Real Estate Commissions are Too Low
People who sell $1 million condos often complain that paying a 6 percent standard (read “fixed by collusion” among realtors) commission is too much ($60,000 for what might only be a few days of work). Economists who have studied the real estate market, however, find that in some ways the commission is too low because realtors don’t work very hard to sell clients’ houses compared to their personal houses. In other words they sell a customer’s house relatively cheap so that it will sell quickly rather than work for many weeks to get the best price and 6% of the extra.
Why haven’t we seen anyone propose a commission structure that says the realtor gets a 25% commission… but only on the amount above the assessed value of the property? Your typical $1 million NY or Boston apartment is assessed at maybe $850,000 and could be sold for that price with almost no effort in a few days so the commission paid on such a sale shouldn’t be more than $1000. If a realtor could sell the place for $1.2 million via clever marketing, however, she should be entitled to a fat commission.
Shannon Clark
June 8, 2005 @ 1:16 am
It is worth noting that the commission is actually worse than 6%.
Between 5-6% is the commission which is shared between the listing and the buyer’s agents. So they each get between 2.5-3%.
Only they don’t even get that as most realtors work for an agency, who then get a portion of that commission.
And also out of that commission comes the cost of real estate ads, MLS listings, signage, open houses, etc.
As someone thinking about both buying and selling a piece of real estate in the near future (though admittedly not at the $1M level, much less expensive) I wonder about these commission schedules myself.
Shannon
chris sivori
June 8, 2005 @ 2:33 am
Brilliant. What a great and simple idea.
Omar
June 8, 2005 @ 4:58 am
I’ve noticed for some time that there is zero incentive for an agent to work for that extra 1,000 dollars when selling a house. 6% of the thousand is only 60 dollars, so they don’t want risk the commission on the offer and will recommend acceptance rather than trying for the extra few dollars. At 250 dollars for the effort, the agent will actually think about whether they can get the extra thousand. In a hot market, this all seems crazy to think about, but I’ve experienced selling a house for 20% less than I paid for it and having the equity I was planning on using for the next purchase eaten up. The agent on that deal seemed like he was working more for the buyer than for me. That’s when I first wondered about changing the incentives for the agent.
To those who argue that the commission gets split and therefore is fair, I say “so what”. The only risk the agent carries is their time and minimal advertising costs. The industry I work in gets that kind of margin on average for our product. We own the inventory; we take trades; and our overhead is a lot higher than the typical real estate office. Our margins are too low, but the real estate industry doesn’t need 6% either. They play on the fears of the home owner that agents won’t try to sell the home if the commission is too low. The selling agent will claim that the buyer’s agents will stay away if there isn’t enough commission.
Matt Henderson
June 8, 2005 @ 7:19 am
Your idea might work for a seller that’s not particularly in a rush to sell. However, a hurried seller might be interested in receiving for consideration any and all offers, and under your proposed commission structure, the agent wouldn’t likely be interested or willing to present below-market-value offers to the owner.
Anonymous
June 8, 2005 @ 7:53 am
I believe that selling agents are legally obligated to present all offers to the property owner.
Michael Slater
June 8, 2005 @ 10:28 am
When I sold my house in the east bay of San Francisco, this is exactly what I did. The commission was tiered and he was better paid the higher the sale price of the house was (starting at 6%) And to be clear, I got significantly more for my house (even considering that I had bought it only 11 months earlier… thanks California Real Estate Market!)
By the way, if you think 6% is low or a lot, consider what the real estate agents in Singapore get…. One Percent.
And yes, the average real estate agent here is about as good as you’d expect for paying only 1%. It’s practically a hobby job for most of them — a bunch of Glen Gary Glenross losers, they don’t even get the steak knives.
Kris Carlson
June 8, 2005 @ 1:11 pm
Assessed values vary geographically as do home values. Your idea about commission structure is probably better than the current one in place. But one thing is for sure, 6% is too much. With home prices skyrocketing, the economy will not be able to withstand the current pace for much longer; and everybody wants to get into the foray now. As was mentioned earlier, then commissions are split between listing broker and selling broker and then again by broker and agent. So of the 6% commission only 1.5% goes to the selling agent. The rest just sit back and lap up the cream. If you wanted to revamp the commission structure to recognize the selling agent more you phone would be ringing off the hook. lol
Gary
June 8, 2005 @ 1:23 pm
Phillip,
I think that you are ignoring a history of collusion between realtors and appraisers. There was this little thing in the late eighties called the Savings and Loan scandal where some industrious fellows made use of weaknesses in federal regulations in order to exploit ‘flipping’. Flipping was a process of re-investing in a prporty by controlled re-sales at progressively higher appraisals. This method required cooperation between the appraiser, the realtor and the Savings and loan in order to successful. I would imagine that an accelerated commisson schedule based on exceeding the appraisal would only result in appraisals (un)padded by 10% (wink wink) and loan officers ready to offer a cheap second loan (nod). The only element left is how to distribute the bloated commission between the three conspirators….
William
June 9, 2005 @ 12:37 am
Yes, economically, the crux of the matter is marginal return (i.e. each extra dollar to the real estate agent) and the corresponding incentive for marginal effort on the part of the real estate agent.
Of course it’s complicated by fixed and variable costs, and the opportunity cost of real estate agents responding to a special deal like this when there’s easier pickings just doing the standard 6% commission.
I wonder if Phil has been reading Freakonomics?
grow-a-brain
June 9, 2005 @ 2:03 am
I’ll be more than happy to go for Philip’s system every time. As a matter of fact, we often do
Graeme Pietersz
June 9, 2005 @ 4:05 am
Even on a 25% commission real estate agents will still not work as hard as to sell their own house. The only way to match the incentive they have when selling their own house would be to give them a 100% commission. On the other hand what Philip suggests is an improvement on current structures for a buyer who wants the best possible price (i.e. a fast sale is not a priority)
I do think there I do think there is a strong argument for selling your house yourself – assuming the estate agent sells at the market value, surely you can find a buyer at more than 94% of the market value? Thats all you need to be better off.
I helped someone sell their house in the Britain. I placed a single free ad and I got them a slightly higher price than the offer an estate agent had brought in in the meantime. It is certainly what I would do myself.
Ken
June 9, 2005 @ 6:01 am
In Australia we pay about 3% with discountng down to 2%. Anything more seems excessive. How much does it really cost to put a few adds in the paper, a few hours supervising open houses and dealing with prospective buyers. Incentive to get a good price is that after a set time, vendor can switch to another real estate agency.
Jack
June 9, 2005 @ 1:55 pm
I sold my own house. Sold it in one month when several others on the same block had been on the market for several months to a year. Spiffed it up first, used little tricks to make it feel good when ppl came to see it and saved 3%. Things like a spreadsheet detailing all utilities costs and putting chocolate chip cookies in the oven when showing it may have helped. Of course not everyone would be good at showing their house to strangers. . .
Peter Gottlieb
June 9, 2005 @ 2:13 pm
In Westchester County, NY a 6% commission is rare. This is a highly competitive market with a large number of agents and firms and 4% is much more normal. Nothing is more split up than a commission, and the previous comment about the split is correct. The marketing and selling side generally split the commission evenly. The agent will get roughly from 50 – 80% of the commission. Large real estate firms will set an upper limit on advertising for any given property to guarantee profit, while smaller firms will sometimes take the loss to make the deal happen, but it is quite possible in an expensive area like here to blow through the full commission for the marketing agency just in ad costs. Regarding the incentives to salespeople, my feeling is that agents will sell what they can, almost regardless of the commission (within limits). On one $2.5MM home we offered to give the selling agent a new car on top of the commission and it didn’t really matter IMHO. Agents who had customers interested showed the house, those who didn’t, didn’t. I get agents who thank me for getting deals with higher commissions but they sell the homes with lower commissions just as rapidly, it really only has to do with what the market wants. Now, if you have two identical properties (like two units in a condo), and one is 4% and the other 6%, *then* it makes a difference and agents will try to sell the 6% one much harder than the 4% one. Most real estate agents don’t make a lot of money and there is a very high turnover rate. Too many are lured by the thoughts of easy money and get disillusioned after a couple of years. Like most other fields, there is no easy money in selling real estate; like I tell all our new agents, it is a 24/7 job where you have to keep a high level of enthusiasm and energy and unless you make an extraordinary effort you will only pull in an average “salary.” This subject is more complex than can be even outlined here, but you know that competitive economics
eventually drives out any excess profit and so if full service commissions bottom out at around 4%, that is about the point where there is zero economic profit.
Gabriel Ricard
June 13, 2005 @ 11:49 am
Phil, I work in a real estate office and asked around about this. Apparently, at least in MA with MLS PIN, you MUST state the commission in the listing as a % of the sale price. (I’m not sure what Links down in Boston does, or if anyone actually uses that MLS) That seems to preclude the possibility of modifying it afterwards. There are two fields in MLS PIN for tracking commissions: Buyer Agent Commission and Seller Agent Commission, so in terms of listing it, it’s a set value. I don’t know how realistic it would be to change that.
I suppose the seller agent could work out a different deal with buyer agent (if they are not the same agent, of course) at the closing. The problem is, how does the owner deal with a variable commission in this case? Are they paying the seller agent a variable commission and the buyer agent a normal commission? The problem with that is that the buyer agent’s commission is usually paid from the seller agent’s office. I’m sure some unscrupulous agents would take advantage of that.
Also, Michael Slater (above) is correct when he says “It’s practically a hobby job for most of them…” The average agent has only a few sales per year. The income resulting from which would put you at poverty level, unless it is simply supplemental income.
Bud Tuggley
June 13, 2005 @ 5:22 pm
Wherever you see huge financial wastes, such as real estate commissions or health insurance administrative costs for example, their will inevitably be a powerfull lobby created by those benefiting from that waste, to protect the status quo.
Of course, homeowners could in princple organize their own counter lobby, however most people do not sell homes on a regular basis so that’s not likely to happen.
Peter Sisk
June 16, 2005 @ 5:30 pm
When I proposed something similar to my broker, she didn’t even bother to respond. 2.5% of $500,000 for essentially NO work is a much better deal (for the broker) than 25% of whatever additional value they might be able to squeeze out of the property. It isn’t clear to me what I was getting for my 5% other than some pricing advice that was biased toward a quick sale at a low price.
Sandra Valente
June 22, 2005 @ 8:26 am
Either way, with the prices that real estate is going for these days, there are some real estate brokers making crazy money.
Bill
July 13, 2006 @ 12:04 pm
I hate to burst the author’s bubble, but this type of commission structure is nothing new. It is a net sales commission. The Agent gets any where from 1-100% of the sales price over a certain fixed number. Remember, commissions are not set, can be negotiated, and are driven by the market. Here in the U.S. for the past couple years most agents are selling for 3% in the residential market, due to the strong seller’s market. As the market cools and it becomes a strong buyers market, it is not uncommon to see 8-10% commissions. This should be common sense to anyone who understands supply and demand. Also, the commission is payed for much more than just “selling” the house. Let’s face it, at a point the property needs to stand on its own. The commission is paid for selling, qualifying buyers, overseeing the very risky business of showing strangers through a property, dealing with reams of legal issues that many FSBO sellers end up losing huge percentages of their sales price on, and actually taking the property through settlement. Discount brokers offer to “sell” your house for $1000 max, because they are not going to be legally obligated for anything else, and if something goes wrong, you are screwed. For example, you sell your house FSBO, next year a highway goes in next door to the house you sold. There was a township meeting approving this that you didn’t bother to attend. The new owners sew you for the 50% drop in value because you never told them about the new highway. So you pay 50% instead of 3%. Good job. If you think this type of thing won’t happen to you, you should talk to the large number of FSBO sellers who either spent 24 months unsuccessfully selling their house and ended up using a broker, or who paid large penalties in one form or the other. There is one condition in which I would sell FSBO, if it is a very strong seller’s market, (i.e. people making offers over asking price) and my property is mortgaged too close to market value to afford a commission. I would still hire an attorney to take it through settlement, and this will be 1-2% of the sales price.
senders
July 5, 2007 @ 7:08 pm
Seems to me the sales commission is only one point, bills senario hits upon the disclosures requirements and how could a FSBO really keep up on all the changes. They are much better off hiring a realtor to protect their interests.
In Northern California, 6 percent is average, unless you discount your services. The true cost of selling a home, especially in today’s real estate market is alot more than you would think, but depends upon supply and demand.
Ernani Uchoa
July 24, 2007 @ 12:51 pm
The 6 percent real estate comissions rate is reducing with the number of foreclosures and fsbo, on which buyers will not pay any comissions. Real estate agents have to reduce their comissions in order to keep up with the competitive market. Good foreclosure listings websites are: http://www.foreclosuredeals.com/, http://www.realtytrac.com/, http://www.foreclosurelistingsnationwide.com, http://ww.foreclosuredatabank.com/
Kyle
August 27, 2007 @ 11:16 pm
I am a Realtor. I think that the FSBO market powered with the Internet may be the eventual end to traditional real estate brokering. I frequently find myself browsing sites like http://www.virtualfsbo.com and the owners website looking for potential sellers. In the early years of the MLS, you could convince sellers to charge a higher percent because every realtor on the MLS would want to show their clients that home. The end result was a fast sell and a bigger commission. Now days, we have to compete with $99 one-time listing fees and flat fee MLS packages. Trying to convince a seller to pay a 25% commission would end up in a closed door in your face. just my thoughts…