It’s a question with big financial implications for you: How do real estate agents get paid?
Real estate agents are some of the last highly-paid professionals in the US that haven’t had their industry turned upside-down by technology. There are some hints at disruption in the real estate industry, but it’s mostly business as usual for now.
As with any industry that has a low barrier to entry and no real “moat” besides the licensing process, the way real estate agents get paid will likely experience some big changes in the near future. In the meantime, it pays to understand the transaction and all the moving parts so you can protect your money.
The commissions in a real estate transaction are almost always paid by the seller. There are some exceptions to this, but the sellers are paying the commission in most deals. The listing agent (who represents the seller) offers to split that commission with the buyers agents (the one representing the buyer). It’s usually a 50/50 split.
Here’s an example:
Real estate agent sells one of her listings for $400,000.
Commission earned is 6% of the sale price (a total of $24,000).
Half of that goes to the agent who represented the seller and the other half goes to the agent who represented the buyer. That’s $12,000 each.
(Please keep in mind the agents have to split that commission with their brokerages, they have to cover all their expenses AND they have to pay income tax on it, so that $12,000 can quickly turn into $4000-$5000 in net income)
Why should you care how real estate agents get paid?
There are a few reasons this should matter to you. Buying a house is the largest financial transaction most people make in their lifetimes and it pays dividends to protect your assets during the process.
First of all, using an agent to buy a property should be free to you because the seller is paying all the commission. Take advantage of this and find an agent that works with a lot of buyers who will represent your interests.
One of the biggest mistakes first-time homebuyers make is using the listing agent as their buyers agent on the same property. That’s idiotic.
Think of it this way: Would you hire a lawyer to represent both the prosecution and the defense in the same trial? Of course not. Then why would you think that’s a good idea in a real estate transaction?
The dirty truth is that many listing agents will try to sell you on the idea of letting them represent you on one of their listings. They do this because they want to keep all of the commission instead of splitting it with another agent. This situation is commonly called “dual agency” and has been declared illegal in some states, but there are loopholes that let agents legally accomplish the same thing (which doesn’t serve you at all).
The second reason you should care how real estate agents get paid has to do with the selling side of the transaction. When you are selling a property, you are expected to pay a commission to the listing agent.
The commission is ALWAYS negotiable. In the US, we don’t usually negotiate things (as a culture). There is no such thing as a “standard” commission rate in real estate.
Real estate commission rates
The past few decades in real estate have shown that the average commission rate for a home sale in the US has been between 5% and 6% of the sale price. Interestingly, that number increases when the market is tough (like after the financial crisis) and decreases when the market is hot (like now, spring 2018).
It makes sense if you think about it. When there are ten houses for sale in the market for every one buyer, it is going to take more effort, marketing dollars, time etc. in order to get a home sold. When the opposite is true and there are ten buyers for every one house that’s for sale, it takes much less effort to sell a house and it’s harder for an agent to justify a higher commission rate.
The tricky part is that even though commissions are negotiable, you will probably find that most of the top agents in your area charge roughly the same commission rate.
A note about discount brokerages
In every major market in the US, there are real estate brokerages that are commonly known as “discount” brokerages or “flat fee” brokerages. Their main pitch is that they will sell your house for a discounted commission. Their rates vary, but they usually charge 1-2% less than the big players in town who are charging full commission rates, or a flat fee for basic services, like putting your property in the MLS.
Great idea, right? Not so fast. In exchange for a lower commission rate, they aren’t able to provide as many services. They don’t make as much from each transaction, so their marketing options are limited. Marketing is expensive and it will suffer if you don’t have enough margin to cover the costs of doing it properly.
The real estate market goes through cycles. When the market is hot and it doesn’t take as much effort to sell a house, discount brokerages seem to be popping up everywhere. When the market gets tough, they are nowhere to be found.
Furthermore, when people are dealing with the biggest financial transaction of their lives, do you think they are looking to cut corners? Nope. They want the best representation and they are willing to pay for it. The stakes are too high to be taking risks with a cheap option. If real estate agents get paid big commissions in order to deliver big sales prices, so be it.
The math is fairly simple. It sometimes takes some wrangling, but when sellers understand they should be focused on NET DOLLARS instead of COMMISSION RATES, everything makes sense. Smart people understand that they may be paying a 6% or 7% commission, but the sale price will be high enough to justify that fee because the property was aggressively marketed and they reached all the potential buyers in the market. That nets them the largest check at the closing table and that’s what matters.
It always pays to shop around when you’re considering a big transaction. Cars, boats, houses…you should know your options and be aware of the costs involved. Real estate commissions are large and you should know if your potential agent is charging at the high-end, low-end or somewhere in the middle. You should also ask some pointed questions about what they DO with those commission dollars to make sure you get the highest price for your home. Knowing how real estate agents get paid can make a big difference in your financial life.
Over the past fifteen years, I have built an international network of agents and brokerages who can be trusted. (I also have a list of agents and brokerages who can’t be trusted!) If you are considering buying or selling real estate this year, I’d be happy to help you find an agent in your area who does good work. Hit me up here if you’d like some help!