Value of Information in Real Estate Transactions” show the asymmetrical benefits for agents and homeowners.
For instance, real estate agents, better informed than their customers, could exploit this benefit to convince their clients to sell their houses too cheaply and too quickly. After all, agents receive only a tiny share of the incremental profit, so they have an incentive to sell their homes fast.

Let’s analyze an example. An agent usually received a 3% of the transaction value plus another 3% from the customer. Usually, a property is listed by the number known as “the list price.” After negotiations, the agreement could be in a number between 8% to 13% less.

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How much lost agent and seller in both cases?

Considering the worst-case scenario for the seller: the house goes down to 13%, in that case, the house owner lost $ 5000 vs. just $150 for the agent. The opposite is valid, too; if the property goes up, the agent wins $150 for his challenging job. So, it is where there is no incentive for the agent to obtain a better price.

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Possible solutions

A possible solution could be offering a 0.5% more in the case, only if the house is sold with a loss of up to 8%