The Real Estate Commission – How it Really Works

By: Victor Normand
Published: July 2015

Part II

The actual commission rate is determined by the marketplace. The rate which prevails in any given market is continually challenged by so called discount brokerages and various self-help real estate selling services. Under our economic system, only the government or governmental agencies can fix prices and real estate commissions are no exception to this. Real estate companies cannot collude among themselves to set rates, though rates can be set by individual company policies for their services, and consumers are free to accept, reject or negotiate those rates.

Under law in Massachusetts there is no requirement for a consumer to have either a seller or buyer agent under contract. However, in order to list property with a multiple listing service (MLS) a listing agreement must be in place. And although both buyer and seller agents are paid a fee, buyer agents rely on the listing published by the MLS to know their level of compensation. A contract with a buyer agent could specify a fee, but that fee is customarily offset by any fees posted in the listing.

The commission stated in the listing agreement which is paid to the listing broker in full at closing is intended to compensate both the buyer agent and the selling agent. It is usually split evenly, but not necessarily. So there are two licensed professionals representing separate clients paid by the seller. However, in actuality, it is the buyer who is paying the commission as part of the purchase price. Unless the property has an upside down mortgage (the sellers owe more than the property is selling for), only the buyer brings money to a closing.

Nearly all property sales include commission in the sale price. It is akin to offers of “free shipping;” shipping isn’t free at all; it is merely included in the cost of whatever is being shipped. Aggregating recent sales of comparable properties to arrive at a projected sale price of a subject property therefore includes commissions paid. So then, the buyer in most instances has no contractual obligation to pay the buyer agent a commission, but ends up effectively paying not only the buyer agent, but the listing agent as well.

The process and practice is complicated and rife for misinterpretation, but it does serve to protect the consumer by providing for a licensed and insured professional operating under strict real estate law. Furthermore, all real estate agents in Massachusetts must work under the supervision of a licensed real estate broker within a licensed real estate brokerage. As mentioned, the commission stated in a listing agreement pays both the list and the buy side of a real estate transaction. In most situations the commission is divided among four parties; the listing agent and buyer’s agent and their respective brokerages.

The internet has radically changed how businesses operate today. More and more retail business is done on line, automobiles are not sold like they used to be and the travel agency is nearly extinct. But real estate agency is as strong as it has ever been. Almost all real estate buyers search for and most find property on line, yet over 90% of all buyers use a real estate agent to make the deal.

Redfin, Trulia, and Zillow have all tried to use technology to replace the real estate agent with limited success. In the end, housing is not a commodity like a book or an automobile and its economic scale is outsized. The internet has made much more information available to consumers, so much so that what may have seemed like a simple process is revealed for its true complexity. The logarithm that replaces a licensed, well trained, and experienced real estate agent has not been written.

The importance of an organized, stable and active real estate market is fundamental to our economy. The role of government regulation, housing associations and the real estate professionals who operate by those standards should not be underestimated or taken for granted. We have recently seen what happens to the economy when the real estate market is disrupted. Hunter-gatherers may have no need for a Resident Expertsm, but you do.

The Real Estate Commission –Some History

By: Victor Normand
Published: June 2015

Part I

Owning property or having rights to it meant little to our hunter-gatherer ancestors, then, beginning about 30,000 years ago, it did. The shift to an agrarian society for most of mankind established the importance of having ties to the land. As societies became more advanced, farmers looked to higher authorities to safeguard rights to hold and use the land. Family elders, village leaders, kings and queens and various forms of government provided a means to temporarily or permanently create rights to the land itself or at least the right to farm it. It is from this need to make the possession of land more secure that official order, common law and eventually written law emerged.

The rise of capitalism and the industrialization of the economies heightened the need to organize the ownership and transfer of property for the benefit of individuals and corporations. In the 1850’s, the first real estate brokerages were established in Chicago. From that time on into most of the twentieth century, the relationship between real estate brokers and their clients was simple: listing brokers represented sellers and the agents who worked with buyers were “subagents” of the listing broker. Buyers were unrepresented.

Under this system and into the twentieth century, most real estate listings were “open listings,” allowing anyone to bring a buyer to the seller (still common in many international markets). Not surprisingly, brokers did not market properties or cooperate with other brokers, and sellers could deal directly with buyers, bypassing brokers altogether. The real estate industry was not organized and very much open to speculation. Often, complicated transactions ensued and consumer abuse was common. As a result of all this, real estate brokers and agents were not held in high regard.

The solution to this problem, put forth by the National Association of Real Estate Exchanges (NAREE) (the predecessor of the National Association of Realtors) was to professionalize the brokerage trade. The relationship with clients and between agents would be set forth in an industry code of ethics and individual state licensing laws. The goal was to raise the profession to the level of lawyers, accountants, and architects where brokers would have duties like loyalty, financial accountability, and obedience and good faith dealings.

By taking on these legal responsibilities, brokers expected to have an exclusive agency relationship with clients and be paid a commission for their services regardless of who brought a buyer to the deal. The advent of the exclusive listing aimed to find the correct balance between protecting consumers and fairly compensating real estate brokers and agents. The only flaw in this arrangement was the fact that buyers remained unrepresented. (See the blog “Who’s Looking Out for Me,” February 2015)

This brings us to the matter of explaining in greater detail the real estate commission. Now that we have all the players: Sellers and buyers and their respective brokers and agents, real estate associations and state licensing authorities, we can begin to see the interplay of the commission structure.

To Be Continued in Next Months Blog: The Real Estate Commission – How it Really Works