Closings, prisoner’s dilemma, and professionalizing markets
At the heart of every real estate transaction is that long-imagined moment called a closing, when title mystically and invisibly passes like a holy spirit, the owner becomes a seller, and the buyer becomes an owner. As anyone who’s ever attended a closing knows, the reality is a paper shuffle among a table full of people, all of whom are either terribly anxious or bored silly.
That’s when it works. When it doesn’t, the smooth becomes rough, and the closing is a catastrophe:
IN a real estate utopia, there are no last-minute meltdowns and no buyers forsaking an apartment because of a $100 microwave. Sellers do not threaten to kill a deal if they don’t have a signature by sundown. No one acts like a character in an Edward Albee play.
But in the ever-so-flawed real world, all those things do happen. And although they happen even in the calmest of markets, real estate brokers and lawyers say that home sales in New York City are now more vulnerable than ever to stumble or crumble at the finish line. There are no data to record how many closings die or are delayed, but brokers are seeing and hearing about more 11th-hour problems.
At any time, finishing a real estate deal can be far thornier than just signing deeds, writing checks and handing over the keys to the front door. Closings may not end with a handshake but with failure, fury and two people nearly aborting a $400,000 apartment sale because they can’t decide who should pay $250 to replace a broken air-conditioning unit.
The disaster stories are everywhere, and brokers and lawyers tell them like Homeric epics.
Why does this happen, and why are they cocktail-epics among professionals? Some core market-dynamic principles are at work, with implications for how we want to grow and develop efficient, robust, functional housing markets around the world.
The closing ends a complicated sequence of steps:
Borrowed with thanks from Saratoga Home Sales
Many of these are technical, subject to professional, legal, or government requirements. They all have to be done or the closing does not go forward. Meanwhile, for the customers — seller and buyer, the process is like many of their great rites of passage — birth, first day of church, first communion/ bar mitzvah, graduation, marriage — something they hope to do only once.
The customers are amateurs, so they’re inexperienced and inexpert. Big money is at stake, so they’re wrought up and anxious. They know that this particular transaction they intend to do once, so they have one operating principle:
He knows something about New York real estate ….
So they do dumb things:
Some don’t research their purchase thoroughly, or rely on inaccurate or incomplete information from the seller or building manager. Some sell before they’re truly ready to move. And many buyers and sellers simply sink their claws into each other, the alchemy of an overheated real estate market turning a business deal into an emotional grudge match.
Since closings a conspicuous financial events, secured by an asset that cannot flee, they are also an opportunity for bystanding busybodies to emerge from the woodwork, their hands out for boon service:
In SoHo, one couple was about to sell their co-op loft and move to the Catskills in upstate New York when, at the closing, a crusty member of the co-op informed the buyers they would be required to rip up their floors, soundproof them and install wall-to-wall carpeting, said Susan P. Meisel of Meisel Real Estate, the sellers’ broker. The buyers pulled out of the deal, and the sellers moved back to their loft, sleeping on cots and using two orange crates as tables until they could find another bidder.
In between sellers and buyers lie the intermediary professionals — brokers, lawyers, mortgage originators. By contrast with the seller and buyer, they are not principles, but agents. And they’re not neophytes, they’re experienced.
Finally, and most importantly, the professionals know they will be doing it again. Tomorrow they’ll be back at another closing table, with another cast of buyers and sellers
“People come. People go. Nothing ever happens.”
These categories are subcases of the famous Prisoner’s Dilemma problem — do you cooperate or betray when you do not know what the other person will do? Betrayal-based tactics work once — the first time — and do continuing damage. (Enactment of rent control can be seen as a betrayal strategy by a municipality against the developers with whom it has historically cooperated.) Extensive game-theoretical and human-behavioral research has demonstrated that, in the long run:
· Betrayal-based strategies lead to meltdown, a reciprocating and accelerating maelstrom of mistrust (e.g. pick your long-running ethnic feud). The extreme end state of the zero-trust one-time transaction is the drug deal, which is why in structural terms so many of them end in violence.
· Cooperation-based strategies lead to stability, where you win the macro-game by refraining from winning any given micro-game. The extreme end state of cooperation-based professionalism is the reputation, where a professional’s word is a currency because it is built on decades of cooperative behavior.
All of these approaches, however, rely on repeated playings. They crumple into nothing when the participants play only once, for all the marbles. Then anything goes.
We can thus see a closing as a mixture of two different categories of game-players:
· Principals, who play once, badly, and with self-interested motives to defect.
· Professionals, who play repeatedly, well, and with self-interested motives to cooperate.
Since we want markets to cooperate, policy makers thus have a stake in seeing the emergence of a successful population of professionals who can rein in their clients’ destructive impulses.
Finally, there is an exacerbating stimulus at work in New York City — the irrational anxiety arising when supply is scarce.
With inventory tight and good deals hard to find, stressed-out buyers are signing contracts fast – often 24 hours after first seeing an apartment – which gives buyers and lawyers little time to research problems with the apartment, the seller or the building.
“People sign contracts, even against their lawyers’ advice, that maybe they regret later,” said Paul Irvine, who owns the Irvine Realty Group. “You’ve got to hit their number and sign a contract quick with as few contingencies as possible, or the seller can go on to the next guy.”