How real estate commissions work and why they may get lower

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How real estate commissions work and why they may get lower

Real Estate News

The results of a Missouri jury this week could prompt some brokerage firms to make proactive changes to their commission structures.

A jury in Kansas City concluded this week that the National Association of Realtors and a number of real estate agents colluded to keep commissions on home sales artificially high.

By Rachel Kurzius, Washington Post

November 2, 2023 | 5:02 p.m

When you sell a home, both your agent and the buyer’s agent get a piece of the pie. But how large the share is is a question winding its way through the courts.

A jury in Kansas City concluded this week that the National Association of Realtors and a number of real estate agents colluded to keep commissions on home sales artificially high. The defendants who filed the appeal must pay nearly $1.8 billion in damages to about half a million home sellers in Missouri, and that amount could rise. The result could completely upend the way real estate agents are paid and homes are sold.

However, to understand how things can change, we first need to clarify how the system works.

How do real estate commissions work?

Most real estate agents make their money through commissions. In the United States, there is generally one agent who represents the seller and one who represents the buyer. The seller pays the commission to both. This has been a common practice for more than 50 years, according to Christy Reap, spokeswoman for Bright MLS, the database of homes for sale in the Mid-Atlantic.

Generally, commissions are 5 to 6 percent of the home sale price. The buyer’s and seller’s agents split the money. So if a home sells for $500,000 with a 6 percent commission, the agents on both sides of the deal split about $30,000 of the sale proceeds.

What’s the problem with the status quo in brokerage commissions?

A seller and the seller’s agent cannot exempt the buyer’s agent from the commission without major consequences. This requirement to “tie” commissions – otherwise – is one of the standards criticized in the lawsuit. The sellers claim that this amounts to unfairly forcing them to pay both commissions.

So what is the penalty if you don’t comply? In most parts of the country, a seller must agree to split their commission (common practice) to get a property on the Multiple Listing Service (MLS) — the essential database of homes for sale that also includes other platforms like Zillow and Redfin populated is 50/50). When a home is denied listing on the MLS, it becomes nearly invisible to potential buyers.

Some industry observers also identify other problems with the commission structure, although those issues are not the subject of the lawsuit.

First, the way people buy a home has changed dramatically thanks to the amount of information available on the internet. You don’t need a real estate agent to show you what homes are for sale in your city or see a list of comparable sales. In other words, while the workload for real estate agents has decreased, commissions have not changed accordingly.

“If we look at the data on commissions, we see that they have remained remarkably stable in the 5 to 6 percent range, although the role of buyers in particular has changed significantly over this period,” said Sam Chandan, the director from the NYU Stern Chao-Hon Chen Institute for Global Real Estate Finance.

Second, industry observers question the one-size-fits-all approach to commissions.

“Economists think it’s very strange that the commission is the same for every deal, because objectively some deals are more difficult than others,” said Jenny Schütz, a senior fellow at the Brookings Institution who focuses on housing. “Some clients are harder to serve, some homes take longer or the negotiations are more complicated, and that is not reflected in the commission.”

What would be the downside of changing the status quo?

Reap, the spokesperson for Bright MLS, maintains that the practice of splitting commissions prevents favoritism and unfairness between agents. She predicts that agents will be incentivized to close more deals and refer more deals to their colleagues, who will continue to split commissions, and exclude those who don’t, without adhering to it as an industry-wide standard. Buyers or sellers who are represented by a broker in the latter camp would then also be disadvantaged.

Reap also pointed out that forcing buyers to participate with commissions would put them at “a significant disadvantage.” Adding these costs in addition to the down payment and other closing costs already required of buyers begs the question: “How can a buyer pay for quality representation in the most expensive transaction of their life?”

Even though the standard is around 6 percent, can a seller negotiate a lower commission with their agent?

Technically speaking, yes. You can negotiate an agent’s commission before you enter into a contract to sell your home. However, most people don’t do this.

“A lot of people just don’t question it,” Schütz said. “[Selling a home] is a large transaction. People don’t do it very often. It’s going to be very expensive, whatever you do, and a whole lot of people you’ve never heard of before are going to get a piece of the action.”

It is precisely this level of complication that compels many people to hire a real estate agent in the first place.

And some sellers worry that lowering the commission will make buyer agents less likely to attract their clients. Think about it: If the buyer’s agent is promised half of 6 percent in every other offer, but your home is only offering half of 4 percent, that agent has less incentive to persuade their client to buy your property.

This fear among sellers is well founded. “There is ample evidence that buyer agents are more likely to offer properties to buyers who offer a higher commission rate,” said Chandan. (The latest lawsuit focuses on how the major institutions in the market, such as the National Association of Realtors and larger brokerage firms, encourage this behavior.)

Some brokers like Redfin offer lower commissions. How did you do that?

Redfin operates differently than many traditional brokerages in that it employs its agents directly and offers them a base salary in addition to their transaction bonuses. So people who sell a home through Redfin don’t pay their agent any commission. Instead, they pay a “listing fee” of 1 to 1.5 percent.

But many other brokerages that promised lower commissions have struggled to break into the market. According to a Wharton School study, new businesses that paid lower commissions grew more slowly than those that offered higher commissions.

Will this ruling change anything for home sellers?

No. The lawsuit itself is being appealed before its outcome is clear. But that doesn’t mean the industry will stay that way until all legal issues are resolved. For one, some brokerage firms are making proactive changes to their commission structure given the risk of becoming embroiled in a similar lawsuit.

Redfin CEO Glenn Kelman said in a statement that the lawsuit will “cause major changes” to the real estate industry, including potentially buyers beginning to pay their own agent commission or buyers and sellers sharing it more frequently could use the same agent as in the UK, Australia and New Zealand.

Chandan believes that decoupling buyer and seller commissions could lead to more competition and diversity in the market. “There is research that suggests or shows that we will see more competitive house prices. . . and more competition among the buyer’s agents,” he said, along with the emergence of technology and platforms that could support buyers who forego a traditional agent.

This could lead to real estate agents changing their scope of work rather than offering a flat-rate service for the same price, Schuetz said. “You could have agents who specialize in higher and lower levels of service and price accordingly,” she said. For example, in this hypothesis, a buyer who doesn’t need help finding a home but does need assistance making an offer might pay less than a buyer who needs both services.

While this could save people money, it could also lead to discrimination, noted Schütz. “We could end up with specialization, with some agents choosing to work only in certain neighborhoods, at certain price points, or with certain types of clients.”

But actually, she said, there are many unknowns: “There could be a number of changes in the industry, and we won’t know what those will look like until they happen.”

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