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September 03, 2006

Information Arbitrage in Real Estate

One industry that’s a last bastion of the pre-internet world is real estate, where information arbitrage has long been real estate brokers’ competitive advantage over home buyers. For background on arbitrage, read Roger Ehrenberg’s recent post or Wikipedia.

But the real estate industry has been resisting the free information trends of the internet for a long time because it threatens the commission structure that’s a bedrock of the chummy industry. I don’t need to elaborate about how the internet is starting to fundamentally change the real estate market like it did so quickly and completely with the travel industry, but this NYTimes article today had a new insight on this discussion:

“But the typical 6 percent commission, paid out of the seller’s proceeds and split between the seller’s and buyer’s agents, is under attack because, as economists note, it does not serve consumers well.

Economists who have studied the current system say that it also does little for most agents — except for a few stars, whose impressive earnings give hope to the large majority of less-successful agents and thus encourage them to protect the status quo.”

Of the reasons that I’ve heard for the real estate industry to open itself to competition (the brokering of buyer and seller can be done more efficiently and cheaper through electronic rather than personal connections- like the battle over electronic trading on the NY Stock Exchange), this is another reminder (Freakonomics concluded the same thing) that economics may be the strongest argument for eliminating the practice.

“Some economists wonder why agents fight so hard to maintain this pricing system when it is making so few of them rich. In every housing boom, the number of new agents entering the market tracks the climb in home prices. As a result, the average agent sells far fewer homes and makes less money.”

I am no economics scholar but I fundamentally believe in the efficiencies of the marketplace and the real estate industry is one ripe for overhauling. Let’s hope that the internet continues to dismantle the information efficiencies that have long fostered the power of the agents over the buyers.

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