Real Estate Agent Commissions – How They Really Work

Jul 27, 2020

Real Estate Agent Commissions How They Really WorkReal Estate Agent Commissions can be the largest single expense in a home sale, yet sometimes buyers and sellers don’t fully understand how the commission rate is set, who pays the commission and what services they should be getting for their money. I’ll answer a few common questions about real estate agent commissions to provide a complete and simple description.

Before we start, let’s understand that real estate agent commissions are a fee paid for a service and the form and amount of the commission is not set by law. All commission agreements are negotiable.

How Are Real Estate Agent Commissions Set?

Real estate commissions are set in the listing agreement for most sales. The listing agreement, prepared by the listing broker based on terms negotiated with the seller, specifies the total commission the seller will pay, expressed as either a percentage of the sale price or a specific dollar amount, sometimes a combination of both. The total commission is split between the seller’s broker and the buyer’s broker as noted in the listing agreement. The split is usually half to each broker, but that may vary based on circumstances.

Is There A “Standard Commission Rate”?

By law, all real estate commissions are negotiable and cannot be established as “standard” or even “prevailing” rates. Brokers are not permitted to discuss their commission rates with other brokers. That said, commission rates are published in Multiple Listing Service information that brokers see when a property comes on the market. Therefore it is not hard to get a general sense of competitive rates simply by looking at listings.

Brokerages, however, can establish commission rates their agents are permitted to charge. Brokers typically begin with a standard rate or range they believe is competitive in their area and adjust the commission for each sale based on listing price, property type, and the work involved to market a specific property. If the sale price that will determine the dollar amount of the commission is anticipated to be unusually large, the listing broker may reduce the commission percentage. The seller’s broker may also reduce their commission if they are providing only a portion of their normal services for a particular sale. Everything is negotiable.

Note: Real estate brokers in most states are not allowed to discuss specific commission rates in public, maybe even in private if they work for separate companies, as it could be construed that they are colluding to “fix” a standard commission rate to the detriment of consumers. If you see brokers discussing commissions in online forums or elsewhere without mentioning actual numbers, that’s probably why.

Does Buyer Or Seller Pay Real Estate Agent Commissions?

At close of escrow, real estate commissions are typically charged to the seller. Standard real estate purchase agreements (sales contracts) instruct the escrow officer to do this. Again, this is the standard method and may be subject to negotiation. All the money that arrives in escrow comes from the buyer or the buyer’s mortgage company. Even though the seller pays agent commissions, the commission is built into the sale price and the seller is paying commissions with the buyer’s money.

Buyers may have reasons to pay their agent directly and when doing so should include that provision in their purchase offer.

Can Buyers Negotiate Commissions Already Written In the Seller’s Listing Agreement?

Yes. Buyers can make their offer contingent upon modification of the listing agreement. The seller may not agree, or the listing broker might not accept the change the buyer proposes, but the buyer may certainly request the change.

Example: Working with a Silicon Valley home buyer, we were locked in a multiple-offer competition for a property my client wanted very much. When the seller presented counter offers to the two top bidders, of which we were one, we had to come up with a tactic that would provide my buyer with a winning offer. We assumed the other buyer would match our price and my buyer could not offer more. I added an addendum to my buyer’s final offer that reduced my commission percentage, therefore reducing the seller’s expenses and giving my buyer a net price advantage. My buyer got the house.

Real Estate Agent Commissions Pay For Which Services?

This could be one of the most overlooked details in a real estate listing agreement. Agents seldom identify all the specific services they will provide during a listing, though many of the better ones do so consistently in the body of the listing agreement or in an attached marketing plan. Variables could include staging, minor repairs, painting, print advertising, Internet advertising, professional photography, aerial photography, video/virtual tour, special promotions and out-of-area advertising. Some of those costs may be charged to the seller as a cost in addition to the sales commission. Some brokers provide all those services and more for only the commission.

Must Real Estate Agent Commissions Always Be Paid Through Escrow?

No. Buyer or seller may pay commissions directly to their brokers, but the payment usually must be disclosed and included in the escrow closing statement and noted as “Paid Outside Escrow” (or similar words). Ask the escrow officer for guidance before paying the commission directly to a broker.

Can Agents Who Do All The Work On A Sale Be Paid Directly Or Must They Be Paid Through Their Broker?

Generally, agents who work for an “employing broker” must be paid through their broker. Escrow officers pay the brokers when escrow closes, then the brokers pay the agents who worked on the sale per their agreements with the agents.

Note: Even if your agent holds a Broker license, the agreement with their employing broker will normally require that all commission payments go through the employing broker.

Does An Agent Receive Two Commissions When Representing Buyer and Seller In The Same Sale?

Maybe. When buyer and seller are represented by the same agent in a sale, it’s a situation called “dual agency.” Dual agency can also occur when agents representing buyer and seller both work for the same employing broker. In some states, two agents working for the same broker is called “multi-agency.” Read more about the pro’s and con’s of Dual Agency and Multi-Agency by clicking the links.

As previously stated, all commissions are negotiable. If the listing agent presents an offer from a buyer the listing agent also represents, the seller may have the option to reduce commissions by changing the terms of the listing agreement as a condition of accepting the offer. The same is true if the offer is from a buyer represented by another agent who also works for the listing agent’s broker.

What Is “Commission Shopping”?

Commission shopping occurs when a real estate agent shows buyers only those properties that offer the buyer’s broker the highest commissions. Agents are ethically (and sometimes legally) obligated to share information regarding all properties that meet a buyer’s criteria. Commission shopping is clearly an unethical practice.

Must Commissions Be Paid in Currency?

Generally, no. Sellers may offer commissions in any form that can be assigned a reliable value for tax purposes. The seller could pay the commission in several forms, a common example is ownership interest in a property.

Example One: Susan is a successful house flipper. Broker Angie finds her a great flip opportunity and Susan buys it at a discount for $100,000 cash. Per a documented agreement, Broker Angie receives no cash commission, but instead receives 5% ownership of that property when escrow closes. Susan remodels the property, thereby increasing its value to $200,000. Broker Angie lists the property for sale and again receives no cash commission when escrow closes. Did Broker Angie get stiffed or did she make out OK? Her original 5% ownership was worth $5,000. When the home was improved and sold for $200,000, the amount she received at close of escrow for 5% ownership was $10,000. Angie made out fine, receiving a little over her target commission for both deals.

Example Two: Susan and Angie do the same deal described in Example One, but instead of receiving an ownership interest in the property, Angie receives a note for $10,000 secured by the property that must be paid off through escrow when the remodeled home is sold.

Example Three: Investor Ivan buys rental homes and Broker John finds a property Ivan might like. Ivan buys the property, but instead of Broker John receiving a cash commission, he receives a note from Ivan secured by the property that is equal to the commission offered by the seller. The note requires Ivan to pay John 10% of gross rents every month until the note is paid in full. If the note is not paid in full within two years, John has legal options to force payment.

In Summary…

All commission terms are negotiable. But I may have mentioned that.

One Final Note: Commission agreements are legal documents. When deviating from commission options presented in standard real estate forms or when you have questions your broker can’t answer to your satisfaction, consider consulting with an attorney to develop a clause or document that fits yours specific needs.

Have questions about real estate agent commissions or real estate in general? Drop me a line: Contact Us.

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