Daniel Harrison's Personal Blog

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Why The Era Of The Insider Will Remain November 24, 2007

Filed under: development — danielharrison @ 10:30 pm

Digital Digressions posted an interesting article about insiders and how technology seems to be displacing them. This is a topic close to my heart and I’m going to disagree and say the era of insiders will never end but will merely be a transformation. Why? well first I think it takes an examination of some fundamentals.

In economics there’s a a concept called information asymmetry. Under this theory insiders can use their knowledge of the market and the cost to outsiders of acquiring this knowledge to either better exploit the market or do something like charge a fee or commission to allow outsiders to act like insiders, ala real estate agents. The less open a market or more complicated it is, the more the insider can exploit this and the higher the premium they can charge to outsiders. Lag measures are a symptom of a closed or opaque market in that it takes time for the true state of the market to become exposed to outsiders. Real estate in many cases is a grossly inefficient market which is why the role of the real estate agent exists, an insider who can theoretically maximise profit via inside information. If the real estate market acted independently and house sales were purely a function of house size, block size, dummy variable of a pool, … then you could expect the insiders to disappear as information becomes more abundant and available to all, but that’s not the case. Perfect information is a concept that helps explain this. Perfect information is where all information is perfectly shared between all participants and sellers know as much as buyers. As long as perfect information cannot be obtained insiders will be able to exploit the cost of acquiring knowledge, so will exist and make money from capitalising on experience and inside knowledge of the market. Real estate is not a market that can be captured or explained purely by the numbers. It helps and can act as a dampener on irrational behaviour, but there are things that are not captured purely in closing prices.

In Canberra we have a local property site called allhomes, it has some ridiculous market penetration, they claim that their Nielson independent monitoring is 99% of people who buy property in Canberra visit the site before purchasing. It has information on all sales in Canberra for the last n years, and things like block size, rates, suburb sales info, pictures, etc. It’s great and it’s how we found our home, so at least in this market, there’s some good experience with online property sales. Anecdotally, I’d have to say though that the number and use of real estate agents is not diminishing. The market in Canberra is pretty solid as it’s got some interesting demographics (large public service with a higher than average income) that isolates it from shocks to some extent, so it may not reflect other markets. One thing you do see is that real estate agents list on the site as well as newspaper advertisements. One of allhomes taglines to sellers is ‘before you list, insist’ on listing on allhomes as well. So while I think commissions for insider information is under pressure, sales volume is increasing over time. Buying a house is one of the most stressful things you can do and is a strong discouragement for people to repeat the process. My guess is as the ease of buying and selling increases so will sales volumes but it’s probably too early to tell. In terms of lag measures though, while these sites are now easier to access they’re still lag measures as they reflect the closing price. It takes time to sell a house and good agents can still outperform outsiders using their knowledge and experience of the market. A month can make a huge difference in the closing price of a home. Getting it right when others get it wrong is the best outcome and this is a skill that insiders, investors, good real estate agents have.

One thing to not forget is that this information previously wasn’t available to real estate insiders either. Insiders with their experience and existing knowledge of the market can also capitalise on the new knowledge which allows them to increase their efficiency as well. This means that they in turn can still outperform outsiders and charge a fee for their knowledge. So I don’t see the era of the insider as over but rather inefficient agents being squeezed out and the way agents behave changing. This should make buying a house easier and more efficient and the flip side is in an efficient market typically there are more sales, so insiders who can capitalise on the information, may charge a lower premium, but make up for it in volume now.

This is why I think the future is more in property sites like redfin, where they still have agents (insiders) but because of changes in the market, the agents act differently. One of their staff outlines why they chose to be a redfin agent and highlights the differences between becoming a traditional agent and joining redfin. The point I think speaks volumes is the ‘work cooperatively with fellow agents’. House characteristics mean different things to different people and one of the skills of a real estate agents is intimate knowledge or a neighbourhood, street, house, people that allows them to act as a broker and map buyers to sellers. Previously the market was, an agent has a specific set of houses they sell to everyone, seller driven really, and it was about the stock of houses an agent had access to. The better agents/agencies had better houses and the cycle would repeat, the more they sold the better their access to house stocks. Compensation had to be price/time based which meant aggressive competition between agents which didn’t necessarily mean the best outcome for buyers or sellers. This is where I think online, information rich clearing houses are changing the behaviour of insiders. Now everyone has the same information and knowledge of the market, it becomes more about the skills in matching buyers with sellers more directly. Sales becomes more cooperative based as the insiders can use their shared knowledge of the market to outperform the individual and maximise volume with more informed buyers and sellers.

When a market is opaque to outsiders, insiders can exploit this and make more money by charging a higher premium per transaction. The more inefficient the market the more likely this is to occur. Once that information is available to all, the insider looses that advantage and has to modify their behavior. The knowledge they have is not worthless though, and by reusing knowledge and acting in groups they can exploit and use each others knowledge to again exploit the market better than outsiders. The insider doesn’t disappear but is rather transformed like a phoenix.

Another article on Wired describing how real estate agents sell their own home provides interesting information as well.

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