How the Commission Structure Works
To understand how commissions are paid in real estate deals it is important to know the terminology and the meanings of those terms. Let us start there.
Here are the common terms and their definitions:
- Real Estate Agent – A real estate agent has a within license a state with authorization to represent buyers and sellers of properties. A real estate agent’s license must always be attached to a real estate broker’s license. The broker agrees to take responsibility for that agent, unless the agent is also a broker themselves.
- Realtor – A realtor is a real estate agent that is also a member of the National Association of Realtors (NAR). This is a private non-governmental trade organization, somewhat like the chamber of commerce. Real estate agents join this trade group and promise to adhere to specific standards of ethical conduct.
- Broker – All real estate agents must be licensed “under” a broker. The broker is responsible for distributing commissions that are paid. The broker takes a fee for this and may charge expenses such as part of the company’s overhead, which are deducted before the commissions are paid.
- Listing Agent – This real estate agent succeeds in getting a written contract from the property owner to list the property for sale.
- Buyer’s Agent – This real estate agent brings a qualified buyer to the table and represents the buyer during the closing transaction to pay for the property and transfer ownership to the new buyer. In some transactions, it is possible that the Listing Agent and the Buyer’s Agent is the same person.
- For Sale By Owner (FBO)- This is a process where the owners of the property sell the property themselves without the help of a real estate agent. The NAR says this is quite rare and accounts for only about 9% of the sales. Many of those FBO transaction are transfers between persons, like family members, who already know each other.
Now that we have an understanding of the terms that are commonly used, let us break down exactly how commissions are paid. There are general rules, such as the “standard” commission in a real estate transaction is 6%. Nevertheless, everything is negotiable. The commissions depends on the relationships and the written contractual agreementsmade between the parties. For example, a commercial property that sells for $100 million may only have a 2% commission. That is still $2 million dollars, which is a nice payday.
Typically, the commission “pie” is split up in this way:
- Listing Agent gets a piece of the pie
- The Broker that the Listing Agent works for gets a piece
- Buyer’s Agent gets a piece
- The Broker the Buyer’s Agent works for gets a piece
Sometimes one or more of these roles is fulfilled by the same person. Typically, the broker on the buyer’s side and the broker on the seller’s side split the commission 50/50, then after deducting the broker’s fees and any authorized expenses, the remaining balance is given by the broker to each of the respective agents (Listing Agent and Buyer’s Agent). However, it does not have to be 50/50. These things are decided in written contracts between the brokers.
Conclusion
Real estate transactions are all about paperwork. Careful attention about the details in the paperwork is necessary to get a clear understanding of how the payment of commissions occurs and what deductions are authorized that reduce the commissions.