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How Do Real Estate Commissions Work?

March 27 2018
by Ben Mizes

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Have you ever wondered why a realtor gets paid a commission or how it works? At some point in time, the approximately 70 – 80% of homeowners who end up using a real estate agent to transact their home will find themselves asking this question.

Rather than taking home an annual salary, a much more common method of payment for real estate agents is a percentage commission based on a home’s sales price. Most American real estate agents will sell around seven houses per year, and because the commission represents a majority of the realtor’s pay, each time they help a home exchange hands is typically for a good chunk of change.

While paying a commission may seem simple at first glance, it’s actually quite complex. In this article, we’ll go into detail on what real estate agent commissions are and how they work.

Real estate commissions are the fees paid to a real estate agent upon the sale of a home. In a real estate transaction, there are two kinds of agents: the buyer’s agent and the seller’s agent. A buyer’s agent represents the person buying a home, and the seller’s agent represents the person selling the house.

When Did Real Estate Commissions Become Accepted?

The history of the real estate commission dates back to the establishment of the National Association of Realtors (NAR). Originally formed to represent the interests of real estate agents across the country through the creation of guidelines for agents to operate by, the NAR is now a nearly 110-year-old association that represents over 1.1 million realtors in the U.S.

The idea of a recommended 6% commission being paid to the agent was formed during the 1940s and rose to prevalence in the 1950s. For years, 6% was the rate that most homeowners expected to pay when they sold their homes, although in recent years this number has been on the decline. In 2016, the average commission was closer to 5%, which is good news for sellers looking to keep more money in their pockets.

What Is a Listing Agreement?

The terms between the seller and the agent are spelled out in the listing agreement. The listing agreement, also known as the listing contract, is the arrangement between the real estate broker and the homeowner which grants the broker authority to act as the owner’s agent in the sale of the property.

Included in the listing contract is the amount of compensation offered to the broker and whether it is in the form of a flat fee or as a percentage of the sales price. The listing agreement also authorizes the listing broker to cooperate with other brokers, such as a buyer’s agent, and details how the buyer’s agent will receive compensation.

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How Are Real Estate Commissions Shared?

Typically, the commission is split four ways among the following parties:

  1. Listing agent: the agent whom the seller agrees to list their property with.
  2. Listing broker: the broker has additional certification and hires the agent. In some cases, brokers can act as their own agents.
  3. Buyer’s agent: the agent whom the buyer hires to advise them in finding a home.
  4. Buyer’s agent’s broker: the broker who the buyer’s agent works for.

Who Pays the Real Estate Agent’s Commission?

All real estate commissions are paid directly to the brokers involved in the transaction. Generally, this commission is paid for by the seller of the property. After the broker receives the full commission, they will then split that amount with the real estate agent who represented their side of the transaction and works under the broker’s umbrella. The normal rate for the broker-agent commission split is 60-75%, although this range can vary considerably.

While the commission for the agent is paid for by the seller, the added commission for the buyer’s agent is usually wrapped into the price of the home. So, in a way, the buyer pays the commission as well.

Are Agents Incentivized to Get You the Best Price?

Agents are paid with commissions as an incentive to see a job through to completion. In general, commissions are paid only when a transaction settles, leaving all agents with the same motivation – get the home sold or don’t get paid. As a result of this compensation mechanism, the agents receiving the highest commissions are the ones who either sell the most expensive homes or sell a larger quantity of homes.

Let’s take the hypothetical example of a traditional listing agent on a $400,000 home. A 6% commission with a conventional split would result in the listing agent and buyer’s agent each receiving $12,000. If the listing agent manages to sell your home over list price for $410,000, they will make an extra $300. While this additional income might make a difference for some agents, the bulk of the money an agent will make comes from listing the house in the first place.

The Clever model does real estate differently than it’s ever been done before. By providing agents access to a higher volume, lower cost way to find clients, homeowners can receive a full-service experience without the traditional 6% commission. At Clever, we call this a “win-win” model for both agents and clients – Full-service, flat fees. Now that’s Clever!

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