How real estate commissions work and why they might get lower
When you sell a house, both your agent and the buyer's agent get a slice of the pie. But just how big of a slice is a question snaking its way through the courts.
A jury in Kansas City this week found that the National Association of Realtors and a number of real estate brokerages conspired to keep home sale commissions artificially high. Defendants, who have pledged to appeal, are on the hook to pay nearly $1.8 billion in damages to about a half-million Missouri home sellers, and that amount might grow. The outcome could totally upend how real estate agents get paid, and how homes are sold.
But to understand how things may change, we first need to clarify just how the system works.
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How do real estate commissions work?
Most real estate agents make their money from commissions. In the United States, there's generally an agent representing the seller and one representing the buyer. The seller pays the commission to both of them. This has been standard practice for more than 50 years, according to Christy Reap, spokesperson for Bright MLS, the database of homes for sale in the Mid-Atlantic.
Generally, commissions are 5 to 6 percent of the home-sale price. The buyer's and seller's agents split that money. So if a home sells for $500,000 with a commission of 6 percent, the agents on both sides of the deal will split about $30,000 from the proceeds of the sale.
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What's the problem with the status quo for agent commissions?
A seller and their agent cannot cut the buyer's agent out of the commission without facing big consequences. This requirement to "couple" the commissions - or else - is one of the standards under fire in the lawsuit. The seller-defendants claim it amounts to forcing them, unfairly, to pay both commissions.
So, what's the penalty if you don't comply? In most parts of the country, to get a property on the multiple listing service (MLS) - the essential database of homes for sale that also populates other platforms such as Zillow and Redfin - a selling agent must agree to share their commission (common practice is 50/50). If a home is barred from being listed on the MLS, it becomes nearly invisible to potential buyers.
Some industry watchers identify other problems with the commission structure, too, even though these issues aren't part of the lawsuit.
First, the way that people shop for homes has changed dramatically, thanks to the amount of information available on the internet. You don't need a real estate agent to show you which houses in your town are for sale, or to see a list of comparable sales. In other words, the work required of real estate agents has arguably decreased, yet commissions have not changed to reflect that.
"When we look at the data on commissions, what we see is that they've remained remarkably stable in a range of 5 to 6 percent, even though the role of the buyer agents in particular has changed significantly over this period," says Sam Chandan, the director of the NYU Stern Chao-Hon Chen Institute for Global Real Estate Finance.
Secondly, industry watchers question the one-size-fits-all approach to commissions.
"Economists think it's very odd that the commission is the same for every deal because objectively, some deals are harder than others," says Jenny Schuetz, a senior fellow at the Brookings Institution focused on housing. "Some customers are harder to deal with, or some houses take longer, or the negotiations are more complicated, and that's not reflected in the commission."
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What would be the downside of changing the status quo?
Reap, the spokesperson for Bright MLS, contends that the practice of splitting commissions prevents favoritism and unfairness among agents. Without adhering to it as an industry-wide standard, she predicts agents will be incentivized to do more deals and refer more business to their peers who continue to split commissions, and ice out those who don't. Buyers or sellers represented by an agent in the latter camp would then also be disadvantaged.
Reap also points out that forcing buyers to pitch in with commissions would put them "at a significant disadvantage." Adding that expense on top of the down payment and other closing costs already required of buyers, she says, raises the question: "How is a buyer going to be able to pay for quality representation on the most expensive transaction of their lives?"
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Even though the standard is about 6 percent, can a seller negotiate a lower commission with their agent?
Technically, yes. You can negotiate an agent's commission before you enter into an agreement to have them sell your home. However, most people don't.
"A lot of people just don't question it," Schuetz says. "[Selling a home] is a big transaction. People don't do it very often. It's going to be super expensive whatever you do, and a whole bunch of people you've never heard of before are going to get a piece of the action."
It's precisely this level of complication that compels many people to use real estate agents in the first place.
And some sellers worry that lowering the commission will make buyers' agents less likely to bring around their clients. Think about it: If every other listing promises the buyer's agent half of 6 percent, but your home only offers half of 4 percent, that agent has less incentive to convince their client to buy your place.
This fear among sellers is well-founded. "There's a considerable body of evidence to show that buyers' agents are more likely to present properties to buyers that offer a higher commission rate," Chandan says. (The recent lawsuit focuses on how the large institutions in the marketplace, such as the National Association of Realtors and larger brokerages, facilitate this behavior.)
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Some brokerages, like Redfin, offer lower commissions. How do they do that?
Redfin works differently than many traditional brokerages because it directly employs its agents and offers them a base salary on top of their transaction bonuses. So, people who sell a home through Redfin don't pay their agent a commission - instead, they pay a "listing fee" between 1 and 1.5 percent.
But many other brokerages that pledged lower commissions had a difficult time breaking into the market. According to a study from the Wharton School, new companies paying lower commissions grew more slowly than ones that offered higher commissions.
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Will anything change for home sellers right now because of this verdict?
No. The lawsuit itself will face appeals before its outcome is clear. But that doesn't mean the industry will remain the same until all of the legal matters are settled, either. For one thing, given the risk of getting roped into a similar lawsuit, some brokerages may make proactive changes to their commission structure.
Redfin CEO Glenn Kelman said in a statement that the lawsuit will "ensure major change" comes to the real estate industry, including, potentially, that buyers will start to pay their own agents' commission, or that buyers and sellers could more commonly share the same agent, as they do in Great Britain, Australia and New Zealand.
Chandan believes that decoupling buyer and seller commissions could create more competition and variety in the market. "There's research to suggest or show that we will see more competitive house prices . . . and more competition among buyer's agents," he says, along with the emergence of technology and platforms that could support buyers who forgo a traditional agent.
It could cause real estate agents to change their scope of work, rather than offering one blanket service at the same fee, Schuetz says. "You could have agents who specialize in sort of higher and lower service levels and price accordingly," she says. For example, a buyer who doesn't need help finding a house but wants assistance crafting an offer could, in this hypothetical, pay less than a buyer who needs both services.
While this could save people money, it could also lead to discrimination, Schuetz notes. "You could wind up having a specialization where some agents choose only to work in some neighborhoods, or at some price points, or with certain kinds of customers."
But really, she says, there are a lot of unknowns: "There could be a bunch of changes to the industry and we won't know what those are going to look like until they happen."
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