The evolution of the brokerage fee

This article presents a history of brokerage fee rates and fee sharing practices, including a discussion of antitrust law and the damage inflicted by anticompetitive practices.

The formation and defense of the standard

The standard 6% brokerage fee appears repeatedly in California real estate history. In the past, Association of Realtor (AOR) boards colluded to cement the practice of charging 6% brokerage fees on all single family residence (SFR) transactions.

As a result, brokers who priced competitively against the 6% standard were confronted with AOR administrative discipline, ultimately facing arbitration to pressure them to conform to AOR fee customs.

This price fixing violated California antitrust laws by setting rates all union members were to charge, thus restricting competition between brokers soliciting and providing services to the public. [Calif. Business and Professions Code §16720]

As recently as the 1980s, AORs openly required brokers with memberships, and thus brokers’ agents, to charge a fixed fee of 6%, to be split 50:50 between seller’s broker and buyer’s broker. The goal was to control compensation paid to brokers in SFR resales. This was declared illegal in the 1981 case, People v. National Association of Realtors (NAR). The court in People v. NAR held NAR was guilty of violating antitrust laws and prohibited AORs (San Diego, in the case) from restricting brokerage fee arrangements and blacklisting noncompliant brokers, their agents and listed properties.

Though the orchestration of a fixed 6% fee has not been the result of verbal communication in more recent history, conscious parallelism (“unwritten rules”) has continued to uphold the inflexible standard of a 5-6% brokerage fee.

Even brokers and agents righteously damning anti-competition practices frequently demean competing agents who charge a 4% fee rather than the standard 6%. “You get what you pay for” is the argument many agents use to discourage buyers and sellers from hiring these “discount” brokers.

Big brokerages are not always so “tolerant,” and have been known to bully nonconformist brokers out of the market. This is accomplished by intolerant (price-fixing) brokers intentionally avoiding listings and offers from “discount” brokers, or property offered in “unorthodox” for-sale-by-owner transactions which attempt to cut out the brokerage fee altogether.

Typical sharing practices

However, these hefty set-in-stone percentage fees are not the norm everywhere in housing markets. Professors from the University of Chicago and the University of San Diego report brokerage practices in the U.K. real estate sales market are much more vigorous and productive.

The average “estate agent” in the Great Britain closes approximately 40-50 deals a year on a 2-3% fee. The average real estate agent in the U.S. closes approximately seven deals a year on a 5-6% fee.

Related article:

The Economist: The great realtor rip-off
Agent snapshot: not your best side

While 6% has long been the standard brokerage fee in California, the number of brokers charging 5% of the sales price has increased and become relatively common. Typically fees are divided 50:50 between the buyer’s broker and the seller’s broker.

Occasionally, a slightly greater share is given to the seller’s broker such as in a 3.5%/2.5% split of a 6% fee. This practice is likely a hangover from the boom-time seller’s market mentality.

Other common fee divisions during a hot seller’s market include 2% to a buyer’s broker and 3% to a seller’s broker on a total fee of 5%. The reverse of these practices often controls in a buyer’s market, though today the heavy influence of speculators over the SFR and multi-family property market has limited distribution of fees in favor of buyer’s agents.

However, the 3%/3% split between buyer’s broker and seller’s broker (respectively) is most common. Whether or not a 6% total fee is fair, 50:50 splits are reasonable if each agent participating in the transaction performs the duties owed to his client (fiduciary/specific) and the other broker’s client (general).

In a recent first tuesday poll, the majority of participants reported encountering 50:50 divisions of 5% and 6% fees, with only a marginal number of participants reporting other fee sharing practices in their real estate business. Though People v. NAR banned the practice of fixing brokerage fees, this indicates that the practice of standardizing brokerage fees is alive and well.

Related article:

Real(i)ty Check: Agent fees and fee sharing practices

Good business

The standardization of the 5-6% fee seems perfectly fair as it is a consistent charge the public has learned to accept, until you consider that two brokers spending the same amount of time and effort in marketing or locating a property for their client will earn widely disparate sums depending on whether the price of the property is low-tier or high-tier.

Brokers working for middle- or low-income clients may be equally skilled, if not more knowledgeable about financing and contingency (cancellation) arrangements, than agents of wealthy buyers and sellers dealing in high-tier properties, yet their fees will be significantly less for equivalent services.

Percentage fees gained from high-tier property sales subsidize those brokers for unpaid time spent searching to locate properties or buyers for deals which never close, or time spent negotiating low-tier property sales.

Regardless of brokerage fee rates or sharing practices, brokers must enter into a listing agreement to document their employment in order to ensure they receive a fee in exchange for providing professional services to their clients. The guarantee provided by a written employment agreement — the listing — establishes trust in the agency relationship between client and broker, reinforcing the broker’s fiduciary duty to his client and encouraging the broker to perform his end of the deal well. [See first tuesday Forms 102 and 103]

Capitalism at its finest

As their breach of antitrust laws implies, price-fixing practices stifle competition in the real estate market. The defining force of business competition when rendering brokerage services improves the quality of services received by the public, and delivers a reasonable market-controlled (not broker controlled) compensation for those services.

Competition challenges professionals to work smarter, be more effective as advisors and be better informed than their competitors. The philosophy of economic Darwinism rules, where the fittest survive, and incompetency, inefficiency and underperformance are eliminated. Brokers’ management and operating ability to offer competitive prices to clients gives them an edge over their competition; it allows them to garner and service more clients while their colleagues focus on adherence to stringent brokerage fee rates, dignified and unperturbed by change — or business.

Related article:

Price fixing and kickbacks for the sake of earnings

Increased transparency of brokerage fees over current non-disclosure to buyers is mandated by legislation in California. If buyers know the fee their agent is to receive on a transaction, more competitive fee arrangements on the part of more efficient brokers and agents will soon be the result, even if railed against by those intent on maintaining artificial levels of pay.

While brokers are currently required to disclose all compensation they receive as a result of the transaction they are handling on behalf of their client, upfront disclosure of brokerage fee rates to buyers is greatly lacking. [See first tuesday Form 119]

Websites like Zillow and Trulia have whetted buyers’ and sellers’ appetites, to the disapproval of resisting brokers, for complete information delivered online from all sources on any property. Such open access to prices, property specifications and conditions, and other previously privatized information will at some point create a public demand for the inclusion of brokerage fee figures on publicly distributed property information. In this case, potential sellers and buyers will likely consider retaining the broker offering a lower fee, all other qualifications being equal. [See first tuesday Forms 119 and 150]

A cornucopia of fee options

Alternative rates in brokerage fees may still be frowned upon by older operatives within the AORs, but charging a contingent percentage fee is not a broker’s only option. Flat fees, which require a specified dollar amount to be paid the broker/agent for their time and talent, contingent on closing and without regard for the selling price, are a viable, if less popular payment method than the sticky percentage fee fixed at 5%-6%.

Brokers may also charge hourly fees, like those used in other professions. Such alternative practices for charging fees may create more focused, conscientious brokers and agents.  Serving their clients on an hourly basis, without concern for whether the transaction sought is ever entered into or closed, helps avoid succumbing to the temptation of offering clients advice drawn from the “close the deal” mentality.

Fees based on a percentage of the purchase price are definitely incentives for productivity. On the other hand, they are contingency fees which lend themselves to the wrong type of performance since the broker and agent will never be paid for their time and talent unless they can finesse the client into a deal and close it.  With contingent percentage fees, the broker’s bottom line drives the advice he gives clients, and interferes with the stability of the market and the financial well-being of the client. Exceptions, of course, exist.

Brokers and agents are more than salesmen; they are the gatekeepers of the real estate industry. Their compensation is not a sales commission as it is called in vehicle (car) sales; it is a fee paid for professional services rendered. Many cannot imagine an attorney or accountant labeling the compensation for their services as a commission, yet real estate brokers continue to use this vocabulary in a clearly parallel profession.

Whether a broker charges 6% of the sales price, or an hourly rate, their responsibility is the same: to serve the client and provide evidence they – their time and talent – are worth their salt.

Have you ever charged an hourly fee, flat fee, or used other alternative fee arrangements for your services? Tell us about your experience in the comments section below.