What You Need to Know About Perfect Competition and the Real Estate Industry
July 10, 2017
Ever been to a farmers market? It probably looked something like this:
Lots of shoppers, lots of vendors, lots of similar goods for sale at prices that reflect supply and demand. There isn’t one single seller controlling prices, and it’s easy for buyers to find better quality peaches or tomatoes from a different seller if they aren’t happy with the inventory at the first few vendors they visit. There’s healthy competition, prices are fair, and overall it’s a great experience for both buyers and sellers.
Sounds pretty much like the opposite of a monopoly, right? There’s an economic term for this: perfect competition. Let’s explore more about perfect competition and how it applies to the real estate market. But first...
Why should anyone care about perfect competition in the real estate market?
We see you with your furrowed brow, arms crossed, looking all sorts of bored. Well, if you’re going to sell a home, perfect competition is absolutely worth caring about because:
Perfect competition in the real estate industry would not just put more money in the pockets of sellers—it’d boost up the U.S. economy
Since the real estate industry is the largest industry in the U.S., making it more efficient means a more prosperous middle class... and therefore a stronger overall economy
Real estate is the largest asset for most Americans—and it’s inefficient and too far from perfect given advancements in technology
With extra money from better real estate transactions, Americans would be able to spend more on retail, services, and more
What is perfect competition?
According to Wikipedia, “a perfect market is defined by several conditions, collectively called perfect competition.” Some of those conditions (you might recognize a few from the farmers market example) include:
Lots of buyers and sellers
There isn’t one seller who sets prices
Similar products being sold
New sellers can easily set up shop
No transactional costs
Really, the standards of a perfect market are so rigorous that it’s actually impossible for one to exist in the real world—so what we have are imperfect markets.
The real estate market is a great example of an imperfect market, though it does meet two of the conditions for a perfect market:
Lots of buyers and sellers
Well-defined property rights
Even though perfect markets are, well, too perfect to achieve, we can still strive for them and get as close as possible.
How the real estate industry falls short of perfect competition
So the real estate market ticks off just two items on the long list of perfect competition conditions. Where else does it fall short?
Zero transaction costs. While it’d be nearly impossible to have zero transaction costs, we’re far from reaching this given that the average transaction cost for real estate is around 10%.
Ease of entry. It’s not easy for homeowners to enter the real estate market—they have to deal with capital and credit requirements, for example. It’s not easy for firms seeking to facilitate transactions, either, thanks to state licensing, expensive dues and memberships, and more.
Homogenous products. Not all properties are the same. In fact, in some markets, it may even be tough to find comparable properties for appraisals.
Profit maximization for sellers. With firms like Opendoor and OfferPad, sellers are walking away with even less equity, moving further away from perfect competition.
Price takers. Firms can’t influence real estate prices.
What would an efficient real estate market look like?
Now that we know where the real estate market is and isn’t meeting the mark, we can nail down 4 ways to get closer to perfect competition:
Reduce transaction costs. Enabling buyers and sellers to exchange property more efficiently would reduce costs. We in the U.S. wouldn’t even be the first to do this—many similar countries, notably the United Kingdom and Australia, have made great strides here.
More perfect information. This starts with more communication, more sharing of data, and more transparency so that buyers and sellers are more empowered during real estate transactions.
Identical products. While no two properties are the same, given the emergence of several new technologies, perhaps the underlying equity interest in the assets can be.
Make it easier for participants to enter and exit. In a similar spirit to stock exchanges, once an identical product or unit exists, liquidity increases—and that makes it easier for entry and exit.
The above items will lead to and promote profit maximization of sellers, another tenant of perfect competition. They’ll also improve the well-being of buyers.
Maybe “perfect” isn’t possible, but making the real estate market better and more efficient definitely is.
Devin grew up surrounded by real estate. Now his mission is to re-architect the industry to benefit homeowners. After studying Economics at Pepperdine and receiving a Fulbright Research Grant to study microcredits in Argentina, Devin grew to become the CFO at a national mortgage bank. When he’s not immersed in starting a real estate revolution, Devin can be found grilling a mean Argentine Asado.
Have questions? Get in touch with a Jovio Real Estate Specialist.
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