Over the past week we've been discussing how commissions in real estate get broken down.  It's easy to believe agents "get rich" selling real estate- on even the smallest of properties- if you look at the whole commission and assume it's going to one person, which is seldom the case.

Earlier we explained the concept of the Multiple Listings System, or MLS, which basically splits a selling broker's commissions in half to share it with the broker and agent who brings in the buyer.  Then we discussed how the owner of the company, called a broker, splits the commission with their agents.  We've also looked at how franchises take their share as well as fees paid out to relo companies and referral sources.

Now we're going to look at the next element of where commission goes- the expenses.

First, an agent needs to pay their marketing expenses (advertising, promotions, etc). This can be simple things like business cards and personalized real estate signs with the agent's 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 earned 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 with these kind of expenses. If that doesn't sound like a lot of money, well the same source says the average agent also only closes about 4 transactions a year!  So that's $2,000 in expenses per transaction!

Going back to yesterday's 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.

Of Course This Assumes Something Sells!

One of the most frustrating things for new agents is the carrying costs of doing business.  You see, when an agent gets a listing to sell either the agent, broker or both has to pay for upfront expense of advertising to promote the home -- and you don't get reimbursed until the home sells.  With buyers, the agent has to invest time AND GAS showing the buyer homes and those expenses aren't reimbursed until the home they buy closes.

And here's the rub... not every home you list sells and not every buyer you work with buys.  In fact, listing statistics from the St. Louis MLS (called MARIS) shows that of all the homes listed for sale in the MLS roughly 50% actually sell.  The rest have their contract expire or the agent gets fired and replaced.  In some markets the list to close ration may be as low as 20%.

So as an agent in St. Louis when you're planning your marketing budget you have to assume you'll only get directly reimbursed for 50% of your listing marketing.  That means every home you list and sell has to also pay for the marketing expenses of a second house you list but don't sell as well as any expense you have to front that money (i.e. credit card interest).

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. This is often called the self-employment tax- so figure in another 15% on your earnings.

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.).

But don't touch that dial!  Tomorrow we'll look at other agent expenses and things you should know before becoming an agent.