Agents Only Blog

Finally, We Talk about Commissions…

To keep this simple, let’s look at a typical full-time residential real estate sales agent. When an agent meets with a seller to list a home for sale, the selling agent and the seller will determine a commission structure in advance to the home being listed. Legally, this is always negotiable but it can be a flat-fee or a percentage of the home’s sale. There can also be agent bonuses or other incentives for a quick sale. Generally, the broker (see Part 1) sets guidelines as to how their agents should structure commission as a part of their overall business plan- however if the broker is a member of a multiple listing system (MLS) then there may be additional requirements as to how the commission has to be structured.

The MLS

A multiple listing system (MLS) is where a selling broker agrees to payout a percentage (or split) of the sales commission to any other member of the system who brings in a buyer for the property. Even though the exact split is unique to every listing (and determined by the seller), the system allows agents who represent buyers to avoid having to negotiate commission with the selling agent on every single deal (or require their buyer’s to pay a commission). Generally, most markets have one major MLS which is usually managed by the local Association of REALTORS (some larger markets may have multiple system’s). The MLS will also have basic regulations as to how member agents can market their listings as well as how buyer’s agents can show them (to create standards and keep everything fair for all parties).

Why all of this is important is because if your broker is a member of the Association/MLS (and most larger brokers are), a seller’s agent will have to submit all of their listings to the MLS, specify the commission split up-front, and post the listing in the MLS database for all other agents to see and sell (there are exceptions to this but they are unique to each MLS so I won’t be discussing them here). A typical commission split is usually somewhere around 50/50 or 60/40. So, if your seller agrees to a commission of 6%, you will probably agree to pay the buyer’s agent’s broker 2.5% to 3% with the selling agent’s broker keeping the rest.

Although a significant percentage of agents and brokers are members of the MLS, not everyone joins. If you join a broker who is not a member, you might be expected to not only list homes but bring in a buyer for the listing as well (or negotiate a commission split up front with a buyer’s agent before they can show the home). Although there are legitimate reasons to not join your local Association/MLS, a significant percentage of home sellers like the benefit of having exposure to all of the potential buyer’s agents (so unless you have a specialization that is unique, you might find it difficult to get clients without the MLS membership).

Non-Traditional Brokerages

This brings us to discount or flat fee brokerages. Despite the marketing hype, discount and flat fee brokerages have been around for a very long time. However the rise of the internet has reduced the start-up costs and created quite a few “internet” based brokerage (although state licensing laws still apply). As the purpose of this article is to discuss how an agent gets paid, I would like to avoid the debate over which business model is better and stick to compensation. But understand, in most commission-based residential real estate transactions the seller generally pays commission only when a property sells (which means an agent or broker might incur marketing expenses they will never recoup if the property doesn’t sell or they get fired by the seller). That may not be the case in a flat-fee scenario.

Flat-fee brokerages may take payment up front or credit card payments at the time a seller places a listing (or they may take it upon sale). If the brokerage is a member of the MLS, they may also require the seller to pay a commission percentage to a buyer’s broker on top of the flat fee (once it sells). A $2,000 flat fee paid up front with another 2.7% paid to the buyer’s broker would be a fairly average transaction from what I’ve seen. Over the past year, the state of Missouri has passed regulation to specify the minimum effort a brokerage must provide a seller (receiving offers and submitting counter offers). This is due to internet brokerages that were basically taking their fees up front and then doing nothing for the client (not even putting them into an MLS).

Many of the really low cost flat-fee brokerages (those that charge under $1000) are often one person shops (because there really isn’t a place for agents in their business model). Of the larger flat-fee brokerages that do have agents, an agent might get a percentage of the fee, or might get paid for “add-on” sales- such as selling the buyer a real estate lawn sign for their yard, or selling the buyer add space in the broker’s newspaper ad. In these cases, the brokerage will establish a “menu” of marketing solutions for an agent to sell to a seller.

Although discount brokerages get lumped into the same category as flat-fee brokerages by most agents, the truth is it’s a different business model. If you join a discount broker, you are basically getting paid the same way as the traditional “full-service” agent would get paid (commission after the sale)- only you are agreeing to provide your service for less commission (and will generally provide less marketing to compensate). In many cases, a discount broker’s only marketing might be to put the listing into the MLS for buyer’s agents to see. As an agent at a discount brokerage, you are generally expected to make your money one of three ways- make up your discount by selling in volume, live off of a lesser commission, or use the listings as a tool to make contacts with buyers (and make your money off of the buyers).

Understanding Commissions…

Now let’s go back to the traditional residential agent working with traditional full-service listings that are a part of the MLS. In St. Louis, the average commission rate is right around 6% of the home’s sale price (again, every listing is unique) and the average home sale price is somewhere around $200,000. For our example, we will use these numbers and assume the split between the buyer’s broker and seller’s broker is 50/50. For the record, when one agent represents both the buyer and the seller, you have what is called “dual agency” and the one broker gets the full commission. Many agents will discount dual agency as a marketing tool to get buyers- although in St. Louis the average number of homes that sell under dual agency is less than 5%. For our example, we will assume there isn’t dual agency.

Upon closing of the sale, the seller pays the selling BROKER the commission who then pays the buyer’s BROKER the commission split. For our $200,000 home, that’s $12,000 total commission which the selling broker then gives $6,000 of to the buyer’s side. Please note that the commission is paid to the BROKER, not the AGENT. Every broker will have their own unique plan for paying agents.

When it comes to paying agents, most brokers will give a percentage of the commission to the agent and keep the rest. It is not uncommon for a new agent to start out at 40-50% or less. Since successful agents are constantly being courted by competing brokerages, the split the agent gets generally goes up the more successful the agent gets. How much commission the broker keeps (i.e. where the broker’s split starts and stops) generally has to do with how many services the broker is providing the agent “for free.” It is not uncommon for top agents to keep 90% or more of their commission.

There are also brokerages (many RE/Max franchises for example) that allow the agent to keep 100% of the commission but then charge the agent a monthly flat-fee (even if nothing sells) as well as fees for any services provided (faxing, copying, desk space, phone usage, newspaper ads, etc). Since real estate sales can often be an up and down business, it is up to the agent to decide which business model is best for them.

There are also other parties that may get a percentage of that commission as well (besides the broker and the agent). Franchises generally take a percentage of the commission (Prudential, for example, keeps 3% of all sales). Referral fees can also occur if the agent found the client through a referral from another agent. These normally are 20-30% of the commission. Examples of this would include: relocation buyers referred to an agent by a relocation company, a seller referred to an agent by another agent across town who doesn’t want the listing or an internet leads referred to an agent from their own broker’s corporate headquarters. In most states it is illegal to pay a referral fee to anyone who isn’t a licensed agent (although agents in other states are acceptable). Only the broker, however, can pay the fees.

So, back to our example: Let’s say the agent is fairly successful and has a 70/30 split with the broker (with the agent keeping 70%). That leaves $4200 of the $6000. If the franchise takes another 5%, you now have $3990 (which we’ll round up to $4000).

Where Does that Money Go?

Most people believe that agents "get rich" selling real estate- on even the smallest of properties- because they never calculate the commission past this point. But realize, there is a lot more to understanding total compensation than we have just covered.

First, you need to pay your marketing expenses (advertising, promotions, etc). This can be simple things like business cards and personalized real estate signs with your name on them, or more complex things like websites, 800 numbers, billboards, postcards or newspaper ads. A general rule of thumb for a successful agent is to spend 30% of commissions on marketing to find the next customer (or advertise a listing).

If you are a new agent, you might find yourself spending 70% or more on marketing, whereas an established successful agent might spend very little (because they are living off of repeat or referral business). Although I have met new agents who have successfully established themselves without marketing (using plain old hard work and a lot of raw sales talent), the truth is those people are few and far between. For the most part, new agents who don’t spend something on marketing usually fail.

The National Association of Realtors estimates the average agent spends at least $8,000 per year. For our example, let’s figure you will spend 30% on marketing (and for the record, I wish I only spent 30%). That leaves you with $2,800 left in commissions in our example.

Meet Your New Business Partner...

To keep things simple, the next thing the agent should plan on is to pay income taxes (we’ll estimate 15%). Since the agent is an independent contractor, they also need to pay FICA and Social Security- things a traditional employer might take out on your behalf. There is also additional tax- sometimes called the self-employment tax- that is basically the tax your employer pays on you that you never see- so figure in another 15%. That leaves you with $1,960 in commission for our running example. (By the way, if you are going to be an agent, by all means find a good accountant to tell you how to pay taxes, what is tax deductible and what isn’t, etc.).

So, on a $200,000 home sale, a fairly good agent could expect to keep just under $2,000 in commission after broker/franchise splits, reoccurring marketing expenses and taxes.

The Real Estate Catch-22

The interesting thing to note is how an established agent can earn significantly more money off of the same sale than a new agent. If a veteran (successful) agent is getting a 90% commission split and has virtually no marketing cost (because they rely on repeat clients and referrals), then they can easily take home $3,500 from that sale. Compare that to a rookie who is only getting a 40% commission split- they are left with just under $1,200 on the same sale (and that’s assuming they don’t have to spend more than 30% on marketing). As you may have guessed, this is the problem with being a new real estate agent. Not only do new agents have fewer prospects for clients, but they have to work harder and spend more money on marketing to get them. Yet at the same time, newer agents can easily get 50% less commission on the same sale so they have less to spend on the marketing they need more of!

But Wait Ron Popeil, There’s More!

Before you rush out to spend that $2,000 in commission, I should note that I’ve only mentioned MARKETING expenses. There are other reoccurring and fixed expenses to know about as well that go above and beyond marketing.

Many states (Missouri included) require agents to carry “Errors and Omissions Insurance” to protect you in a lawsuit from an unhappy client. This is a per agent fee even if you are on a team and the contracts are all run under one agent (or you don’t actually sell anything). I can’t find the exact cost, but I believe I pay $300-500 a year for this.

Many brokerages also have various fees they charge their agents (I personally refer to them as “bullsh**” fees). My broker charges their agents a “technology fee” of $25 per month per agent to pay for the technology in our office (which is far less than most so I’m not complaining too loudly).

You also have membership fees into any professional organization you join- the most common of which would be your local Association of Realtors which you will probably want to join (if for no other reason so you can get access to the MLS). These fees can add up to several thousand dollars a year. As a new agent, plan on having $1000 ready to give your local Association/MLS as soon as you get your license. You will also be required to take continuing education every two years (pricing can vary, but expect to spend $500 or so every other year).

After that, you will probably have to buy your own computer (and software), cell phone (and service), digital camera (to take photos of homes with), office supplies, and (of course) a car to haul around clients. I would also recommend talking to your auto insurance agent to make sure you have enough liability coverage should a client be injured in your car.

If you work from home (even part-time), you will probably want to buy for your home office a fax machine (everything in real estate is faxed), color laser printer (for printing flyers), office furniture, high-speed internet and a business phone line.

As your business grows you might want to consider a toll-free (800) number for relocation clients to call, professional binding equipment for quality looking proposals, staff assistants (which can be paid in commission (if they are an agent) or as a salaried/hourly employee, sales management software, etc. If you get an assistant, you might need to buy him or her a computer, software, etc.

Want to start your own brokerage? Visit realtor.org for the things you will need to do that. General rule of thumb is to have $50,000 ready to invest (more if you want a franchise).

The final thing to consider would be personal expenses that might be covered by your traditional employer that an agent doesn’t get because they are an independent contractor. The largest of these would be health insurance. We pay approximately $400 per person per month for our plan (and the coverage isn’t that good). We do not have dental or vision.

(Editor’s Note: Much of this stuff is tax deductible, so consult your accountant first.)

Summary

The most important thing to realize in understanding real estate compensation is to understand that you truly are working for the client (buyer or seller) and not the broker or brokerage. Other careers might emphasis the importance of a happy customer and might fire you should there be too many customer complaints, but when the day is over your salary, hourly wage, or even commission is being determined by the employer- not the customer. That is usually not the case in a real estate career; without clients there isn’t a paycheck- and the product you have to sell is yourself, not some gadget or other tangible product.

As a self-employed person, you need to realize there is a fine line between being self-employed and being unemployed. I know of an agent who has spent 40 hours a week, every week, for the past 4-5 years working in real estate as an agent- answering the phones at the office trying to get leads, sending out postcards, calendars, magnets, etc. This agent even has a website, a sign on the car, a name tag on the suit jacket, everything “the book” tells an agent to do to get business. Despite all of this, the agent suffered through a drought of more than 24 months without a commission check. That’s more than two years of full-time work- and marketing expenses- without a single penny in pay.

The purpose of this example isn’t to cast doubt on a real estate career or end the article on a sour note, but to make the most important point there is. If you want to know how you get paid in real estate, the answer is to know the industry, select your specialty, train yourself to be an expert, sharpen your sales skills, work hard, make your clients love you and market better than the other agents around you. After that, the commission checks will take care of themselves.

(Note: I found some very interesting statistics on the real estate industry while I was writing this piece that I will publish later in the week.)