The Housing Market and Real Estate Brokers

By Mantrala, Suryamani; Zabel, Edward | Real Estate Economics, Summer 1995 | Go to article overview

The Housing Market and Real Estate Brokers


Mantrala, Suryamani, Zabel, Edward, Real Estate Economics


Edward Zabel [**]

Suryamani Mantrala [*]

The major development in this paper concerns the failure, in earlier studies, to consider interaction between alternative methods of arranging sales in the housing market. A seller may market a house by direct negotiations with buyers, without the intermediation of real estate brokers, or by listing the house with a broker. A rational seller would choose the option which offers the higher expected return on the house. In a sequence of models we argue that the seller's option of a method of sale induces competitive pressure in the choice of the commission rate by the broker. We also consider the split rate in a multiple listing system, ease of entry of brokers and the cartel hypothesis as applied to brokers. We conclude that the competitive pressure of direct negotiations between sellers and buyers, relative free entry of brokers and the inappropriateness of the cartel hypothesis cast serious doubt about a general consensus of opinion that the brokerage system is characterized by price fixing, excessive commis sions and excessive marketing costs.

Expenditures on housing are a large component of household spending. These expenditures are an important economic indicator in a major industrialized economy such as the United States. Despite the obvious importance of the housing market, until recently, (beginning about 1980), little attention has been devoted to an analysis of how this market operates. A recent survey of the housing market literature by Smith, Rosen and Fallis (1988), in particular, suggests a shortage of analytical and empirical work incorporating the important role played by real estate brokers. [1] The focus in this paper is the interaction of various agents in the operation of the housing market, evaluating and extending work of other authors.

The principal agents involved in housing market transactions are the seller of a house, the buyer of a house and the real estate broker. The main function of the real estate broker is matching prospective sellers and buyers. Various characteristics of the housing market complicate the matching process. Among these characteristics are: (1) fixed locations of houses; (2) heterogeneity of houses; (3) infrequent transactions among sellers and buyers; and (4) complexity arising from the financial and legal dimensions of the transaction.

Real estate brokers facilitate the matching process in various ways. They collect information about prospective sellers and buyers of houses, provide familiarity with bargaining and special details of real estate transactions, may function to mediate differences between principals and may expedite a transaction by providing guidance and information about the settlement process. For these services the broker charges a commission, usually from the seller. [2]

Various theoretical papers now study the operation of the real estate market, emphasizing the choice of the commission rate, housing prices, search for buyers and sellers and the role of the multiple listing service (MLS). Notable papers are Yinger (1981), Crockett (1982), Wu and Colwell (1986) and De Brock (1988, 1989). [3] These studies tend to support a general consensus of opinion that the market provided by real estate brokers is characterized by price fixing, excessive commissions and various inefficiencies. [4]

The major development in this study concerns the failure, in each of these papers, to consider interaction between alternative methods of arranging sales in the housing market. A seller may market a house by direct negotiations with buyers, without the intermediation of real estate brokers, or by listing the house with a broker. The two options offer a different menu of costs and probabilistic features of the search process among buyers and sellers. In the first option the seller incurs the cost of searching for buyers, the cost of showing the house to prospective buyers and the cost of holding the house until a sale occurs. …

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