Understanding Real Estate Commissions (And How to Negotiate Them!)
If you are preparing to buy a home in 2021, you’ve got plenty to think about. Long before you put your money on the table, you should make sure you have a number of key advisors in place. You should, for instance, choose a financial planner who truly understands real estate investing, then conduct adequate research to find the right real estate broker for your city.
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Taking good advice is only part of the picture, though. You should also make sure that you understand how buying property actually works. This includes the legal implications of ownership, as well as how and when money changes hands. Part of this process is a real estate commission.
First-time homebuyers are sometimes confused by commissions. It can seem like you are paying a real estate agent a lot of money for what appears on the surface to be little effort. But while there are some work-averse agents out there, good agents use a commission to cover costs that you might be unaware of.
In this article, we’ll break down everything you need to know about real estate commissions—how much they are, what they are used for, and whether you can negotiate them.
What is a real estate commission?
The reason real estate commissions exist is the slightly unusual way in which real estate agents are paid. Most real estate agents, even if they work for large firms that have a flow of steady sales, don’t get paid a salary. Instead, they make money when a real estate deal actually goes through.
Agents who work hard do well financially with this system, because it incentivizes them to make plenty of sales, negotiate hard, and close deals. This system also means that they might not get paid for months on end, receiving a sizable paycheck just twice or three times a year. For most of us, that kind of unreliable cash flow would be unacceptable. In the world of real estate agents, though, it’s par for the course.
How much is a real estate commission?
Because real estate agents only get paid when a purchase goes through, the commission represents weeks or months of work and arrives in one chunk rather than being spread out. To the average consumer, this is the property world version of sticker shock.
Different agents and brokerages charge different amounts of commission and have different models for how they charge. However, commission rates typically range from 5% to 6% of a home’s final sales price. On a $200,000 home, a 6% commission would amount to $12,000, which is paid by the home seller out of their proceeds.
That seems like a lot of money, but it's important to recognize that not all of this money goes straight into the pocket of your real estate agent. The average agency uses this sum to cover many of the operating costs of their business—advertisements for their properties, a relatively new and exponentially increasing amount to fight cyber fraud, and, finally, their agents’ bonuses.
Who pays the commission?
Again, there is a range of models in use across the country, and the way in which commissions are charged may vary widely between brokers and agents. However, in the “traditional” model, a buyer’s and a seller’s respective agents will split the agent commission equally. So if a home sells for $200,000 at a 6% commission, the listing agent and buyer’s agent will split that $12,000, and each receives $6,000. This comes off the top before a seller realizes any profit.
Within this broad picture, there are more than a few complexities. It’s not unusual, for instance, for a commission to be based on the experience level of an agent, so that someone who has been in the game for decades takes a larger share than a younger agent.
There are also sales in which the same agent represents both the buyer and the seller. In this case, they are what is known as a “dual agent,” and get paid both parts of the commission. While lucrative for the agent, the specter of conflict of interest—since the agent stands to gain from a higher price—is never far away. Obviously, a shady agent could play buyer against seller to artificially inflate the final sale number.
For this reason, some agencies don’t allow their agents to work as dual agents. This practice is even illegal in some states.
What does a real estate commission cover?
People are often wary of taking on real estate agents because of the level of commission charged. Buying property is likely to be the single largest expense in a person’s life—whether seeking a house to live in or property as an investment. Paying an extra 6% on top of an already large number is more than some stomachs can stand.
In reality, employing an experienced and trustworthy real estate agent saves stress, time, and money. This is because a good real estate agent provides a wide range of advice and service—not just helping you price your home, but also listing and even advertising to get the word out.
The real value of a real estate agent, though, becomes apparent once negotiations commence. An experienced agent knows the property sales process inside and out and can help you get the best price, whether you are buying or selling. That's why the typical "For Sale by Owner" home sells for considerably less ($200,000 compared to $280,000, in 2019) than agent-assisted home sales. A bit of simple math tells us that, judging by the numbers, going with an agent is a no-brainer.
This advice and plethora of services are ultimately paid for by your commission. As mentioned, the commission seems high, but remember it represents the only pay they receive for months of work.
Can I negotiate a real estate agent commission?
This is the first question out of the mouth of some people when confronted with the reality of the cost of their real estate agent. The simple answer is yes, you can often negotiate a lower commission.
At least technically, that is. Though 5-6% has long been the industry standard, there is nothing in the law that sets a commission at this price point. This means that real estate agents can charge, in principle, any level of commission they like. Conversely, you can definitely ask them to reduce it.
If you’re operating in a dual agency arrangement—where the listing broker also represents the buyers—they may be willing to reduce their compensation. However, there are a number of reasons dual agency isn’t a great deal, even if you are getting a reduced commission. An agent representing both the buyers and the sellers will struggle to keep both parties’ best interests in mind.
Whether they will actually be open to negotiation is a different question. Given how standardized the 5-6% fee has become, many agents are reluctant to even enter into a discussion about it. They know that, even if you shop around for alternative agents at a lower price, you are unlikely to find one who is willing to significantly reduce their fee—at least, a reputable one.
The only major exception to this is that some agents might be open to a deal in which you pay slightly less commission, but don’t receive their full service. You could take charge of listing and advertising your property yourself, for instance, in exchange for paying a lower commission.
That said, and given the amount of money you will likely spend on your property, it makes sense to spring for an extra 1-2%, given the value that a real estate agent provides.
Alternative commission models
Finally, a quick word about alternatives to the traditional system. As we’ve explained above, some real estate agents work on a non-standard model for commissions. However, in most cases, and no matter how much complexity they’ve built into their commission model, at the end of the day it’s likely that they will receive a percentage of the final sale value. If an agent tells you they use a different model, make sure you understand it fully before signing anything.
The most popular company that uses a non-standard model is Redfin. This company uses a slightly different commission structure, in which listing your property for sale is cheaper than with traditional agents (1.5%). However, you may also have to pay an agent’s fee on closing, which pushes the total commission to around 3.5%.
Some agencies also work on a flat fee commission model. These agencies may specialize in for sale by owner properties (FSBOs). In these scenarios, the flat agent fee often simply covers listing on the multiple listing service (MLS).
When you start the search for real estate agents, see that their commission is 6%, and do the math to work out what that actually means, it can seem like you will be paying them a lot of money for nothing. In reality, the 5-6% is typically dwarfed by the tools and services a quality agent provides, and will be smaller than the impact they will likely make on the final negotiated sales price.
Once you factor all of that in, commissions start to look pretty cheap. That’s why one of our most important tips for a smooth sale is to make sure you have an experienced real estate broker representing you.