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How and Why Commissions Work in Real Estate

A recent pending legal settlement from the National Association of Realtors (NAR) has put real estate in the mainstream headlines, and over the last several weeks there have been a lot of questions, speculation and misinformation about the future of the industry. 

Most of the headlines and stories have been concerned with commissions in real estate, and, while I can’t answer all the new questions raised by last month’s news, I thought I’d take some time to go over the basic principles related to the stories out there.

For now I’ll refrain from trying to explain or speculate about any changes coming to real estate following the NAR’s settlement because the agreement hasn’t been finalized and there’s still a lot that needs to be clarified and worked out first. 

The lack of clarity combined with general impatience among the media has led to false information and misleading headlines.

So instead of adding to the chaos I thought I’d go over what you need to know about how real estate commissions have worked in the past, which might help you better understand what’s been going on in the courts and the media since last month’s news.

The recent proposed settlement from the NAR comes from pending lawsuits surrounding buyer agents and their commissions.

This may come as a surprise to anyone who isn’t familiar with real estate transactions, but currently only the seller in a real estate sale pays out commission. At the closing on the sale of their home, a seller pays out commission to his agent. The buyer’s agent isn’t paid by their client but takes a cut from that commission.

Generally, the Listing Agent decides how much they pay out to the Buyer Agent from his or her negotiated commission. Traditionally, the Listing Agent splits their commission evenly.

The pervasive headline over the last few weeks has proclaimed the end of the six percent commission. This headline, I think, incorrectly insinuates that commissions in real estate are a fixed number and that six percent is some kind of mandated rate.

Commissions in real estate have ALWAYS been negotiable. When a client is ready to sell, they enter into a listing agreement, which is a contract with their agent who agrees to represent them and find the best offer for their property. The agent’s commission is negotiated through this listing agreement. 

Although agents generally have a standard rate, the client listing their property can negotiate with their agent, and the commission negotiated is ultimately split between the Listing and Buyer agents.

For example, let’s say you want to list your property with an agent for $400,000, and you negotiate a 5% commission. This means that if your property sells for its listed price of $400,000, you would pay out a $20,000 commission to your agent. Meanwhile, when listing your property, your agent would offer a share of their commission to other agents with clients looking to buy property.

An agent with buyers interested in the property would receive a share of the commission if their client or clients ultimately purchase the property. The clients buying the property do not pay their agent out of pocket.

This may seem strange that a client wouldn’t pay for their own representation, but remember that the Listing Agent is agreeing to share the negotiated commission and that the buyers are paying for or signing the mortgage on the property.

And there’s good reason for a Listing Agent to offer a share of the commission. Inviting agents to show the property to their clients can increase demand and bring in a higher sale price.

The added benefit of both parties in the transaction having their own representation can’t be understated. Listing clients have the advantage of more potential buyers, and buyers get the security of having a professional in the business looking out for their best interests.

So what does all this stuff about commissions mean and how does it relate to the pending legal settlement for the NAR? Again, it’s worth reiterating that the settlement hasn’t been finalized, but the potential aftermath could mean that buyers will be asked to pay for their own representation.

This could be a potential hardship for a lot of buyers, who already have to come up with funds for a down payment and closing costs

If the pending settlement goes through, we do know it will require buyers to have a written agreement with a Buyer Agent regarding compensation before that agent can help them begin their home search. This agreement would be in addition to a Buyer Representation Agreement, which already exists.

The traditional compensation for a buyer agent, through a shared commission with the listing agent (as described above), could be in jeopardy.

Unfortunately, nobody knows for sure what the ramifications will be. But it’s worth noting that many of the headlines out there are simply untrue. I caution you not to pay much attention to headlines like: “The end of the six percent commission is here.”

Commissions have and should remain negotiable between an agent and a client looking to list property, regardless of compensation for Buyer Agents. Media reports speculating otherwise are simply trying to sensationalize headlines to pull in more readers.

The next couple weeks and months in real estate could be dynamic, and I expect to have a much clearer picture of the pending litigations and their impact on the real estate world soon. I plan on following up with another post when more information becomes available.

For now, you should know that business is continuing at the status quo, and for those interested in entering the real estate market, there’s no reason to hesitate.

If you have any questions or concerns, or just want to say hello, shoot me a message today!

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Melanie Graham

Melanie Graham