If you are preparing to buy a home in 2021, you have a lot to think about. Long before you put your money on the table, you should make sure you have a number of key advisors. For example, you should choose a financial planner who really understands real estate investing, then do enough research to find the right real estate broker for your city.
However, getting good advice is only part of the picture. You should also make sure that you understand how buying a property actually works. This includes the legal implications of ownership, as well as how and when the money changes hands. Part of this process is a real estate commission.
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First time home buyers sometimes get confused about commission. It may seem like you’re 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 commissions to cover costs you may 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’re used for, and whether you can negotiate them.
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What is a real estate commission?
The reason real estate commissions exist is because of the slightly unusual way in which real estate agents are paid. Most real estate agents, even if they work for large firms that have steady sales, do not receive a salary. Instead, they make money when a real estate deal is actually completed.
Hard-working agents tend to do well financially with this system, as it incentivizes them to sell a lot, negotiate hard, and close deals. The system also means they may not get paid until the end of the months, receiving a sizeable paycheck just two 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 real estate commission?
Because real estate agents only get paid when a purchase is completed, the commission represents weeks or months of work and comes in a lump sum rather than spread out. To the average consumer, it’s the property world’s 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 the final sale price of the home. On a $200,000 home, the 6% commission would amount to $12,000, which is paid by the home seller out of their proceeds.
That sounds like a lot of money, but it’s important to recognize that not all of this money goes straight into your real estate agent’s pocket. The average agency uses this amount to cover the many operating costs of their business – advertising their properties, a relatively new and rapidly growing amount to fight cyber fraud, and finally, their agents’ bonuses.
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Who pays commission?
Again, there is a range of models used across the country, and the way commissions are charged can vary widely between brokers and agents. However, in the “traditional” model, the respective agents of a buyer and a seller would split the agent commission equally. So if a home sells for $200,000 at 6% commission, the listing agent and the buyer’s agent would split that $12,000, and each would receive $6,000. It comes from above before the seller realizes any profit.
Within this broad picture, there are more than a few complexities. It is not uncommon, for example, for a commission to be based on an agent’s experience level, 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 known as “dual agents” and get paid both parts of the commission. While attractive to the agent, the specter of a conflict of interest—since the agent benefits from a higher price—is never far away. Obviously, a shady agent may play buyer against seller in order to artificially inflate the final sales number.
For this reason, some agencies do not allow their agents to act as dual agents. This practice is also illegal in some states.
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What does a real estate commission cover?
People are often wary of hiring real estate agents because of the level of commission charged. Buying property is likely to be one of the biggest expenses in a person’s life – whether looking for a home to live in or property as an investment. Paying an additional 6% on top of an already large number is more than some can stomach.
In fact, hiring an experienced and reliable real estate agent saves you stress, time, and money. This is because a good real estate agent provides a wide range of advice and service – not only helping you with pricing your home, but also listing and advertising it to get the word out.
The true value of a real estate agent, however, becomes apparent once the conversation begins. An experienced agent knows the property selling process inside and out and can help you get the best price, whether you are buying or selling. This is why the typical “for sale by owner” home sells for significantly less ($200,000 compared to $280,000 in 2019) than an agent-assisted home sale. A little simple math tells us that, looking at the numbers, going with an agent is a no brainer.
This advice and a plethora of services are ultimately paid for by your commission. As mentioned, the commission sounds high, but remember that it represents the only pay you receive for months of work.
Can I Negotiate A Real Estate Agent’s Commission?
This is the first question on some people’s lips when faced 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. Although 5-6% has been the industry standard for a long time, there is nothing in law that stipulates commission at this price point. This means that real estate agents can, in theory, charge any level of commission they like. Conversely, you can certainly ask them to tone it down.
If you are working in a dual agency arrangement – where the listing broker also represents buyers – they may be willing to reduce their compensation. However, there are several reasons why dual agency is not a big deal, even if you are getting less commission. An agent representing both buyers and sellers will struggle to keep the best interests of both parties in mind.
Whether they will really be open to talks is a different question. Given how standardized the 5-6% fee has become, many agents are reluctant to even discuss it. They know that, even if you price shop around for alternative agents, you won’t find one who is willing to undercut their fee – at least, a reputable one.
The only major exception to this is that some agents may be willing to negotiate a deal in which you pay a small commission but do not receive their full service. For example, you can take on the responsibility of listing and advertising your property yourself in exchange for paying a small commission.
That said, and given the amount you are likely to spend on your property, it makes sense to spring for the extra 1-2% that a real estate agent provides.
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alternative commission model
Finally, a brief word about alternatives to the traditional system. As we mentioned above, some real estate agents work on a non-standard model for commission. However, in most cases, and no matter how much complexity they have built into their commission model, at the end of the day it is likely that they will receive a percentage of the final sale price. If an agent tells you they use a different model, make sure you fully understand this before signing anything.
The most popular company using non-standard models is Redfin. This company uses a slightly different commission structure, in that listing your property for sale is cheaper than with traditional agents (1.5%). However, you may also be required to pay an agent’s fee on closing, which increases the total commission to around 3.5%.
Some agencies also work on flat fee commission model. These agencies may specialize in for sale by owner properties (FSBO). In these scenarios, the flat agent fee often covers the listing on the Multiple Listing Service (MLS).
When you start researching real estate agents, see that their commission is 6%, and do the math of what that really means, it may seem like you’re giving them a lot of money for nothing. In fact, the 5-6% is usually dwarfed by the tools and services provided by a quality agent, and will be smaller than the impact they have on the final negotiated sale price.
Once you factor all that in, commission starts 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.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
