Back in 2005 I bought my first house. It’s the only house I’ve ever owned. After 8 years, my family and I decided to relocate due to my wife’s job promotion. The problem was that her company wanted her to move quickly. Since I’ve never sold a house before and with the huge housing market downfall, I was a bit nervous. How much of a hit was I going to take? How long was it going to take to sell my house in this market? While I’m not an expert in direct real estate, here’s what I learned.
Lesson #1: Real estate commissions create a conflict of interest
When I interviewed real estate agents to list my house, I learned that just about all of them get paid after the sale is completed. In other words, their compensation is tied to the sale of a specific product – your house. As a result, from a seller’s standpoint, they were overly concerned with closing the deal and getting paid rather than providing objective advice. As a seller, I want to talk about pricing strategy. When do we lower the price of the house? What improvements do I need to make in the home before putting it on the market? Anytime compensation is tied to a transaction, you have to wonder if the “advice” you’re getting from a salesperson is really in your best interests.
Lesson #2: Find a listing agent that charges a flat fee or a smaller commission
Typically the commission across the buyer and listing agents is 6% of the value of the transaction, with each getting 3%. On a $300,000 house, that’s $18,000 gone in commissions. I understand that real estate agents should get paid and I’m OK with spending a few grand, but nearly $20,000 is a bit much for a single transaction. So I found a real estate agent that charges a flat upfront fee for listing my house and then gets paid one third of one percent as a commission after the house sells. I thought that was reasonable, but like anything you buy, you have to consider the fee in relation to the value you get. Was a lower cost real estate agent going to spend less time with me? It turns out the answer was yes, and that’s why the fee was lower. Then again, so much of real estate marketing is done on the internet now using MLS listings and popular websites such as Zillow, Trulia, and others, that I simply didn’t see much point in paying five times more for a traditional listing agent.
I still had to pay 3% to the buyer’s agent, but my savings with my listing agent gave me more flexibility. For example, I could lower the price of my house so it sells more quickly. Or I also have the option of increasing the buyer’s agent commission to 4% so that more buyer’s agents would show my house to prospective new owners.
Lesson #3: Don’t get emotional about the house
While my kids grew up in the house and we have many memories, in the end selling a house is a business transaction. Part of this entails accepting the fact that the market determines what my home is worth, not me. Many people peg the value of their home based on what they bought it for and hate to lose money. We’re so fixated on what we paid for it that we don’t take a rational approach to pricing our homes. It’s similar to what we do with our investments: we get caught up in what we bought a stock for and in our minds think that it’s worth $25 a share when the market price is really $10 a share. Since direct real estate is an illiquid asset, it’s tough to know what the market value of a home is and how much I should list the home at. I bought the house for $300,000, and after looking at comparable sales in the surrounding area, we decided to list the house at $275,000.
Lesson #4: It’s what you keep that matters
On the surface it looks like I would lose only $25,000 on the house, but it’s what you net after all expenses (direct and indirect) that matters. Here’s a breakdown of what I pocketed after all expenses:
You can see that my loss after factoring all expenses for the transaction was actually $66,000 or over 20% from the original purchase price. If I really want to get picky, then I should add in the property taxes, insurance, and repairs I’ve made over the years to the purchase price. As an estimate, suppose that’s about $50,000, then my net loss is actually over $100,000. The lesson learned here is that you can’t just look at what price you agreed with the buyer to figure out what you’re netting on the house. You’ve got to think about total costs (especially those ridiculous real estate commissions!) and subtract those from the selling price. This holds true even if you sell a house for a gain. If you bought a house for $500,000 and sold it for $600,000, do you really have a gain after factoring all expenses?
Lesson #5: Look at your overall financial picture
I decided to lower the price of my house, pay 3% of the closing costs for the buyer, fix a few items for him, and buy a home warranty. All this cost me over $15,000. My neighbors thought I was out of my mind. This is when you have to take a step back. It was still more of a buyer’s market than a seller’s market at the time I sold the house in my area. Also, I only had one offer on the house, but the buyer was preapproved for a loan. In my mind that means he’s serious. While I could hope for another offer to come along, what if that didn’t happen for 6 months? Now I’m paying property taxes, insurance, and utilities on an empty house. Or what if a tornado rams through the area? More importantly, the loss on the house really didn’t matter much anyway since my wife’s promotion and higher income made up for it in less than a year.
In a future article I’ll share with you the lessons I’ve learned from buying my next house. Wish me luck.
Setu Mazumdar, MD, CFP® is board certified in EM and he is the president of Physician Wealth Solutions.