The True Cost of Free

Something happens to us when we are offered something for free: our brains shut down. Free is irresistibly seductive. It is a source of irrational excitement. Witness people who grab coupons offering a free trinket that they have no need for.  And people who return to the buffet line for more “free” food even though they are full (and are likely to feel a pang of guilt the following morning).

This phenomenon has been studied by psychologists and behavioral economists. Dan Ariely, who is both, and a frequent contributor to the Wall Street Journal, talks about an experiment he devised to measure the intoxicating power of free. In his book, Predictably Irrational, the Hidden Forces that Shape Our Decisions, Ariely describes an ingenious experiment involving the most common psychological guinea pig – college students. At the college dining hall checkout station, Ariel gave the students a choice of buying one of two chocolates. The first was a Lindt truffle, which he explains is one of the finest chocolates in the world, and the other was a Hershey’s Kiss, nice enough but nowhere near the quality of the truffle. Over the course of the experiment he changed the pricing of the two chocolates but kept the price difference constant. His results:

Scenerio             Price of                                                   Amount Sold
Lindt Truffle Hershey Kiss Lindt Truffle Hershey Kiss
A 15 cents 1 cent 73% 27%
B 14 cents 0 cent 31% 69%

Ariel repeated the experiment pricing the truffle at $.27, $.26 and $.25 and the kiss at two cents, one cent and free. Same result: with a constant 25 cent difference in price the more expensive truffle was greatly preferred until the price of the kiss was free, at which point the demand dramatically flip-flopped from the truffle to the kiss.

Ariel posits that one of the reasons for the phenomenon is that most transactions have both a clear upside (getting the chocolate) and a clear downside (parting with money), but when something is free we forget the downside (the cost of making the wrong choice).

Interesting, but what does this have to do with real estate?

Well, having a broker represent you as a tenant in your leasing transaction is free of charge. It is free because the landlord pays the tenant broker out of the commission pool created for the transaction. If the tenant is not represented, the listing agent simply gets the entire commission pool. Your tenant broker costs you nothing since he is paid out of funds that would otherwise go the building broker.

That’s great, tenant brokers are free. What’s the problem with free?

Well, as we saw with the college students in the above study, the problem is that our brains stop being discriminating in making a choice once an item (or service) is free. It’s like taking the coupon for the product that we don’t need or getting an extra plate of food. We sometimes grab it because it’s there, without thinking about the true cost.

As a result, when hiring a tenant rep broker there are two significant costs that can be incurred because of the irrational tug of being free:

  1. First, some people tend to be less selective in choosing a tenant broker because, after all, it costs them nothing. When choosing a lawyer, accountant or other professional most people look for someone who has the skill set and track record that can produce great results. Also, because these advisors come with different costs, they need to be selective in order to justify paying a premium for one or in demanding a discount from another.  Selecting a broker is often much less discriminating and sometimes comes down to who last called you soliciting your business or who you last played a round a golf with. Why not? It’s free. Of course the true cost of “free” is the cost of not choosing the best broker for your particular requirements. Choosing the wrong tenant broker can end up costing you big money on your lease deal.
  1. The second cost of a free broker is that some tenants tend to expect very little from their brokers because they are not paying for the service. Just show me some space, tell me some clever stories and make me feel good. How can I expect a lot of value from my broker – after all I am not paying them? While many companies expect their attorneys, accountants and consultants to be “smart”, “tenacious”, “creative” and “workaholics” given the large fees they pay them, they often accept much less from their brokers.  It’s enough that they are simply “nice guys”, who call them back promptly and “seem to know the market.”

Just because something is free doesn’t mean the decision comes without costs or ramifications. While picking a free Hershey’s Kiss over a more expensive chocolate isn’t going to change your life, picking the wrong broker may cost you a lot of money on your lease transaction.  The real estate market is far less efficient than the real estate industry would like you to believe and, as a result, who you choose to represent you can mean the difference between a bad deal and a very good one.

The next time you need to hire a broker, don’t let the siren song of “free” turn your brain off.  Hold your broker to the same standards that you expect of your attorneys, accountants and consultants.  If you do otherwise, you will get what you pay for.

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