When you sell a house, both your agent and the buyer's agent get a share of the profits. But how big that profit is is a matter that's been contested in court.
A Kansas City jury found this week that the National Association of Realtors and several real estate agents conspired to set unfairly inflated commissions on home sales. The defendants, who have pledged to appeal, must pay roughly $1.8 billion in damages to roughly 500,000 Missouri home sellers, with the amount potentially increasing. The ruling could completely upend how real estate agents are paid and how homes are sold.
But to understand how things will change, we first need to be clear about how the system works.
How do real estate commissions work?
Most real estate agents make their money through commissions. In the United States, there is typically a seller's agent and a buyer's agent, and the seller pays a commission to both. This has been standard practice for more than 50 years, says Christy Leap, spokeswoman for Bright MLS, a database of listings for sale in the Mid-Atlantic region.
Typically, commission is 5 to 6 percent of the home's sales price. The buyer's and seller's agents split the money. So if a home sells for $500,000 and the commission is 6 percent, agents on both sides of the transaction will split about $30,000 from the sale proceeds.
What’s wrong with the current state of agent commissions?
“If a seller-agent cuts the buyer's agent's commission, it will come at a heavy price. This requirement to “combine” commissions is one of the standards attacked in the lawsuit. The seller-defendants argue that the requirement is tantamount to unfairly forcing them to pay both commissions.”
So what are the penalties for not complying? In most parts of the country, in order to list a property on the Multiple Listing Service (MLS) (the MLS is the go-to database of homes for sale that are also listed on other platforms like Zillow and Redfin), the selling agent must agree to split the commission (50/50 is the common practice). If a home is banned from being listed on the MLS, it becomes largely invisible to potential buyers.
Some industry watchers point to other problems with the fee structure that are not the subject of the lawsuit.
First, the amount of information available on the Internet has dramatically changed the way people search for homes. You don't need a real estate agent to show you what houses are for sale in your town or to view listings of similar properties for sale. In other words, real estate agents are expected to do less work, but their fees haven't changed to reflect that.
“If you look at the commission data, you'll see that commissions have remained remarkably stable in the 5 to 6 percent range over this period, even though the role of buyer agents in particular has changed significantly,” says Sam Chandan, director of the Stern Chao Hong Chen Institute for International Real Estate Finance at New York University.
Second, industry watchers question the one-size-fits-all approach to fees.
“Economists think it's very odd that the fees are the same across all transactions, because some transactions are objectively more difficult than others,” said Jenny Schutz, a senior fellow at the Brookings Institution who works on housing issues. “Some clients are harder to serve, or some homes take longer, or are more complicated to negotiate, and that's not reflected in the fees.”
What are the downsides to changing the status quo?
Liep, the Bright MLS spokesman, argues that the practice of splitting commissions prevents favoritism and unfairness among agents. Without it being observed as an industry-wide standard, Liep predicts, agents would be incentivized to do more business and refer more work to peers who continue to split commissions, weeding out those who don't. Buyers and sellers represented by agents in that latter group would also be penalized.
Leap also points out that forcing buyers to shoulder the cost of the commission puts them at a “significant disadvantage.” Adding that cost to the down payment and other closing costs that buyers are already required to make begs the question, “How can a buyer afford to pay for a quality agent on the most expensive transaction of their life?” he said.
The standard is around 6 percent, but can sellers negotiate with their agents to lower the commission?
Technically, yes, you can negotiate your commission before you sign a contract with a real estate agent to sell your house, but most people don't do that.
“A lot of people don't question it,” Schutz said.[Selling a home] “It's a big deal. It's not something that happens very often. Whatever it is, it's going to be very expensive and it's going to benefit a lot of people who have never heard of it before.”
This level of complexity is exactly why many people turn to real estate agents in the first place.
Some sellers also worry that if they lower their commission, buyer's agents will be less likely to bring in clients. Think about it: If every other property is promising buyer's agents 1/2 of 6 percent, but your home is only offering 1/2 of 4 percent, that agent will have less incentive to convince their clients to buy your home.
Sellers' fears are well founded: “There is considerable evidence that buyer-side agents are more likely to present buyers with properties that will command higher commissions,” Chandan says. (Recent lawsuits have focused on how larger market institutions, like the National Association of Realtors and large brokerages, are encouraging this behavior.)
Some brokerages, like Redfin, offer lower fees. How do they do that?
Redfin operates differently from many traditional brokerages in that it employs its agents directly and pays them a base salary in addition to transaction bonuses, so people who sell their homes through Redfin don't pay commission to an agent but instead pay a 1-1.5% “listing fee.”
But many other brokerages that promised to lower fees struggled to break into the market: A Wharton School study found that new firms that promised to lower fees grew slower than those that promised to raise fees.
Will this ruling change anything for home sellers now?
No. The lawsuit itself will likely be appealed before the outcome is known. But that doesn't mean the industry won't change until all legal issues are resolved. First, some brokerages may be more willing to change their fee structures in light of the risk of being caught up in a similar lawsuit.
Redfin CEO Glenn Kelman said in a statement that the lawsuit would bring about “profound changes” in the real estate industry, including the possibility that buyers would start paying their own agents' fees, as in the UK, Australia and New Zealand, and that it would become more common for buyers and sellers to share the same agent.
Chandan believes decoupling buyer and seller fees will bring more competition and diversity to the market: “There are studies that suggest or demonstrate that it will lead to more competitive home prices and more competition among buyer-side agents,” he says, citing the emergence of technology and platforms that can help buyers who can't access a traditional agent.
Rather than offering comprehensive services for the same fee, real estate agents may vary their scope of work, Schutz says. “You can hire agents who specialize in higher and lower level services and set your rates accordingly,” she says. For example, a buyer who doesn't need help finding a home but does need help writing an offer could hypothetically pay less than a buyer who needs both services.
While this could save people money, Schutz said, it could also lead to discrimination: “It could lead to increased specialization, where some agents choose to work only in certain geographies, at certain price points, or with certain types of customers.”
But the reality is, there are a lot of unknowns, she says: “A lot of change is likely to happen in the industry, and we won't know what it will be like until it happens.”