Understand Incentives

To be successful in the real estate industry (or any business, and for life in general) you need to understand incentives. Everyone intuitively understands that people respond to incentives, both monetary and otherwise, but few understand how powerful this force is.

Real estate agents, when selling their own homes, keep them on the market for an average of 10 days longer and sell them for about 3% more than non-agent owned homes (see this article, citing to the book Freakonomics). Why is this? Because when an agent is selling their own home, almost every extra dollar that the house sells for goes into the agent's pocket. But when selling someoene else's home, they only get the commission percentage of that increased amount (example: for an average $250k house, a 3% increase in price is $7,500, the agent's portion of this is probably 2.8%, or $210). An agent would rather just get the house under contract and sell it quick rather than put in a lot of extra work for not much more money.

You might think "well, those are agents, business people, looking out for number 1, not too surprising." But it goes deeper than that. A recent study (referenced here) studied the effect of financial incentives on doctors performing cesarean sections. There were several astounding findings. First, when doctors are paid more for c-sections than regular deliveries, they about 10% perfomed more c-sections on "civilian" patients than on patients who were themselves doctors, because the patients who were doctors would push back when the c-section was not medically necessary. Similarly, where the financial incentive was to NOT perform a c-section (where the doctors are salaried and not paid per procedure), c-sections were performed LESS on "civilian" patients. The researchers performing the study speculated that the doctors weren't aware of the effect the financial incentives had on their decisions, but were driven subconsciously by the knowledge. The results is that even our most trusted professionals are driven by financial incentives when deciding whether to perform a highly invasive and complicated procedure.

What does this have to do with real estate investing? You need to understand that everyone is driven by incentives, whether consciously or not. That contractor? He will try to do the least work for the most money. So one way to create the correct incentive is to put off payment until the work is done, and create a bonus structure for work completed early, and a penalty for going past a deadline. Give real estate agents a bonus if they sell (or offer) at or above the listing price. Create strong incentives for your tenants to pay on time (late fee of $50 the first day and $20 dollars every day after that). Cash for keys is another example of this.

Good luck and have fun!