Real estate agents hear it all the time: “How does the whole real estate commission thing work?”

I’ve had to explain it during litigation as an attorney, teach it to licensing students as an educator, create graphics about it for auditors as a compliance officer, document it for CPAs as a taxpayer and, most importantly, walk through it step by step for my buyer and seller clients as a Realtor.

It’s important to understand how all of this works as we examine the health of the industry in its current state. 

As this article gets published, there are lawsuits in the courts arguing that the offer of Buyer Broker Compensation as directed by the listing agent is actually harming the seller. The filing with the most notoriety is:

Christopher Moehrl, on behalf of himself and all others similarly situated, Plaintiffs v. The National Association of Realtors, Realogy Holdings Corp., Homeservices of America, RE/MAX Holdings and Keller Williams Realty

This action argues that the seller is being harmed by the listing agent because potential buyer’s agents may not show properties to their clients if the offer of compensation is not high enough.

It also argues that the buyer-broker marketplace would be more competitive if it was negotiated by the buyer directly with their agent, hence putting more money in the seller’s pocket at close of escrow.

In light of that, let’s examine how the commission process works in the majority of cases. There are, of course, exceptions to the rule, but for the most part, residential real estate agents get paid in the same manner. 

So, how do commissions work?

Typically, a listing agent representing the seller of a property will formally sign listing paperwork that identifies the brokerage representing the seller, and the amount the licensee is charging to represent the seller in the transaction. 

There are some states that allow for a listing agent to charge a non-refundable (don’t even get me started on what that means) retainer fee for marketing and other services upfront. Some states also allow for a “fee for service” type of listing where an agent can charge certain amounts for certain duties they perform, but there are states that do not allow that at all.

Agents usually charge a percentage of the final sales price as the commission for representation. Licensees are taught over and over during real estate school that commissions are not set by any regulatory board or agency, and an agent can charge whatever they like.

It’s negotiable. 

Licensees may have parameters they are required to follow within the brokerage they join, but agents are generally free to negotiate their own fees with their clients.

What sellers and buyers don’t always understand is that the total commission collected following negotiations between the seller and the listing agent is then divided up in a ‘cooperation/compensation’ agreement with the agent who brings the buyers.

When brokerages and agents join an MLS, the compensation offered to a buyer’s agent must be clearly stated on the listing, and the membership in that MLS requires the listing agent to honor that amount to the buyer’s agent at the close of escrow. The offer of compensation is truly the only contractual obligation within a listing on the MLS, and it is between brokers.

That means that the listing agent’s total commission charged to the seller is paid to the listing agent’s brokerage, which in turn pays the amount offered in the MLS to the buyer’s agent brokerage who pays it to the buyer’s agent. Whew. Confused?

Why it matters

What the above description shows is that the seller is technically footing the bill for both the seller’s and buyer’s agents out of the proceeds from the sale. Legally, the seller is only paying the listing agent brokerage who then agrees to share those fees with the buyer agent brokerage. 

The reason this is important is the number of lawsuits and legal arguments surrounding sub-agency. Before we evolved as an industry and allowed for the buyer to actually be represented by an independent agent, the buyer’s agent was paid as a sub-agent of the seller, and that caused confusion regarding to whom the buyer’s agent actually owed a fiduciary duty.

There are some who will argue that in the above description, it is actually the buyer who is paying the fees through the purchase price. That opens up an entire can of worms from an appraisal point of view, and of course, from the lender’s point of view. Is the house really worth the whole amount minus the expense of the sale, or is it worth the base amount plus the commissions?

Time will tell if the various lawsuits, like the one mentioned above, force a change in the process.