Debunking Myths Around Real Estate Commissions
Lately, real estate commissions have been a hot topic in the news. With many headlines suggesting that agents are overpaid, that commission structures are outdated or even that agents are unnecessary. As a potential home buyer or seller, you might feel overwhelmed by the mixed messages. So we wanted to clear the air by debunking some common myths about real estate commissions, while also providing clarity on how these fees actually work and why.
Myth #1: The Commission Structure Is Outdated
To debunk this myth, we must first make sure you understand how the traditional structure works and WHY it has worked this way. For too long, the real estate industry has done a disservice to consumers for not fully educating on this subject. So here’s a hypothetical scenario on how the traditional structure works (bear with me, it’s long but worth it!):
John hires Jill, a Realtor, to list and sell his house.
Hiring an agent means a listing representation agreement is signed by both the seller and the agent. This Agreement outlines who gets paid what.
Jill charges 5% of the final sale price to sell a house. She also explains that she offers to share her commission with a cooperating broker who brings a qualified buyer.
John agrees to this because it is a seller concession that can be offered as incentive to help a buyer purchase his house. John’s goal is to sell.
Jill lists John’s house for sale on the MLS for $500,000.
Betty is a Realtor working with Ben, a buyer preapproved up to $510,000.
When Ben hired Betty as his agent, he signed a buyer representation agreement. The Agreement outlines what Betty charges to work with a buyer.
Betty charges 3% of the final sale price to help a buyer search for, contract and close on a home.
Ben agrees to this because it’s his first home and he wants professional guidance.
Ben and Betty have looked at 10 houses so far. John’s house is pops up and it is perfect! Ben’s goal is to buy.
Betty writes up a full-price offer on Ben’s behalf, including asking for cooperating compensation in the amount offered - 2.5%.
Ben’s approximate closing costs are as such:
5% down payment = $25,000
Loan fees & prepaids = $6,500
Title insurance, taxes and other closing costs = $7,500
Buyer Agent Fee = $15,000 - $12,500 (offered) = $2,500
Total Cash-to-Close = $41,500
Ben has $50,000 to put towards this purchase.
Ben buys the the house.
John sells his house. After agent commissions and closing fees, but before paying off any loans, John nets $473,000.*
Here’s what would’ve happened if John did not offer cooperating broker compensation:
Ben offers $475,000 for the house.
Ben scrapes together another $1,300 to cover the total $51,300 cash-to-close amount.
Ben buys the house.
John sells the house. After listing agent commission and closing fees, but before paying off any loans, John nets $461,000.*
Some believe that this traditional commission structure is outdated and that a seller will net more money if they do not offer cooperating compensation. However, this model remains prevalent because it continues to enable both sides of a transaction to afford representation at a higher rate of closing transactions in an economical way - as a part of the price of the house. And what some might not know is that this model actually came to be as a response to the lack of buyer representation in the 1990’s.
Moreover, real estate is a service-oriented business. Agents provide personalized guidance, advice, and negotiation skills, which many clients value. While the industry may evolve and offer more options (i.e. flat fees, à la carte services), the commission-based model still provides a fair and transparent way to compensate agents for their expertise and effort.
*We are not lenders or title companies. Any numbers are based on prior comparable settlement statements, and being used as an example only.
Myth #2: Real Estate Commissions Are Set in Stone
Another widespread myth is that real estate commissions are non-negotiable. There is no set commission. Let me say it another way, there is no standard commission. In fact, it is against federal anti-trust laws to have a fixed rate. The reason so many agents might choose to do a percentage of the sale price rather than a flat fee is because the fee is then in line with the amount of money the client is able to spend.
In the state of Tennessee our listing and buyer representation agreements are bilateral contracts. Which means that both parties have to agree to them. So, if what your agent charges for their services is not agreeable to you, then you are within your right to not sign or discuss with them why you think you should pay a different rate. Therefore, any agent commission charged is very much negotiable and can vary depending on market conditions, the property, and the specific agreement between the client and the agent.
Myth #3: Real Estate Agents Pocket All of the Commission
One of the biggest misconceptions is that real estate agents keep the entire commission. In reality, the commission is typically split multiple ways. Here's a breakdown:
Broker: All real estate agents are required to have oversight in order to have a license. This means we must be affiliated with a brokerage. The Broker charges a fee to each individual agent and is the one to collect commissions at closing. So when a transaction closes, the brokerage receives the check, NOT the agent. The split a Broker takes from each closing varies, but it is common for Brokers to take around 20-30% of the commission.
Agent: Once the Broker has received the commission and taken their split, the agent is paid the remainder.
Cost of Doing Business: Agents also have to pay income taxes on all commissions earned (anywhere from 20-35%) and incur all costs of doing business, such as marketing, gas & mileage, insurance and licensing fees, which further reduce their take-home earnings.
So unless an agent owns their own brokerage, which is not very common, each agent is taking home less than 50% of each commission earned. Not the full amount.
Myth #4: Agents Don’t Earn Their Commission
Some critics argue that real estate agents don’t do enough to justify their commission fees, claiming that the work involved in selling or buying a home doesn’t merit the cost. However, this perspective often overlooks the many roles agents play:
Marketing and Exposure: Agents invest in advertising, professional photography, staging, and online listings to ensure your property gets the best exposure. Not to mention the time spent meeting and communicating with clients before the process even begins.
Negotiation Expertise: Real estate agents have experience negotiating on behalf of their clients. They understand market conditions and can secure better deals than a homeowner or homebuyer might achieve on their own.
Handling Legalities and Paperwork: Real estate transactions come with a lot of legal documentation. Agents ensure that contracts are properly drafted and that all legal requirements are met, reducing the risk of future disputes and/or lawsuits.
Local Market Knowledge: Agents are familiar with local market trends, neighborhood dynamics and pricing strategies, which can be crucial in both selling and buying homes.
Myth #5: You Can Easily Sell a Home Without an Agent
With the rise of online listing services, some homeowners may think they can sell their home without the help of an agent. While it's certainly possible to sell a home without an agent (known as For Sale By Owner or FSBO), it’s not always easy:
Pricing Mistakes: Without a real estate agent's market knowledge, sellers may overprice or underprice their home, potentially costing them more in the long run.
Limited Exposure: FSBO listings may not receive the same level of visibility and marketing as those listed by real estate agents, leading to a smaller pool of potential buyers.
Negotiation Challenges: Negotiating directly with buyers or their agents can be intimidating and may result in less favorable terms for the seller.
Conclusion: Understanding the Value of Real Estate Commissions
While it's easy to get caught up in headlines that criticize real estate commissions, it's important to understand the value that agents bring to the table. Commissions aren't just a paycheck for agents; they're an investment in professional expertise, marketing, negotiation, and legal guidance that can make a significant difference in the outcome of your real estate transaction.
If you're considering buying or selling a home, take the time to discuss commission structures with your agent and understand the services they provide. By doing so, you can make an informed decision that best suits your needs and goals.