The real estate brokerage business has a public relations problem. The public views them as making money hand over fist, but in reality, the margins are fairly small. Many full service brokerage companies can make more profits associated with ancillary services like title and mortgages than in their core businesses. Why?

The residential brokerage business structure is flawed:

The law of thirds: If the talent pool of a typical brokerage firm is divided into thirds by productivity, it becomes more apparent what the problem is.

  • Superstars – (Top third): These agents make the highest commission splits and make the most money personally. They are the role models for the remainder of the agents in firm. The brokerage firms often make little money off of this group after deducting their related expenses.

  • Want To Be Superstars – (Bottom third): These are the new agents who are learning the business, the part time agents who do very little business and the agents who just don’t produce. There is tremendous turnover in this group and most full time agents here can’t last here very long unless they move up.

  • Next In Line to Be Superstars – (Middle third): This classification is the most profitable group of agents for the brokerage firm because their fee split is not as high as the Superstars and they consistently perform unlike Want To Be Superstars. Ironically, brokerage firms spend a great deal of effort to teach them to be less profitable for the firms themselves (Superstars).

And now to make matters worse, there is a growing discussion to cut commissions or change the commission system all together. Since the beginning of time (well sort of) traditional brokerage fees are paid as a percentage of the sales price rather than at a flat rate. The industry talks about the percentage paid out as falling which is a misonomer since the dollars paid out during the boom increased despite falling percentages.

Mark S. Nadel’s A Critical Assessment of the Standard, Traditional, Residential Real Estate Broker Commission Rate Structure [AEI-Brookings], analyzes five elements of the traditional residential real estate broker rate structure, the most important of which are: 1) setting fees as a percentage-of-sale-price, 2) letting the seller’s broker set the fee received by the buyer’s broker, and 3) refusing to unbundle the price of a full package of services.

While I am not endorsing the current commission setup, one of the flaws of the logic in this type of study, is that it gives the impression that agents make money hand over fist. This report lacks analysis of time spent in the profession by agents not making money. For every commission paid out, there is endless time spent with buyers and sellers who do not buy or sell a property. Its the cost of doing business.

In addition, the market will dictate what buyers and sellers want. If there is demand for flat fee services and low commission structures, then the market will gravitate toward that direction.

I would venture to guess that in a weakening housing market and rising competition between listings, alternative forms of brokerage will lose their some of their edge as buyers and sellers feel less experimental and want full service.



21 Responses to “Broker Commissions: The Law Of Thirds, Getting A Percentage”

  1. Nice piece. Even though I am a realtor I get it from the consumers point of view, they are paying me a lot of money. I honestly wish I could do it all for less money, but have not figured out how to deliver the same level of service and still make a profit.

  2. Dan Green says:

    I think you’ve just summed up every single mortgage company in the world, too.

    Terrific piece.

  3. Found myself on your blogroll and am honored! Was wondering if you could change the link to: http://www.stpaulrealestateblog.com? If not I am still honored indeed!

  4. skep-tic says:

    “If there is demand for flat fee services and low commission structures, then the market will gravitate toward that direction.”

    this might happen if realtors didn’t function as a cartel locking out any real competition. just try to sell your home FSBO and see how many realtors show your house

  5. Jonathan J. Miller says:

    Teresa – I just updated the link. Thanks!

  6. An Honest Broker says:

    Echoing Skep-tic, Query: If brokers aren’t afraid of competition from unbundled service providers, why are they feverishly working to pass anticompetitive “minimum service” laws in various states around the country (“petitioning” legislatures being the only collusive conduct exempted from the antitrust laws)?

  7. “just try to sell your home FSBO and see how many realtors show your house” (per skep-tic)

    To skep-tic: Are you offering to pay the agents who bring buyers when you sell FSBO? If not, why should an agent who does not have a buyer’s agency agreement show your house for free?

    It is my impression from brethren and sistren around the US that buyer agency agreements are much more common outside Manhattan. I just signed one up today, with a buyer who will be exposed to the entire market (including FSBOs who don’t want to attract buyers by offering cooperation) and will pay my fee if there is no offer of cooperation. So his costs will be higher than unrepresented buyers who see no-fee FSBOs.

    I think the Manhattan agents who don’t use buyer-agency-agreements do that for reasons wholly unrelated to cheap FSBOs, so that is not (IMO) a cartel issue. FSBOs who do not offer cooperation to a buyer agent should not expect to see most of the buyers who are working with agents, because those agents want to get paid for their work and have not protected themselves with a buyer agent agreement.

  8. John K says:

    I don’t know the solution to this problem, I wish I did.

    I have nothing to say to people who whine about their FSBOs, commissions, Realtors, etc. You’re cranky people to begin with.

    What you say is true, Jonathan, that the 2.5% commission I collect from a successful buyer’s transaction compensates me for all the buyers I work with who end up not buying.

    That’s not fair to the buyer who buys, right?

    What other option is there?

    No buyer wants to pay up front, because he or she can’t be assured that he or she will end up buying. But, they are still costing me money, every day, because I am spending time on them and with them.

    I think I’m going to go the flat fee route, starting January 1. A $1,000 retainer up front, will keep the non-serious buyers away, and a flat $5,000 due at closing will compensate me, well enough.

    There is a good discussion about this, at http://www.bloodhoundrealty.com/BloodhoundBlog/

  9. skep-tic says:

    no one is suggesting that brokers should work for free. the question is whether the RE industry welcomes competition. let’s say a FSBO offers the same commission to the buyer’s agent that a agency-represented seller offers. does the buyer’s agent show the FSBO as readily as a non-FSBO? or does she only show the FSBO if her clients insists on seeing it, or if there are no similar non-FSBOs?

    what about sellers represented by discount agents? do buyers agents avoid them, even if they are offered competitive fees?

    I am sure I’m not the only person who’s heard stories of agents shunning FSBOs and discount-agent represented sellers even when they offer competitive fees for the buyer’s agent. Is it not true that agents view both of these as threats to their business? If agent’s are so certain that their 6% is earned, then shouldn’t they welcome competing business models?

  10. UrbanDigs says:

    Great topic Jonathan. I’ve had similar thoughts to John K., that is, considered charging buyers a $500 retainer for my services but then I would REFUND that deposit at closing, when I collect my commission due from the seller (split between buyer broker and seller broker).

    As far as the entire topic is concerned, this industry should realize that it is the BUYER BROKER that brings the deal to the table and I’ve seen numerous times the seller agent not do anything other than list the apt in a central system, have a buyer broker bring a deal in, and then collect their 3%! Sounds like the seller is getting screwd. But thats the way it is.

    What if down the road a new marketplace existed where sellers can reach the entire brokerage community plus direct customers, that offered the buyer broker (the bringer of the deal) a 3% reward for their services payable by the seller? So, it eliminates the seller broker altogether.

    Probably not a realistic scenario as who will run open houses, who will pay for ads, etc.. However, if everything gets more efficient over time, than the ebay of real estate is not to far off!

  11. UrbanDigs says:

    I should add. That i know many more seller agents that do a terrific job marketing a property, holding OH’s, dealing with clients, dealing with other brokers, making NY Times ads, paying for extra marketing and email blasts, promoting the property to their db of past clients, etc.. to get the most exposure and the highest price possible for their clients.

    So, there definately is value in a full service brokerage firm that has hard working agents.

    Just throwing out some thoughts before. As far as your agent breakdown of income, your right on.

  12. MSN says:

    Jonathan:

    Re: Nadel’s article. You state:

    “one of the flaws of the logic in this type of study, is that it gives the impression that agents make money hand over fist. This report lacks analysis of time spent in the profession by agents not making money. For every commission paid out, there is endless time spent with buyers and sellers who do not buy or sell a property. Its the cost of doing business. In addition, the market will dictate what buyers and sellers want. If there is demand for flat fee services and low commission structures, then the market will gravitate toward that direction.”

    I would like to know if you actually read my 75-page article, with almost 400 footnotes, before criticizing it. Certainly the $30 billion figure in the abstract and introduction clearly states that TOTAL brokerage fees are probably much, much too high, but the article does not make the claim that agents on average are making big bucks, because, of course, they are not. The problem here, which economists have pointed out, is that the excessive lottery like payouts for SOME easy sales and purchases attracts too many agents into the industry who then spend most of their time prospecting for customers rather than serving customers.

    If brokers and agents were paid based on the service provided – as Julie Garton-Good’s 2001 book “Real Estate a la Carte” has long advocated — those who wasted agents’ time would pay for it and those who did most of the work on their own would benefit from saving their agent time.

    Skep-tic and an Honest Broker have pointed out the main reasons that non-traditional brokers have not been more successful, and section VIII of my article discusses others.

    If you or any of your readers read the report and believe that there are any specific statements that are in error or are misleading or that important points have been omitted, I would be happy to make any appropriate corrections. I showed this draft to many experienced brokers broker before posting it and think that it is both accurate and fair. msnadel@gmail.com

  13. Jonathan J. Miller says:

    Wow – towel off. No offensiveness meant, its just an opinion. Its a well written article and I am sure took a lot of work on your part. And yes, other than the 400 footnotes, I did read the (75 page) article. – Although I forgot whether the page count included the 400 footnotes or not. My commentary was based on the impression I got from the piece.

    Its good to see someone so passionate about their topic and their work. However, attacking me and the post contributors is not a great way to deliver your message or represent your credibility.

    I hope you come back and share further insights on Matrix as I think you have a lot to say.

  14. MSN says:

    Jonathan:

    I am calm and certainly recognize that you may disagree with my proposal and that I may even be convinced to change my own conclusion or analysis if others point out errors of fact or analysis or crucial omissions. What irritates me, however, are critical statements that criticize something the article does not say or that ignores an important point that it does offer.

    As an example of the latter, you state that “If there is demand for flat fee services and low commission structures, then the market will gravitate toward that direction.”

    That is a very reasonable conclusion to reach before reading my article or even after reading the first 60 pages of the article. The article has just criticized the traditional rate structure and pointed out many of the alternatives out there. So, if the latter are truly better for consumers, why aren’t consumers choosing them?

    Therefore, I specifically address that issue in section 8 (pages 60-68). I review the many findings of the FTC’s 1983 study and update and supplement them. I think that I make a reasonably good case that brokers offering new rate structures are being illegally discriminated against in many ways, and as the Wall Street Journal editorial page complained in 2005, sanctions against brokers have not been forthcoming.

    You can disagree with any of the reasons I offer and I would welcome any specific thoughts that might help me modify any parts of my analysis on that point. But you presented your statement as if it was something that proved that my analysis was obviously flawed. I anticipated your reasonable question and offered an answer and then you wrote your comment as if I had not already offered a 9-page response.

    That was what irritated me, but, as I said, I am calm and look forward to learning more about these issues from you and your audience. I do not have any experience in the industry and am greatly indebted to the many brokers and agents whose books, articles, blogs, and direct comments have enabled me to produce the draft article I did.

  15. Jonathan J. Miller says:

    Thanks. Glad to get your response. I see what you mean now and thats not what I meant at all.

    Interesting point about discriminating against new models. I’ll re-read those pages. One thing you’ll learn about this industry, is that it is very passionate and much of the information is disjointed and inefficient to extract.

  16. jf.sellsius says:

    Jonathan

    Did the author cite the law of thirds? I always thought that was a rule of photography composition. I have never heard it applied in economics.

    I thought the distribution of wealth followed the power curve and the 80/20 rule (Pareto Principle). I guess I have to read up on my modern day economics 🙂

    Commissions based on the % system of compensation will always be criticized as unfair for the same reason a waiter serving one $200 meal gets a $40 tip while one serving five $20 meals gets only $20.

  17. Greg Tracy says:

    Nice post- in real estate management we called this quartiling.

    Basically we break the office into quarters and evaluate where the money is coming from. To improve the margins of the office I would try to recruit to the second and third quartiles.

  18. Jim Lee says:

    This is somewhat similar to the Department of Justice’s (DOJ) current rant against the “lack of competition” in real estate especially relative to commissions.

    We need to send a few of the DOJ lawyers on listings appointments; that would change their minds faster than all the Congreassional hearing in the world. 😉

  19. Jonathan: Though attorneys probably fare worse than Realtors in the public eye, we both operate on similar models. Some attorneys and most Realtors work on a contingency model. We are paid only if the case/transaction comes to a successful close. Other attorneys and some Realtors work on a retainer or fee-based model.

    There is room for both. Some can live with the uncertainty of a contingency-based business model; others cannot.

  20. Donna Lloyd says:

    I have never heard any encouragment from my Broker or other real estate agents in traditional firms to shun competetive forms of real estate services to keep them “out of the business”.

    I have experienced some sense of resistance in my personal preferences when I have needed to work with some discount/flat-fee services and with unrepresented sellers (FSBO). But, my fudiciary responsibility to my client is to represent them in the purchase of the house that meets their needs. Wherever it is. So I do my best to find that house and negotiate the purchase no matter how it is listed. (or sale when it is time for that.)

    My reticence has to do with not having the presence and representation of a professional agent on the other side of many styles of non-conforming transaction in order to make communication efficient; oversight of the transaction professional which reduces risk for my client and me; and often experiencing a real lack of knowledge and information on the part of the listing party about the property/sellers itself.

    Just as a surgeon surrounds themselves with professional support to reduce risk, the more trained professional real estate consultation comes to bear in a transaction, the more likely there will be a fair, honorable, successful transaction. (in my experience.) Just harvesting facts about a house, popping it on a website and connecting a buyer to a picture- and collecting a fee is totally irresponsible in my professional opinion compared to the depth and level of service I see provided through more traditional brokerage forms which are funded by the more historical commission structures.

    I felt almost guilty when negotiating as a tranined professional against a Seller who basically had NO representation or counsel in negotiation. His choice for service was list/flat fee only or no service (FSBO). I maintain a professional commitment to provide ethical, professional real estate counsel to my clients. I seek to bring that to the real estate scene as a whole. I feel both parties deserve that level of representation and it requires an investment in compensation to get it. I HATE being in a transaction where I know that the Seller or Buyer doesn’t know what the heck they are doing – are opening themselves to lots of unknown risks and liability – and there is no one there trained to assist them.

    The conversations of some our legislative representatives who imply consumers are being raped by what they deem as high fees for real estate transaction is so totally uninformed, in my professional opinion. Somone is looking throught the microscope at one transaction/commission at a time rather than through the telescope to get the entire universe of services a realtor performs over the long haul.

    I KNOW that I KNOW the value of service I bring to my clients in consultation, advocacy, accessiblity, knowledge of the market and protection from the millions of details or predatory acts that can sidetrack a real estate transaction. What a shame that service is so underestimated by a surface judgement based on a transaction at a time.

    Much like we all pay higher prices for medical care so that people who cannot afford to pay will also have medical care, I believe that traditional brokerage commissions are what have proven to be required to fund the provision of this service. Therefore, we all pay a sufficient amount to keep the professional advocacy system in place for ALL buyers and sellers when they seek to make decisions around what, for most, are the biggest financial investments of their life.
    I tell my friends all the time that being a REALTOR is like being an OB/GYN. You’re on call all the time and never know when the next baby is coming. As much time as I spend on call and available and as much time as I spend on the toole of technology, training and support to provide consistently excellent service- my fees are not exhorbatant. I would be very hard pressed to really provide SERVICE to my clients for less.

  21. chris says:

    I have a home listed with a flat fee realty group which basically consists of them putting me on the MLS and me doing everything else. I do use their name on all my literature to indicate realtors are welcome. I can testify first hand that traditional realtors have brought no one to see the property in over three months. Close to a 100 work the town and its small (approx 9,000 homes). 30+ did attend the realtor open house because we offered a lunch. Granted the property is over $1,000,000 so buyers are a scarce commodity. What would be the best way to attract traditional realtors. We are offering 2.5% commission (does this need to be higher?). Would sending information to realtor offices reminding them we are in the market and paying commission help. Either the market is still really slow or we are definitely being ignored. What do you guys think? I have run ads, have a take one box, have the house/sign lighted up at night, hold open houses, have beautiful full color signs on my car featuring the house. Is there a way to have better communication with traditional realtors to get them motivated to show the property to their clients.