Why Agent Commissions Are So High

A common refrain - real estate agent commissions are too high.

If you’ve just sold a median-priced home, you may well be handing over $20,000 to a traditional real estate agent. Ouch. People complain, yet do it every day, almost without thinking. Why are they so high and how do agents get away with it?

It’s not real

Traditional real estate agents can charge these eyebrow-raising figures because the amount doesn’t seem real to the home owner who is paying the bill.

The agent’s commission usually comes out of the deposit before it’s sent by the agent to the seller’s solicitor, which means the seller doesn’t pay the bill directly, it's bundled up into an overall settlement statement from their lawyer. What happens is called the Framing Effect (see here for more on pricing psychology). Because the price is bundled into other things sellers are far less sensitive to it. If the home owner had to physically write the agent a cheque or count out five figures’ worth of hundred-dollar bills, it would be a different story! All of a sudden it becomes real money. 

It’s tied to the house price

Traditional agent commissions are based on a percentage of the home’s sale value, which means the dollar amount paid has increased over the years in line with house prices. If house prices go up the agent gets paid more - completely independent of the effort, value, or service they provide.

Over the last 10 years house prices have increased by 124%, while general prices have increased 35% (CPI and QV Housing Index - March 2001 to September 2012). The base used to calculate your real estate commission has increased nearly four times the rate of increase in costs. This of course ignores all the benefits and efficiencies that agents have gained over that time too, for example, real estate websites, smart phones, wireless etc.

Quite simply there is no correlation between the service and value an agent adds and the total value of the house. In fact, it can actually drive the wrong behaviour by being structured that way.  Think about it - if house prices in your area increase 15% this year, the commission base increases the same amount without any changes from the agent.

You gotta feed the middlemen

The commission you pay goes to a number of middlemen who all take their cut of the fee.

A traditional agent operates as their own business within a local real estate office, which is often just one branch of a national brand. When a house sells, there are  a number of people who all need to be paid: the listing salesperson, the selling salesperson, the sales manager, the branch manager, the office owner, and the franchise owner.

The roller coaster of commission-only income

A real estate agent works on a contingency basis. If the property doesn’t sell, the agent doesn’t get paid, which means they’re taking a risk.  So you pay more than you would if you were paying for the service (like your lawyer charges). Not all homes the agent lists will sell, so the income earned on a successful sale also needs to cover the time, money, and energy spent on any unsuccessful sales.

It can be feast or famine - a little like the lion or the crocodile, who feed up large when food is available to make sure they get through the leaner times!

It’s a numbers game

From the traditional agent’s perspective, their most important daily, weekly, monthly task has nothing to do with selling your home. The most important task of the agent is to chase more listings for their books - that is, they need to find more homes to sell. This is known as prospecting and it’s a time-consuming business.

Think of it as being like a shop: if the shelves are empty, the shopkeeper earns no money. It’s the same for the agent. If they don’t have listings, they don’t earn an income.

The money they make from the sale of your property needs to cover the cost of all their prospecting, whether it’s successful or not.

So there you have it:

  • The commission charges are framed (structured) in a way that makes them seem to not be real money
  • The fees are tied to house prices which have increased dramatically
  • There are more than one person lined up to be paid when you sell - the commission needs to cover all the middlemen involved
  • Its contingent, which will be higher than paying a certain fee
  • The fee has to cover all the work to get the listing in the first place too

And we’d add a final one - there hasn’t been an effective alternative. That, of course, we’re working on!

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