We’ve become romantic about real estate, which undermines how serious of an investment it is.
After the industrial revolution, after the advent of modern medicine, we could spend less time suffering and start thinking about how to maximize our quality of life; vacations, cars, big-screen TVs, etc. A house was no longer is just a shelter, it became a reflection of our tastes and could convey our status.
Residential real estate is an extremely important asset. Home equity makes up the majority of most American’s net worth.
Although the market value of property (appreciation) mostly just keeps up with inflation, the principal payments we make each month is an effective forced savings. Home ownership is a much better alternative to renting and saving nothing, but we sadly overspend in the home ownership department in pursuit of status rather than equity build-up. Then when we go to sell our homes, we don’t hire asset managers, we hire sales guys — Realtors — whose five or six percent fee against the entire sales price inevitably consumes an obscene percentage of that hard-earned equity.
Consumerism has indeed spread its tentacles into real estate. Some of the most popular TV shows revolve around the home’s sex appeal; Extreme Home Makeover, Flip or Flop, Fixer Upper, Love it or List It, etc. Investing in the S&P 500 is less romantic. You can’t decorate your stocks and bonds with purchases from Crate & Barrel and Pottery Barn, but you can treat your home like a consumer packaged good, rather than a good investment.
I believe this is one of the reasons why homeowners don’t give much thought to what they pay a Realtor. Realtors have snuck their way into the retail compartment of the brain. Do you really think you will ever see a reality TV show dedicated to accountants or financial advisors?
Someone selling a $400,000 home with $100,000 in equity gives a Realtor 5%, or $20,000 to free their equity. Meanwhile, if we had $100,000 in stocks and bonds, there is no way in hell we would agree to pay a broker a $20,000 commission to free that cash.
To illustrate how financially irresponsible real estate commissions are, let’s say you bought a $450,000 house, and you put 11% down, so you got a loan for $400,500. Your interest rate is 4%, your principal and interest payment is $1,912.05:
Lets say you decide to sell five years down the road and receive an offer for $475,000. A 6% commission amounts to $28,500. We could stop there, at twenty eight thousand friggin dollars. If you have $150k in equity, the commission is consuming 19% of all your equity. But people actually pay these fees, so lets continue.
The commission is 46 months worth of hard-earned principal build-up:
Consumerism and the excitement behind selling and purchasing takes precedence over the rational-responsible part of the brain would look these finances over carefully; estimated closing costs, what you’re going to net after commissions, etc.
Save more so you can spend more.
The irony is that paying less attention to these things decreases one’s purchasing and spending power… There are plenty of full-service alternatives to paying a traditional 6% commission aside from selling by-owner. In nearly every market there are full service flat fee brokerages that get homes sold just as quickly, for the same amount of money as a traditional Realtor, but for a fraction of the cost. Trelora, Houwzer, Reali, Door, Homie and Homebay, to name a few, offer low flat fees to list. The money you save on the sale side can go toward increasing the down payment on the purchase, thereby increasing the amount you’re approved for. Most of these alternative brokerages will rebate as much as half of the commission they receive from helping you purchase your next home. There is no universe where working with a traditional Realtor will increase your net worth.
