Musings On Incentives

I had a long conversation recently with a friend who is serving as the president of a large REALTOR Association. He had heard my latest podcast in which I debate two of my friends about the value of the REALTOR brand, about the Association, about professionalism, and so on and he had questions. It was a great talk, and his basic question was how he and his Association could improve the situation… but realistically.

After we hung up, I began mulling some of the things we discussed in between actual client work. The thing that occurred to me was that we talked a lot about what the Association can and cannot do, should and should not do — but in terms of policy and activities. We didn’t really dig into the issue of incentives.

It is sort of a truism… maybe I could call it an axiom of economics that people respond to incentives. You get more of what you incentivize, and less of what you disincentivize. That’s the theory in tax policy: subsidies for solar power because we want more of that, and taxes for cigarettes because we want less of that. Neither have much to do with raising revenues for the government; both have to do with encouraging more of one and less of the other.

I am not in the least bit ashamed to say that my favorite economist is Thomas Sowell, and one of his quotes is:

As I kept thinking about the question of incentives, however, it occurred to me that if incentives lead to more of what you incentivize, then logically, getting less of something means you have not incentivized that activity. (This is the “If A then B = If not B then not A” or modus tollens. I almost made the error of affirming the consequent… but anyhow….)

Critically, intentions have nothing to do with that state of affairs.

And if Dr. Sowell can apply the logic of incentives to economic policies, it seemed to me that we might profitably apply the same logic to Association and MLS policies as well as brokerage and agent behavior. It seems to me that the real estate industry is full of such examples where intentions and hopes are divorced from incentives and outcomes.

The Eternal Question of Professionalism

Let me start with the topic that my Association president friend raised: REALTOR professionalism. We know for a fact that this topic more than any other has been, is, and likely will be a perennial complaint in the industry. Various solutions and suggestions have long been floated: licensing should be more difficult, dues should be raised, there should be more of a penalty for unprofessional behavior, etc. None of them have actually produced the outcome we all say we want: more professionalism among REALTOR ranks.

[I do note that “professionalism” is ill-defined in the industry. Broadly speaking, it appears to kinda sorta refer to adhering to the Code of Ethics or at least the principles in it, along with some notion of fiduciary duty to the client and courtesy to other professionals. But it is not well-defined. That might lead to differences in opinion on my thoughts below.]

I have long had my own theories on why we don’t have more professionalism in the industry but applying the logic of incentives, I have to conclude that the lack of professionalism means that we have not incentivized professionalism. (“If not B, then not A.”)

So let’s think about this: What incentives are there to be professional?

Do more professional REALTORS make more money? That can’t be the case, or else, we’d have more professionalism since incentives –> more of what is incentivized. And off the top of my head I can think of a number of ways in which behaving in an unprofessional manner makes you more money: double-ending deals, manipulating clients, playing favorites with offers from friends, etc. Furthermore, I have heard from too many people I truly respect that some of the worst offenders, some of the least professional REALTORS, in their local markets are the top producers who rake in millions.

Do more professional REALTORS get higher social status? Everybody wants to be be liked and respected, and one might think that those REALTORS who behave in exemplary fashion might find themselves higher up on the social ladder. That would be a powerful incentive to do the right thing all the time. But again, having less professionalism suggests that it is not incentivized, which argues against the proposition that professionalism –> popularity.

In short, it is not obvious to me that there are any extrinsic incentives for REALTORS to be more professional. It’s difficult to see what the concrete benefits are to the REALTOR — money, fame, status, etc. — for being more professional. It is easy to see what the concrete benefits are to the REALTOR to be less professional: money.

Most of what drives professionalism in real estate appears to me to be intrinsic incentives: how being more professional makes that individual REALTOR feel about himself or herself. There are moral and emotional rewards from a job done well, from having served the client as best as one could; and for some, that’s reward enough. For most human beings, it is not.

So instead, the industry as a whole tends to approach the question of professionalism through disincentives — that is, we punish those who are unprofessional, rather than rewarding those who are professional. Code of Ethics, MLS rules, fines, damage reputations, etc. etc. We demand certain levels of professionalism, then punish those who fall short.

On the one hand, following economic axioms, that does lead to less unprofessional behavior. On the other hand, it often leads to more and more sophisticated ways to evade detection, find loopholes in the rules, and in some cases, simply accept fines and penalties as “cost of doing business.”

Professionalism Incentives for Institutions

Furthermore, consider the incentives to the institutions — REALTOR Associations, brokerages, franchises, vendors, etc. — to drive greater professionalism. What extrinsic incentives exist for them to drive professionalism?

Most of the critics of the Association often mention that the Association doesn’t want to do anything about professionalism because they want/need dues dollars. That’s a fair criticism, but it’s shallow. Because we have to look not only at the faceless companies and organizations, but at the individual decision-makers and their incentives.

Plainly put, what’s in it for the staff of the various Associations, brokerages and franchises if their members/agents become more professional? We’ve already established above that there does not appear to be any extrinsic benefit to the agent for being more professional, so what does professionalism do for the Association Executives, for the brokerage manager, or for the franchise owner?

No AE anywhere in the country has his or her compensation tied to the level of professionalism of the membership. Not one. Same goes for brokerage managers or franchise employees. There are no big industry awards for the Association staff with the highest metric of member professionalism. There are rewards, however, for agent satisfaction… which is why so many of our institutions focus on making agents happy, on member benefit, on member value.

So why would any of them want to drive professionalism when the incentives are so weak (and mostly intrinsic emotional rewards) and the disincentives are so strong (lost income)? It’s fair to criticize the organizations, but at the same time, it isn’t fair; the critics in the same position would do the same thing. Because it’s all about incentives.

MLS Consolidation

Another area where we see a disconnect between intentions and incentives is MLS consolidation. Ever since I got into the industry some 15 years ago, just about everyone wanted to see fewer MLSs. Consolidation has been a goal for the industry as a whole for decades. Through that effort, we are now somewhere near 600 MLSs in the country, down from over 850 when I began. Yet… just about everyone agrees that’s hundreds of MLSs too many.

So what gives? Why do we have so little in the way of MLS consolidation?

Examine the incentives for consolidation. I think that makes things easier to understand.

What are the incentives for the MLS to consolidate with another MLS? Taken at face value, by looking at the arguments offered by the pro-consolidation folks, the biggest one appears to be lower cost for MLS services/technology. The basic idea is that by bringing more subscribers together under one entity, the MLS can negotiate better rates from vendors and afford more products and services for the members. A small MLS can only offer so much, while a larger MLS could offer more and at lower cost.

The issue is that this is a fairly weak incentive for decision makers. For the CEO of the MLS looking at consolidation, it isn’t as if lowering the cost to members leads to a bonus or personal wealth via stock options; most MLSs are nonprofit, and even if for-profit on paper, they operate as if they are nonprofits. I’m not aware of a single MLS that offers stock options or RSUs to its employees the way Zillow or EXP or Compass do. For Board members of the MLS, lowering the cost is nice, but every consolidation scheme in the industry inevitably revolves around the question of control: who has it, who will share it, who will “have a voice.” To dilute their own power by bringing others into the boardroom for the sake of lowering costs is… well, let’s just say that isn’t a particularly strong incentive.

Furthermore, that incentive is stronger for the larger MLS and far weaker for the smaller MLS. A large regional with 25,000 members can add a board member “representing” a smaller Association of 2,500 members and still maintain most of the power. That smaller Association, however, is now completely dominated on the regional Board… and the compensation for that loss of power and influence is  slightly lower costs for MLS services.

Think of the membership as well. Say I’m the #1 brokerage in my 2,500 person MLS with 30% market share. That brings me enormous benefits from a marketing standpoint, both for consumers and for agents. If my MLS joins a large regional with 25,000 members, I might end up as the #30 brokerage. What is the incentive for a big fish in a small pond to become a small fish in a big pond?

In normal non-MLS world, consolidation happens because those being absorbed into the larger get paiiiid. When CoStar acquired Homesnap for $250 million, or Zillow acquired ShowingTime for $500 million, the CEOs and board members of those smaller companies were fully aware that they were giving up power and control. But they got paid millions for what they had built. Most of their employees, I’m sure, got paid a windfall via stock options as well. This dynamic simply does not exist in the MLS world, since most are nonprofits with no shareholders whatsoever.

So what’s the incentive to consolidate especially when compared with the disincentive to consolidate?

The lack of actual consolidation signifies a lack of incentives to consolidate. And until we create real incentives to come together, it isn’t likely to happen.

Create and Align Incentives to Achieve Intentions

If the industry truly wants to achieve what it wants to, then it is necessary to create and/or align incentives accordingly.

Take the professionalism issue. If we really want more professionalism, creating more rules, more policies or more education programs — all of which we have tried and continue to try — won’t work. Instead, we need to create incentives for professionalism that aren’t simply intrinsic emotional satisfaction.

For example, look at the program I mentioned on the podcast with Jeff and Phil: Best of Zillow. That program rewards customer satisfaction, which at least partially comes from professionalism (e.g., faster response to inquiries, etc.), by providing branding that might make a difference. Money is the incentive; the result is better responsiveness (a feature of professionalism). If brokerages and franchises wanted to reward professionalism, they could provide financial incentives for results as well — better splits for higher rated agents perhaps?

Could REALTOR Associations do something similar? I don’t know, since there are all kinds of political problems with promoting specific members, but perhaps Associations can at least incentivize the staff somehow through bonuses for professionalism of members or some such thing.

If MLS consolidation isn’t working out, instead of just blaming politics or personalities, perhaps we need to be looking at incentives. As things stand today, I think incentives are weak while disincentives are strong. We’d need to look to change that if we want more consolidation.

Fact is, you get more of what you incentivize. We’ve tried preaching. We’ve tried education. We’ve tried cajoling and threatening and begging. We’ve tried punishing bad behavior, with mixed success. Maybe it’s time we try incentivizing behavior we’d like to see.

-rsh

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Rob Hahn

Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

4 thoughts on “Musings On Incentives”

  1. May I suggest the Cooperative Change Model as a template for bringing about individual change and societal change. It takes elements of Individual Change — operant conditioning– (Positive Reinforcement, Cumulative Compensation, and Variable Rewards) and Community Change (Societal Esteem, Interlocking Messaging, and Normative Change) and then uses bridging elements to amplify the efficacy of the Individual Change and the Community Change (Public Individualized Recognition and Public Cumulative Recognition). Essentially you are are designing a wholistic approach to the problem that once established with a little momentum it drives itself.

  2. It starts at the top. Execs, broker owners, and firms are all acting unethically and many even unlawfully. The industry should be embarrassed. NAR & Realtor associations are all self dealing. Crap rolls down hill. Fingers should be pointed at some of these so called “leaders”. The end.

    PS. Hopefully Lina Kahn will dig into the RE industry. Her appointment was the best news I heard today.

    • This sort of ad hominem attack is precisely what I think is so misplaced. Look at the incentives. You think execs, broker owners and firms are acting unethically, even unlawfully. I think they’re just acting according to incentives and lack of incentives.

      How about instead of just pointing fingers — something so prevalent in the industry — we look at what the extrinsic incentives are?

  3. I disagree my attack is misplaced; but I agree execs, broker owners, and firms are most definitely acting according to how they are incentivized. I am aware of many Realtor paying members who appreciate your articles, Rob. You continue to ask the questions and have a platform where most do not. Most of my responses are due to personal experiences w/ boots on the ground as both a previous agent and “manager” of two offices of around 70 agents. I continue to read legal filings across states and agents/employees still continue to call me asking me for help: “what should I do” on who to go for legal advice (even though I am not a lawyer–but it’s about navigating the very broken legal “system”). It’s always been about $$, but it doesn’t mean the behavior is lawful OR ethical. In the past week I have heard of multiple agents (top agents in my state who should know better) representing two buyers for the same exact house! Not just showing the home but writing offers on the same home. Does it get any lower? The greed is unreal. These agents could easily refer one of their buyers to another agent to write up the office in the 100 person office (at the min.). The supervising manager is well aware (and no the manager did not step in) The usual real estate lawyers are aware too. You think they would speak up and say this is a conflict of interest. Breach of your fiduciary duty. Or even ask the question: “does the other buyer know?” If it’s a top agent, these lawyers and firms cater to this unethical (unlawful) behavior. If this became public, would this change the behavior? Change what incentivized this agent to represent both buyer on same house? How about a lawsuit? If the top 10% of agents are doing 90% of the business, how often is this happening now with how tight inventory is. So many people make excuses for the RE industry. STOP. Think again if the buyers/consumers are unaware. The real estate community is small and most buyers move within the same town. People talk (oh and agents talk) and sellers are NOT stupid. What is it going to take? More lawsuits to disincentivize this behavior? This post will be long, so fair warning. Because yes I am pointing fingers because unethical and unlawful behavior should not be dismissed as they are only acting how they are incentivized.

    Recruiting is another issue. Firms and managers are incentivized to recruit and say whatever they need to say to get and agent from A to B. The pressure for managers to recruit is *unreal*. Are they managers/supervisors are really just recruiters? No disclosure of the FTC business opportunity rule to agents during recruiting either. No disclosure the X% “marketing” or “licensing” fee is actually Y royalty using franchise math. But this is where firms are their own worst enemy. Half of the managers can’t even explain a commission math problem (yes really!) in a traditional real estate model. I know, bc I’ve asked managers to explain it. When agents come to complain about the math, the splits just keep gong up and up. It’s just easier to give a split raise than actually explain the unethical math. About 10 years ago the math changed for many of these firms from “off the top” or “fees on net” to franchise math (some call the franchise math off the bottom”?–I call it a three tiered franchise scam with creative math). Instead of actually explaining the how the royalty is calculated (because middle management can’t explain) to agents and *disclosing* to 1099s that 1099s are part of a three tiered franchising model (hello FTC biz opp rule), the splits just keep going up. Firms are incentivized by cheating but are they really winning? Try to find language about the FTC business opportunity rule on NAR site…the article is posted in 2012. Transparency is kinda of a thing these days. And these greedy brokers are just digging themselves deeper with the help of NAR casually looking the other way. NAR looks the other way when it suits them and become involved when it benefits NAR. You think NAR isn’t well aware of the recruiting tactics going on? What incentives NAR to look the other way?
    When the competition is fierce with agent recruiting (and supervising manager is incentivized to keep unethical agents on roster), it becomes a relationship where the supervising manager is more literally like the b*tch of the agents. Most traditional firms are modeled this way. People can say whatever they want (because agents have opinions–lots of opinions but majority of them don’t know what goes on behind closed doors). So many cheerleaders in the RE business and not enough who will speak up. If a top unethical agent leaves (is recruited away) will the manager’s comp go down? Be dinged? The incentives are great to continue the status quo with zero consequences of bad behavior by agents. Anyone who is a manager working for a franchise/big firm knows I am right. If your firm is different (which I doubt due to incentives and the need to compete) then I applaud these firms. Is NAR and these Realtor boards aware of bad behavior? Of course they are! It’s just all behind closed doors in kangaroo court. Speaking from experience I know most managers feel stuck due to non-competes and crazy clauses. Most are even scared to talk due to confidentially clauses. Are confidentially clauses meant to silence or protect legitimate trade secrets? I am sure all Realtor association employees have similar silencing clauses. If those walls could talk. The amount of tortious interference suits in this industry should be raising eyebrows from the FTC. Am I not right? So yes I am pointing both of my fingers at the lack of ethics (and unlawful behavior). Is the real estate industry a free and open market? Hardly. I’ve read many of your past articles. Is competition tortious interference? What is “incentivizing” firms to file these suits if they know they will likely lose in court (or are aware suits are baseless). Should I list a few of these suits? They catch the headlines for sure but no one actually reads whether the case is dismissed and why?

    Furthermore (I warned you this would be long). Little triggered, mostly because I know too much of what actual goes on behind closed doors and the actual incentives. You know what would incentive agents to do the right thing? To make complaints public. Get rid of the kangaroo courts and arbitration. Who are on these kangaroo courts? Not lawyers. Not anyone who actually knows anything about law. Managers and execs on these boards? Yes they are. NAR talks a good talk about caring about consumers and even agents (hello NAR recommending firms put forced arbitration in independent contractor agreements, do I need to say more? And anyone who talks poorly on the Association receives attacks from insiders (so thank you again Rob for continuing to ask the questions). For anyone who thinks I am exaggerating about those attacks, take a gander over at past Facebook posts. The President of MAR from a few years ago was vicious to anyone who spoke badly about the association (my opinion based on her comments online to people and me!).

    I’m not finished…..
    What is incentivizing Sam DeBoard to *keep* going down the rabbit hole about pocket listings? It’s almost like he is getting paid (or incentivized) to continue to tout the benefits of pocket listings? Hmmm? He’s go to bat to defend these so called whisper properties? For starters his so-called “independent” voting members of RESO (I’ve said this before) are mostly execs working for big tech (tech or platforms which matches buyers and sellers in-house). No wonder he’s all in on pocket listings. Sam is incentivized. He’s in bed with the voting members. These same voting members also vote on his 501(c)6 salary. Anyone can look up the 990. Conflict of interest? Is the 990 form disclosing accurately these members as “independent”? And RESO works closely with NAR. Another what in the AF?

    Their mission: “To Develop, Adopt, and Implement, Open, and Accepted Data Standards and Processes”.

    What helps brokers in the financial industry do the write thing? A U4. What helps lawyers also act in good faith when they represent their clients? The Bar of Overseers.

    -Jerry Maguire 🙂
    PS. Writing this on my iphone. So likely grammar/or spelling errors . I’m not incentivized to write a masterpiece or get paid to write; just here to share my experiences without spending hours editing as I’m ready to start my day.

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