My wife has been looking to purchase a property lately. We are obviously dealing with a broker who did show us some properties. We did manage to finalize our decision and made 2 offers. None of the deals went through and we were asked by our broker to increases the offer a bit in order to close the deal.
Let me shed some detail on the first offer. I did some basic research about asking rates for house prices before making my offer. Even when I met the broker for the first time, I clearly informed him of our budget. Our budget was about $500 per sq ft. As per my research, that was the high point of the range at which property deals were happening this year in our area of choice. Since we were looking at completely newly built properties, I was happy to pay the high point of the deal range. When the houses were shown to us, the builder of flat 1 quoted us an offer of $650 per sq ft. We simply said no to this one.
The second flat was a lot better. Inside the flat, the builder had done a lot of work that we would have had to do once we purchased the flat. So we did decide to increase our offer. However, we were told that all other flats had gone at $650 per sq. ft., so we will have to push our offer higher. The broker is supposed to negotiate a good deal for us. After all, we pay him 1% of the deal amount.
Not a single deal worked out. It is important to note that the economy is in the doldrums, and property deals are simply not happening. I did some more research only to identify that we had made a good offer but there is a huge gap between what sellers are willing to pay and what buyers are asking. Why did the person, our broker, who is responsible for helping us get the best deal, not telling us this information? Why is he asking us to increase our offer? The answer is his incentive.
He will make 1% if we close a deal. We will pay him 1% and ideally, the builder will pay him 1%. What happens if he gets us a good deal? He gets paid a lower amount by us. Moreover, it is quite likely that the builder will blacklist him with respect to all his future constructions. Should anyone ever rely on a broker? Nope! Their incentives are not aligned with ours.
Understanding people's incentives is an extremely important skill set. If you are upset with your government, growing wealth divide, your manager's behavior, your meager pay rise, or why a company is buying stock as opposed to investing in the future - the answer will lie somewhere in what incentives are driving people's behavior.
Governments work for those who help them fund their way into power. In poorer countries, they are actually incentivized to not bring any change in the fields of education, public healthcare, and economic growth because the citizens of such countries will never become aware enough to think about anything other than survival. Why should central banks across the world not worry too much about the growing wealth divide - because central bankers and politicians fall in the wealthy category? Why is your pay not rising fast enough? Because you are not incentivizing your company to take care of you. Incentives play a role in managing relationships, raising kids, and in normal day-to-day life, more often than we realize. After all, understanding them provides an insight into people's personalities and behavior.
If you are a business owner, setting the right incentives works tremendously well as far as staff productivity is concerned. In fact in negotiations, you can assess the incentives of the counterparty to negotiate your way to a win-win situation. Most banks were able to acquire talent because of the financial incentives they offered them. Some companies put a cap on variable pay, some as low as 10%. This is an insanely beautiful way to destroy the objective of any incentive plan. If you are looking at a job, the incentive structure can help you understand how much the company cares about its employees.
The reason why I shared my simple story was to shed light on the fact that understanding incentives can help cut through a lot of bullshit in life. My wife was quite eager to buy the house at a much higher price than was justified. She was upset that the deal did not work out. She did not understand that the counterparties are not working in her best interest and are bullshitting just to get the deal done.
Very often in life, we are upset by certain outcomes. Most of those times, understanding what led to such outcomes, i.e. incentives can help us not only feel less upset but also tweak the incentives so that the outcomes change in our favor. Being aware of this is the first step.
