Understanding in‐house transactions in the real estate brokerage industry

• Date: 01 November 2016
• Author: Lu Han,Seung‐Hyun Hong
• DOI: http://doi.org/10.1111/1756-2171.12163
• Published date: 01 November 2016

RAND Journal of Economics

Vol.47, No. 4, Winter 2016

pp. 1057–1086

Understanding in-house transactions

in the real estate brokerage industry

Lu Han∗

and

Seung-Hyun Hong∗∗

About 20% of residential real estate transactionsin North America are in-house transactions, for

which buyers and sellers are represented by the same brokerage. We examine to what extent in-

house transactions areexplained by agents’ strategic incentives as opposed to matching efficiency.

Using home transaction data, we find that agentsare more likely to promote internal listings when

they are financially rewarded and such effect becomes weaker when consumers are more aware

of agents’ incentives. We further develop a structural model and find that about one third of

in-house transactions are explained by agents’ strategic promotion, causing significant utility

loss for home buyers.

1. Introduction

Over 80% of home buyers and sellers carry out their transactions with the assistance of

licensed real estate agents. Yet concerns persist that incentives betweenreal estate agents and their

clients might be misaligned, thus causing a loss in consumers’ welfare. A growing literature has

studied such incentives issues and market efficiencies in real estate brokerage markets, focusing

on home sellers and their agents (see, e.g., Levitt and Syverson, 2008a, 2008b; Hendel, Nevo,

and Ortalo-Magne, 2009). In this article, we aim to contribute to the literature by examining

a misalignment of incentives between home buyers and their agents, particularly involving in-

house transactions, that is, transactions for which buyers and sellers are represented by the same

brokerage office.

In-house transactions account for about 20% of transactions in North American hous-

ing markets. In theory, in-house transactions could create informational advantages and reduce

∗University of Toronto; lu.han@rotman.utoronto.ca.

∗∗University of Illinois; hyunhong@illinois.edu.

We thank the Editor, Chad Syverson, and two anonymous referees for helpful comments and suggestions. We also

thank conference participants at SITE 2012, Pre-WFA Summer Real Estate Symposium 2013, Rotman Real Estate

Microstructure Conference 2013, AREUEA Meeting 2014, Israel Real Estate and Urban Economics Symposium 2014,

Barcelona GSE Summer Forum2015, as well as seminar participants at the Atlanta Fed, KoreaUniversity, National Science

Foundation, Penn State, Seoul National University, UC Berkeley, UIUC, University of Amsterdam, and University

of Toronto for their helpful discussions. Lu gratefully acknowledges financial support from the Petro-Canada Junior

Professorship in Business Economics.

C2016, The RAND Corporation. 1057

1058 / THE RAND JOURNAL OF ECONOMICS

transaction costs, in which case buyers may receive higher utility from internal listings than ex-

ternal listings, thus resulting in efficient matches. However, given that in-house transactions help

clear inventories and maximize total revenues faster,brokerage firms often pay a higher commis-

sion to reward agents engaged in in-house transactions (Gardiner et al., 2007). As a result, agents

may strategically promote in-house transactions for their own financial interest. Such strategic

in-house transactions, if present, can entail a suboptimal choice for consumers in the search stage

and an apparent conflict of interest in the negotiation stage. For this reason, many jurisdictions

have now introduced disclosure requirements for dual agency in order to help consumers avoid

unintended dual agency relationships.1

This article investigates strategic in-house transactions by analyzingreduced-for m evidence

to test their presence, and by employing structural estimation to quantify their magnitude and

welfare implications. Tomotivate our empirical strategy,we consider a simple agent-intermediated

search model and examine under which circumstances agents are more likely to strategically

promote in-house transactions. The model shows that when agents are financially rewarded by

their brokerage for selling internal listings, the informational advantage of agents may compound

incentive conflicts, thereby enabling cooperating agents (i.e., buyers’ agents) to steer buyers

toward internal listings, despite the availability of better external listings. Their ability to do so,

however, decreases when clients are more informed about agents’ incentives. Furthermore, the

resulting efficiency loss for home buyers depends on the difference in the expected matching

quality buyers obtain from internal and external listings.

We test these implications, using a rich data set from the Multiple Listing Service (MLS)

in a large North American metropolitan area. Our empirical strategy is akin to a difference-in-

differences approach. Wefirst exploit differences in commission structures. Specifically, agents in

a traditional brokerage firm split their commission revenues with their firm on the per-transaction

basis. Full-commission brokerage firms, on the other hand, allow their agents to retain 100%

of commission revenues but require fixed amount of upfront fees instead (Munneke and Yavas,

2001). Because the traditional brokerages’ revenues strictlyincrease with the number of either end

of transactions, these firms are more likely to offer their agents higher bonuses for promoting in-

house sales (Conner,2010). Such promotion bonus would be particularly attractive for cooperating

agents if commission fees they receive from listing agents are lower than the market rate.

Nevertheless, these commission-related effects alone can be problematic, as the commis-

sion structure/rate could vary endogenously with the degree of matching efficiency in in-house

transactions. Hence, we further examine differences in different commission incentives before

and after the implementation of a new legislation (Real Estate and Business Brokerages Act,

or “REBBA,” henceforth) that requires agents engaged in in-house sales to inform their clients

about the dual agency relationship in writing. To the extent that the REBBA informs consumers

more about the agency relationship and related incentive issues, it can constrain agents’ ability to

promote internal listings, but it is unlikely to affect matching efficiency in in-house transactions.

Thus, the identification in our model does not require the commission rates or split structure to be

exogenous. Instead, it relies on the assumption that no other commission-related factors, except

for the REBBA, differentially affectthe incidence of in-house transactions when the REBBA was

implemented. To ensure our assumption, we control for a large number of time-varying house

and brokerage observable characteristics. To allow for possible time-variation in unobservable

house and brokerage characteristics that may be correlated with commission variables, we also

include the interaction of the REBBA with house fixed effects as well as brokerage fixed effects.

In addition, we find no systematic changes in observed attributes of houses sold under differ-

ent commission structures before and after the REBBA, providing reassuring support for our

identification assumption.

1Massachusetts, for example, requires that real estate brokerages and agents involved in dual-agencytransactions

obtain informed written consent from both sellers and prospective buyers before completing a transaction (254 Code of

Massachusetts Regulations). Similar laws havebeen implemented in other states, including Wisconsin and Illinois.

C

The RAND Corporation 2016.