What’s a fair commission for selling your home? $5,000? $15,000? $50,000? That last amount is what you’ll pay on the sale of a typical $1,000,000 property in America today. For an average $250,000 house, you’ll end up spending about $12,500 in commission.
Is it fair? If you ask the typical real estate agent what a fair commission is, the most common answer you’ll receive is 5-7% of the sales price. And that seems logical right? Because the “percent of sale” approach seems to align the agent’s incentives with your own. If you get a higher price for your house, the agent gets a bigger payout.
But what if your house is worth $250,000, and your agent sells your home for $240,000? That’s a difference of negative $10,000 to you. Guess how much it impacts the agent’s real bottom line?
About $150.00.
To understand why, first remember that the selling agent doesn’t receive the whole commission on a sale. Typically, 50% of the commission is offered to the buyer’s agent as incentive to bring the buyer to see the house, and another 40% of what’s left goes to the broker for whom the agent works. Of that $12,500 typical commission, the selling agent ends up with about $3,750 (or 1.5% of the home’s sales price). Second, remember that because the agent’s fee is a flat percent of the whole value of the home, the agent receives the bulk of the commission even at terrible sales prices.
In other words, for doing a sub-par job of selling your home, the agent still reaps $3,600 in this scenario.
“But my agent is different! She’d never cheat us”, you say. And maybe you’re right. Maybe your agent is different. But what if there’s an offer on the table for $240,000. The offer arrived just 6 days after listing and it has excellent terms. Your agent sees that $3600 commission in sight. Might she not encourage you to take the lower offer? It would be easy to justify. The housing market is soft. And this offer has really good terms.
She probably doesn’t feel like she’s cheating you.
It gets worse.
What if you have a $220,000 mortgage on the property? The difference between a $250,000 sales price and a $240,000 sales price ends up being more than half of the profit on your home after you deduct selling expenses. Instead of walking away with $17,500, your take away is only $8,000. (I’m excluding transfer taxes and other fees to make the comparison simple).
I’m not the first one to point out this unfortunate reality. Freakonomics (the book) explores this situation in depth, comparing sales of agents’ own homes to those they represent. And not surprisingly, they found that agents selling their own homes left them on the market longer, and sold for a higher average price. A great case study from Jonathan Meer confirms these findings. (It was featured on the Freakonomics blog.)
Unfortunately, Freakonomics stops short of providing a solution. At least I think they do.
So here it is. Here’s the fix.
The Big Fix
We know that real estate commissions should be heavily weighted on achieving a fair sales price. To do this, we need to offer the selling agent an escalating incentive fee for selling the house at a higher value. We also need to keep the buyer’s agent’s incentive flat (otherwise, the buyer’s agent won’t do a good job of representing the buyer).*
Let’s take the $250,000 example from above. In our new scenario, we’ll set aside 2.5% of the expected sales price for the buyer’s agent. For the seller’s agent, we’ll use the following approach.
If the agent sells the property for less than $242,000, she receives no commission at all. At $242,000, she receives just 0.5% commission. For every $2,000 in increased price, she receives an extra 0.5%, through a sales price of $250,000, where the commission will total 2.5%. For every dollar earned beyond that, the agent and the homeowner split the amount above $250,000, 40/60, respectively. Take a look at this table that shows how the value work out.
Sales Price | Commission
- $240,000 | $0
- $242,000 | $1,210
- $244,000 | $2,440
- $246,000 | $3,690
- $248,000 | $4,960
- $250,000 | $6,250
- $260,000 | $10,250
Using this approach, the selling agent is incentivized with $1,300 to negotiate the buyer up from $246,000 to $248,000. That’s real incentive!
If the agent does an outstanding job and sells the property for $260,000, she can earn a whopping $10,250 (equivalent to 40% of the value in excess of $250,000).
The key to such a scenario is knowing the market value of the home. For that, the answer is simple: prospective sellers should get a pre-sales appraisal. This appraisal, ordered and paid-for by the seller, serves as the basis for setting the sales price.
That Is…Assuming You Still Want an Agent
This approach assumes you (as a seller) still want an agent to represent you. In Meer’s paper we linked above, there is significant evidence that agents don’t offer much value at all beyond listing your house on a multiple list service (MLS).
In fact, based on our own experience, we believe that the two most critical aspects of selling a property are:
- Pricing it right.
- Putting excellent pictures and a great description on the MLS.
Is it worth paying agents and brokers 5% for that? Perhaps it is for some. But our guess is that FSBO will become an increasingly popular sales tool over the next decade as the internet and technology erodes the advantages agents have traditionally enjoyed.
What do you think? Can a more fair system work?
*To properly incentivize the buyer’s agent, we’d need a more complex discussion. But I think that this, too, is possible, based on the outcome of a post-offer appraisal.
(photo credit: mbowlersr)
Great post. The commission system is based in antiquity, from a time before the internet leveled the playing field. When only realtors had access to listings and not all listings were known to all agents. It does need to be thrown out and redone.
I don’t know if your solution could work though because most realtors work strictly off commission. Realtors will tell you, rightly so, that their commission covers all the intangibles like driving to the house for showings, field calls from interested buyer agents, etc.
Let’s assume you and I put our houses on the market say Jan 1. Let’s say they are similiar — heck lets say they are identical, built by the same builder. Let’s say it takes 2 weeks to sell yours and 2 months to sell mine because it’s further from the Metra station. The system is supposed to balance that out time spent on both houses.
I’m not convinced a realtor actually pursuades anyone to buy one house over another. But you need a realtor to handle showings unless you have a ton of free time. Even if you do, you don’t want to be present when someone picks apart your home.
Fred,
I’m going to have to disagree with most of this approach. Now my view is probably biased as I work for a construction company that is also a real estate brokerage firm.
While I don’t disagree that sometimes the incentive to find a better deal isn’t all that lucrative I do believe that ultimately the final decision is the seller. Furthermore, the bigger issue is your proposed fix. Brokers for our first only make money on a sale, and in today’s market many of them sit on listings for months on end and sometimes over a year. They attend countless open houses, show the house, pay marketing fees, insurance, MLS fees, the list is endless. So at the end of the day none of them would take your listing.
The commissions sound like a lot…but the reality is they don’t add up fast and it’s a tough way for many to make a living. Million dollar homes seldom end up paying much more than 5% and even when they do the cost to sell a home that expensive can be quite high. Most homes of that size are typically advertised heavily in not only local media but also national media.
The system isn’t perfect, but it’s certainly not a get rich scheme that many complain about.
It surely could use revamping. There are pro’s and con’s to both ends. I did notice however real estate brokers seem to make enough money to live in big fancy houses so either they make enough in commission to pay high mortgage payments or they all snapped up a deal for themselves 🙂
Great comments, all…
Todd, no argument that brokers should be fairly compensated for their time when they deserve it. The emphasis here is on what’s fair. If a broker fails to get you a fair price, they shouldn’t reap the reward as though they had. Note that I think it’s very different for well-informed commercial sellers. Those sellers have the wherewithal to represent themselves and likely will hold an agent accountable over several transactions. For individual sellers with less knowledge of the market, they are much more likely to make a decision out of lack of knowledge, rather than a surplus of it.
Don’t get me wrong. Real estate isn’t the only industry where this is a problem. Financial advisers are another class of “experts” that frequently make out much better than their clients, regardless of performance.
Here’s another point of evidence: Despite the market going up more than 50% over five years, real estate commissions in our area dropped an average of only 15% over this time… all the while more agents were entering the market. Now, to their credit, rates haven’t risen in tandem with the fall in prices either.
It’s clear that an approach that better aligns seller interests with agent compensation is in the best interest of the general population.
I don’t understand something here. Maybe I’m missing it. How is it you expect a Realtor to get zero commission if they close a deal? After all you’ve said “YES” to the offer. They obligation is to present you with offers, you get to say yes or no.
This is especially true in today’s market. Buyer’s know they are at the advantage so they low ball everything, the selling agent can’t control the offers they get. Am I missing something here?
Todd, now that’s a valid point. So perhaps the chart I propose is too steep. Perhaps some fee ought to be paid no matter what. But there needs to be some built in accountability and incentive beyond flat commission percentages for agents to work towards higher offers. Agents *should* be incentivized to FULLY represent the seller. There are ways to modify my suggested approach that would add modest additional complexity but could preserve the general principle MUCH better than the current system does.
You should really take a look at Freakonomics (it’s a great, easy read and available at every library or in the common online places). Agents tend to sell their own homes over longer periods of time and at higher prices. Further, the link I cited demonstrates that when a popular FSBO alternative exists, prices for those sales roughly approximate agent-closed deals.
The bottom line: we need to call agents to a seller-aligned standard. In fact, they ought to call themselves to a higher standard.
The internet, with sites like http://www.FSBOMadison.com, are going to dramatically alter the real estate landscape over the next decade.
Fred,
I am a realtor and I do get creative with me commission structure to benefit the seller. I realize that it is a tough market and it is really hard on sellers. However I do not just stick a sign in the yard and hope that someone else comes and sells the home for me. I spend hours posting the house online, taking calls, showing the home to everyone that calls, marketing the home in local magizines, informing other agents about the home. I work everyday of the week from about 8am till sometimes and usually 11 at night. I spend 1000s in marketing dollars to ensure that the homes I list are well seen online. I also hire professional photographers to take pictures and do virtural tours. This is a few of the many things I do. I also am an expert in distressed prtoperties, I have handled countless short sales and helped families avoid foreclosure due to a true hardship which you cant do as a homeowner. The banks only deal with agents and in this market most buyers are looking for deals like this so you have to have an agent. You mentioned FSBO sellers, there is a terrible sucess rate of that were Im from. Real buyer have agents, bottom line. It costs a buyer nothing to have an agent and an expert. There is no other way to get into a home without an agent unless you want to go to open houses all day long. The internet does not have up to date information on homes either. Zillow will not tell you the day a home reduces in price or when it is under contract. I see this all the time, someone falls in love with a house on Zillow and calls me to see it and I look it up in MLS and it was under contract or sold months ago. A house sells strickly on value, it doesnt matter what you owe or what you put into it. The BUYER decides the value not the SELLLER there is nothing your agent or you can do about that. Honestly the best advise you can give rather than changing commission structure is to price your home correctly by looking at the comps in your area and going off those. That is what any buyer is looking at and no one is going to pay more than they feel your home is worth. It is your agents job to market it, negotiate, inform you and other agents but it is not to try and convince someone to purchase a house that is over priced so she can make more money. That is just not the way things work and quite frankly this market would get a lot worse because houses would sit for months and months longer. We would also see a drop on quality agents with a structure like this because with the amount we pay in dues, taxes, splits with brokerage its hard to make ends meet most times anyway.
I respect that you had a bad experience with your realtor but with all due respect would you want someone coming to your work and asking you to give a service for free?? When you put time and money into it daily?? You really think you would do a service for free.
Finally it sounds like you are very emotional about your sale and that always plays a big part in a real estate transaction. But that has nothing to do with your agents commission. You mentioned what an agent gets paid for selling a million dollar home. Where I am from that is a once in a lifetime sale and I would be so excited to sell a listing like that. And I would hope that seller would think I deserved every bite of it.
One last comment….I also donate 25% of my commission back to a charity of my buyer or sellers choice in thier name no matter what the cost of the house. There really is no scam or anything unfair here…we are all just trying to make a living.
Amy,
A few things:
1) It sounds like you’re a great agent who cares about her people. That’s fantastic.
2) I’m glad to hear you get creative with your commission structure to benefit the seller. You are in the small minority of agents who consider this.
3) I was not unhappy with a Realtor when I published this article, as you suggest. In fact, I have a great relationship with the real estate agent I use.
4) The article cites data from studies of others and from one book I’ve read.
5) I don’t think there’s a “scam” per se. What I do think is that as with every principle-agent situation, there is an unequal amount of expertise involved in setting the commission structure. Agents use this to their advantage.
I don’t even get into the fact that agent groups protect access to MLS in order to create an artificial barrier for the data for homeowners. While an agent may pay up to $1,000 a year for such a service, at least in our area, you cannot get read-only access to this data unless you are a licensed agent. Why? Because the real estate profession has this locked up.
I understand you are trying to make a living and respect that. Please don’t misunderstand and think that because this article takes a critical look at the price of selling a home means that I don’t think agents are always a bad investment. But, I think that homeowners should seriously consider their options and make an informed decision.
All good points. I think some sort of incentive system certainly might be valuable to all those involved. But I also fear that the reality of the real estate market is fairly set. What I mean is the length of time and final sale price are driven almost exclusively by market demand.
Now it’s true that selling it yourself can ultimately mean a big pay day for the seller. But it can also mean some serious headaches and liability.
No doubt online resources will drastically change the landscape. I sure am glad I have no future intentions on selling, having done it once in the past it’s not an experience I want to live again anytime soon!
Thanks for the great subject Fred!
Two of the best agents in Annapolis, MD area wanted to sell our spec home 7% listing at $799,000. One of them particularly said that she would typically only show homes that had higher commissions no matter the “fit” for the buyer.
We decided to buy a nice sign, paid $500 to get it onto MLS and had it sold ourselves for $805,000 in about six weeks.
If your willing to gain a little knowledge and home some common sense – sell the home yourself . . . totally worth it.
Hey Greg, great addition to the conversation. I think the culture’s headed in the direction of self-selling, especially for houses in the $800,000 range, where commissions are more than $50,000. And rightly it should. $50,000 is more than median annual American salary.
The culture is changing but there are still real estate “agents” who bristle at the thought of someone even making their own offer without “broker representation”.
Folks – you can do these things by yourselves.
So this fix…isn’t really a fix. In today’s market a Real Estate Agent is most likely out to get the higher price for their seller. Why wouldn’t they? It’s a win/win situation. The seller makes out and the Real Estate Agent through diligent efforts and good follow up, also gets to make a little more.
However, giving an Agent more money for getting a higher price sounds like a great idea, but in most markets across the Nation, the appraisal will not come in. That means there has to be a buyer who can come in with the difference. This may work out in some cases, but in most it will not.
Dana, in this case, getting the appraised value results in a 5% commission. Getting more results in substantially more. The Realtor is only lesser compensated if they sell an offer worth less than the appraisal. Are you a Realtor?