What is a Moral Hazard and Its Relevance in Real Estate
Moral hazard refers to a scenario where one party is more likely to take risks without facing the full consequences of their actions.
It arises when individuals or entities are shielded from the negative outcomes or costs associated with their decisions, leading them to behave differently than if they bore some responsibility.
For instance, in the financial sector, moral hazard can occur when banks or financial institutions take excessive risks because they anticipate government bailouts in case of failure. This creates a moral hazard problem as these institutions may engage in risky practices that they would otherwise avoid if they had to face the full consequences of their actions, as seen in the significant investment collapses in 2007.
Addressing moral hazards often entails implementing mechanisms that align incentives and ensure that individuals or entities assume the appropriate level of risk and responsibility for their actions.
In the context of real estate agents, the risk they face when listing a home is that they are compensated solely through commission. Unless they perform and successfully sell the home, their livelihood is at stake.
Typically, home sellers have no direct financial stake in the sale of their property apart from their investment. They are motivated to secure the highest possible price to maximize their profits or recoup their initial investment. However, when sellers lack monetary involvement in the home sale, such as costs associated with preparing the property for sale, their incentive to make rational decisions and actively pursue the sale diminishes.
In the absence of financial engagement, sellers may be inclined to overprice their homes and adopt a wait-and-see approach. They might even choose to cancel the listing or engage other agents, as there are no direct monetary consequences for doing so, so long as their current agent approves.
During the Bay Area’s robust seller’s market, the occurrence of Moral Hazard was infrequent. Home sellers had strong confidence in selling their properties, and the majority followed their agents’ pricing recommendations, resulting in most homes being sold above the listed price with multiple offers.
The number of canceled listings due to sellers insisting on the price they envisioned for their homes was extremely low compared to the total number of listed properties.
However, as the market approaches a state of equilibrium, some homes now struggle to find buyers, and sellers are inclined to find fault with any factors that have hindered the sale of their homes. Rather than accepting the possibility of their homes being overpriced, they quickly point out external reasons for the delay.
By implementing a premature cancellation clause penalty in a listing agreement, the interests of both the real estate agent and the seller can be aligned. Both parties become invested in achieving a successful sale, or else they bear the costs associated with failure.
If implemented, an agreement for early termination may allow the seller to reconsider their decision to sell their home before the agreed-upon cancellation date. In such a circumstance, the seller would only be responsible for covering any “out-of-pocket” expenses incurred, such as marketing materials, photography, and other related expenses that are capped in the initial agreement. This arrangement grants your agent the flexibility to adjust commissions to reflect the reduced level of risk associated with recovering the financial investment in selling a home.
It’s important to note, however, that your agent is under no obligation to release you from the contractual agreement you entered into, and doing so unilaterally could make you liable for the entire commission as per the agreement.
To learn more about the benefits and functionality of our Flex Plans℠ tailored to your needs, don’t hesitate to contact us. You may reach us by phone or email at info@morganhomes.com, or by requesting a call back here.
Drew & Christine Morgan are REALTORS/NOTARY PUBLIC in Belmont, CA. with more than 30 years of experience in helping sellers and buyers in their community. As Diamond recipients, Drew and Christine ranked in the top 50 RE/MAX agents nationwide and the top 3 in Northern California. They may be reached at (650) 508.1441 or emailed at info@morganhomes.com.
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The information contained in this article is educational and intended for informational purposes only. It does not constitute real estate, tax, insurance or legal advice, nor does it substitute for advice specific to your situation. Always consult an appropriate professional familiar with your scenario.
