Market Strength and Brokerage Choice in Residential Housing

Abstract

This study develops a theoretical model examining the relation between housing market strength and brokerage choice. Our model shows that although internal transactions (where both buyer and seller agents are either the same or work for the same firm) have the potential side benefits of higher commission rates and lower search costs, in a strong housing market, brokerage firms are more likely to engage external transactions because of the greater demand for housing. However, when the market weakens, external demand for housing decreases, and brokerage firms become more willing to conduct internal transactions. Furthermore, while an internal transaction tends to occur at the expense of lowering the selling price, we show that it could also be chosen by brokerage firms with higher in-house searching-matching efficiency. This higher in-house efficiency generates a (second-order) counterforce of increasing the price. Hence, our model demonstrates that the housing market has a (partial) self-correction mechanism for the principal-agent incentive misalignment problem, especially when the market strengthens. Conversely, when the market weakens, internal transactions increase and prices decline, which can further weaken the market. Therefore, the equilibrium brokerage choice creates a self-reinforcing mechanism for generating more extreme market conditions. Using the Doubly Robust (DR) estimation method, we present empirical evidence consistent with the model with multiple listing service data from Hampton Roads, Virginia.