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Ending the entrenched real estate racket

Discussion in 'Real Estate' started by Tropo, 20th Mar, 2012.

  1. Tropo

    Tropo Well-Known Member

    17th Aug, 2005
    Conflicts of interest undermine the quality of advice and policy. It is critical to the functioning of markets and government that parties involved are free of conflicts, especially monetary ones.

    We would like to believe others are ethical, engage in honest practices, and do not withhold or manipulate information for selfish reasons.

    Sadly, the real estate industry is saturated with such conflicts. Individuals and organisations with direct and indirect connections to the industry are so plagued by conflicts of interest that the industry is a textbook example, along with the defence and pharmaceuticals sectors, of what not to do.

    Real estate agents make their living from the commissions on real estate transactions. Thus, it is in the agents’ self interest to maximise the volume of transactions. It ought to make little difference whether prices are rising or falling, but in practice it matters a great deal. In a property market of high volumes and rising prices, agents can make small fortunes. Real estate is a big business where vast amounts of profit can be made, and where corruption and dishonesty inevitably corrode ethical practice.

    Australia’s market from 2001 to 2004 was an era of golden rewards. Gripped by speculative fervour, owners engaging in “flipping”, or short-term reselling of property for capital gains. It is the profits realised from flipping, backed by lax lending standards and preferential tax treatment, that drives the market into a Ponzi or pyramid scheme.

    Agents are faced with a set of incentives to optimistically promote (“spruik”) the prospects for the property market. If prices are increasing, they say, “buy now or be left behind”; if stagnant (tracking inflation), “buy now because the market is soon to rise”; or if prices are falling, “buy now because housing affordability has never been better and the market has bottomed out”.

    Sound familiar?

    Likewise, real estate intelligence firms face a set of incentives to argue property is always a good investment regardless of market conditions. Their public faces are articulate and well educated, which comes in handy when offering technical arguments that rationalise sky-high housing values, and claim with confidence prices are based upon fundamentals and could never fall. The fact that they always assert this even when, in reality, a bubble exists (as in the case of the US, UK, Latvia, Ireland, Spain, Lithuania and so on) should come as no surprise.

    These optimistic appraisals should be immediately dismissed on the grounds that they are completely predictable and thus tell us no new information about how the market is really performing, on much the same basis that politicians reflexively inform us they always have our best interests at heart.


    In the US, the leading spruiker was David Lereah, the former chief economist of the National Association of Realtors. He championed rising housing prices, denied a bubble existed and cited sound fundamentals in the form of a housing shortage, demographic change and low interest rates. He published the book Why the Real Estate Boom Will Not Bust: And How You Can Profit From It at the peak of the bubble in early 2006.

    Lereah has claimed that NAR executives pressured him into fabricating optimistic forecasts – something any skilled professional ought to have the capacity to resist.

    Potential home buyers rely upon agents as the primary source of market information and place a high degree of confidence in them. Never mind agents operate for their paymasters – sellers – and are constantly working to remove buyer resistance to close the price gap to seller expectations. Sellers, however, are also affected by the perverse set of incentives that agents operate under.

    Given their institutional bias toward spruiking, it is problematic that agents and real estate organisations can make outrageous assertions about the investment potential of both the real estate market and individual properties without bearing responsibility if things turn sour. Their “conversations” with buyers are deniable in a court of law.

    Financial advisors are regulated by the Australian Securities and Investment Commission (ASIC) and must meet strict guidelines. Anyone providing investment advice without a licence is subject to serious penalties if apprehended. A different standard applies to real estate agents who can endlessly spruik million-dollar assets (homes) without a license.

    The information asymmetry between buyers and industry is enormous. Atomised buyers rely on the advice dispensed by multi-million dollar organisations and multi-billion dollar sectors with a direct interest in maintaining the status quo of overvalued multi-trillion dollar property markets. These include the central bank, Treasury, commercial lenders, investment banks, real estate intelligence firms and agencies, mass media outlets, governments, and the vast array of professionals employed in these sectors.

    When real estate bubbles burst, the industry PR machine goes into overdrive, placing blame on everyone except themselves. Apparently, the poor have cheated the banks and real estate agencies by refusing to keep up with mortgage payments, running rings around the oppressed sectors of power and privilege. (As Ayn Rand put it, America’s persecuted minority is big business.)

    The mass media is heavily reliant upon advertising revenue from the real estate industry, thus gagging outlets from speaking out against the interests of industry. Industries can and do use the threat of withdrawing advertising revenue to change editorial lines. Agents’ organisations depend heavily on journalists and editors casting the industry in a good light to maintain their supposed ability to self-regulate. This is similar to believing the nice, furry fox will guard the chicken coop – after all, real estate institutes represent agents, not consumers.

    The incentives faced by the mass media ensure overly positive outcomes for the real estate industry and other sectors as well (finance, insurance, mining, government, etc).

    The industry desperately needs to have these conflicts of interest and incentives to deceive removed to ensure an efficient property market for both buyers and sellers.

    Agents should be required to have the equivalent of a financial services license, and pass a rigorous course in ethical practices. Neil Jenman, an experienced Australian real estate consumer advocate, has sought to tackle these conflicts with his system of approved agents who adhere to high standards of ethical and consumer practice (that is one of the reasons why Jenman is not well liked within mainstream industry).

    Eliminating the causes of high housing prices that promotes a bloated real estate industry is a must. To this end, ending lax lending standards by the banks and taxing land is a necessity (though in Australia it is a case of too little, too late).

    Regulators and politicians have not tackled these conflicts of interest for two reasons. The first is the belief that privatisation and deregulation is the way to go; that markets can often do a better job via self-regulation. Even if market advocates point out that problems still exist, the second reason rears its head: the real estate lobby is immensely powerful, representing the $4 trillion landowning class. The lobby will ensure that little will be done about the current state of affairs.

    Given the inherent difficulties of such a task due to entrenched vested interests, a cynic may conclude it would be easier to clean up Chernobyl.

    Philip Soos