For property investors, the concept of a buyer’s agent should be very familiar by now, especially after COVID. There are many myths surrounding their values — some say they buy better properties than you, some say they help you save time, while others paint them with a negative image.

As someone who believe that there are sufficient alphas in property investing, I had hoped that some alphas could be uniquely delivered by buyer’s agents. However, after engaging with buyer’s agents offering different propositions and understanding them from first principles, I grew more pessimistic about their unique values that experienced investors can't already deliver themselves.

Are They Selling True Alphas?

The first step in determining whether buyer’s agents can deliver alpha is to look at the source of alpha. If there isn’t a plausible story behind alpha, chances are, there is no alpha. By plausible story, it needs to simultaneously explain why the alphas exist and why they are available to the agent but not others. There are roughly five business models, even though one of them is arguably a scam.

Market Making - Some buyer’s agents explicitly help owner-occupiers find properties in highly prestigious areas where there is a reluctance to list homes publicly. These buyer’s agents function more like market makers. The goal is to find a home that matches customised needs. They aren’t there to deliver alpha and aren’t the buyer's agents that investors generally consider.

Market Timing - This type of buyer’s agent uses metrics like vacancy rate, days on the market, yield, and their first derivatives to identify areas with immediate price growth potential and buy properties in those areas. They are top-down investors who attach the hopes of alpha to the area they choose, not the individual properties they buy. The bottom line is to not overpay for properties. By definition, this is market timing on areas — you may think it sounds like it would work.

Local Experts - Local buyer’s agents believe that it is important to leave their footprints on every street in the areas they serve and develop a deep intuition about any individual property they come across. This way, they can produce deep insights beyond what is available on the internet. Local knowledge definitely comes in handy for someone looking for a home. However, whether their choice of investment properties in the area will perform better than those selected by simple metrics remains to be seen.

Off-market distressed sales - These buyer’s agents claim to have access to off-market listing databases from the agents they work with. The off-market listings sometimes come from distressed sellers who have to sell due to divorce, deceased estates, bankruptcy, etc., which could knock off the price a bit.

Spruikers - These are the people who pretend to have secret deals for you and even offer short-term incentives like rental guarantees, stamp duty concessions, etc., but their primary business model is to receive kickbacks from selling worthless junk.

It is quite easy to tell that spruikers and market makers are unlikely to generate alphas. Market timing, local experts, and distressed sales are all likely to generate alphas at first glance. This is where deeper exploration is required.

Scale Prevents Commoditisation

I will say the conclusion first—the scale challenge of alpha will prevent it from being commoditised away by buyer’s agents. In other words, there is a winner’s curse even for those who have the ability to find alpha.

For those who specialise in market timing, they will hold on to the areas they think have high potential. It is common to see them claim they invest in the top xx% of the market. The story sounds nice, but there are a few fatal flaws. The first flaw is that the area selection approach is highly similar across the buyer’s agent community. As a result, you often do not have one buyer’s agent searching in that area, but multiple. Currently, lots of buyer’s agents are looking at Perth, for example. Investors who understand how they choose areas are also looking at Perth. It is said that 40% of Australian investors are in the Perth property market at the moment, making it extremely crowded considering Perth only has 7% of the Australian population. The second flaw is that reaching the top 1-5% in the broader area is not difficult. Once the budget and a set of criteria are set, there are generally just a handful of areas to choose from, especially if one invests only in metropolitan cities and has a state preference due to exposures in existing portfolios. You can’t go too wrong picking an area closer to the city than a more remote area if they are in a similar price range. The third flaw is that individual property selection remains highly important. An area could have hundreds of listings, and their investment potentials could vary more than the variations between areas. Yet this is not being optimised by buyer’s agents as their primary drive is to close a deal, rather than finding the best deal for every single client.

For the local experts, they should have the ability to know the fair price of the property, know all the local sales agents, and even know the situations behind certain properties in the market. This is an unique edge, especially in a hot market where any property can go at auctions for an unpredictable price. However, I think this service is probably more suitable for owner-occupiers knowing which area they want to live in than investors. For one, good investors tend to avoid hot markets because unsophisticated/retail participants quickly drive up the market price, sucking away growth potential for years. For two, it is unclear whether the local agent’s expertise is significantly better than decisions based on simple metrics like rental yields. A not well-known fact is that most value investing managers in the stock market can’t beat a simple value portfolio created by stocks picked by PE/PB/Div Yields metrics. Those buyer’s agents charge a fee between 2-5% of the property value, so it is important to ensure the costs stack up against the values they create.

For distressed off-market listings, it comes very close to answering both why the alpha exists and why it is available to the agents but not others. However, just because a listing is distressed and off-market does not mean it will be sold below market value, given the property market has a good level of liquidity, especially if there is a good sales agent. Quite counterintuitively, in most off-market deals I’ve seen, it is the buyers who are at a disadvantage because subpar quality assets get packaged up and offered at a predetermined price without any price discovery process you’d see in the public market, similar to how some individual angel investors get ripped off in some private deals. Even if a deal is truly undervalued, it will be contained to a modest degree, as the sales agent and the buyer’s agent see the deals before you do. And then after fees, chances are, you would be able to spot better deals yourself.

In addition, off-market is not the only way to capture distressed listings. There are various public market signals where a listing is distressed, including low-quality listing descriptions, frequent openings, stale listings with multiple price adjustments, disinterested or overly enthusiastic agents, etc. For some of these types, the discount you can get can be huge, yet there is no middleman.

Incentives

The last part is about buyer’s agent incentives. If we say business models determine how much alpha you can get, buyer’s agents’ incentives determine how much alpha you will get.

For buyer’s agents targeting investors, they don’t get a slice of the alpha but get paid on deal closing. Some get paid a fixed fee, and others get paid a percentage fee. Either way, for buyer’s agents, their incentive is to close as many deals as they can, rather than picking the best deal in the market for a specific investor.

In doing so, chances are, buyer’s agents won’t be price sensitive, as many people would’ve observed when dealing with them. Unlike investors like Robert Kiyosaki who can go as far as offering less than half of what the vendors ask for, buyer’s agents could even pay a slight premium so they can lock in the sell side of the transaction.

The other angle is similar to ‘diworsification’ in investment management, where low-quality deals get added to the portfolio, reducing the overall returns in the portfolio for the sake of the quantity of holdings. Assuming property deals’ quality can be ranked, individual property investors would like to settle for the top deal as most investors would have no more than a handful of properties in their portfolio, but buyer’s agents will just pick the top N deals in the market where N is the number of clients they have.

Ultimately, good deals for property buyers are rare to come by, as the property location, conditions, budget, and most importantly, price all need to be right. Good deals on the extreme side are often the deals that sales agents do not want to bring up ever again, something that buyer’s agents naturally steer away from because of the need to maintain good relationships with sales agents.

Let me close with the famous Steve McKnight quote

If you are hoping to become a great investor with alphas in your portfolio, buying solutions created by other people is likely the wrong place to start.