Have you ever wondered why some things are the way they are? Such as, why do men’s shirts have buttons on the right, and women’s are on the left? Or why do they keep trying to make a better toothbrush—isn’t it basically as good as it’s going to get? (Yes, I know there are answers to these questions… that’s not the point.)
The point is—there are things in life we know are true, but sometimes we don’t understand why. For years, I’ve explained the way commissions work in real estate, because if you aren’t in real estate full time, you probably have a general idea but may not know the backstory.
Before I go any further, I have a crucial disclosure. In the world of real estate, one of the first things the elders teach you is that all compensation is negotiable. There is no “standard commission” and openly discussing commission rates is a strict anti-trust violation. My purpose and intent here is not to talk at all about WHAT agents charge, but HOW the compensation structure came into existence.
Also, a second caveat (boy, this is starting to feel like a dangerous topic…): there are many models in the real estate world. There’s the traditional approach, which… is pretty traditional. But there are now, there always have been and there always will be creative and alternative models of real estate brokerage.
In explaining how the traditional model came to be, I in no way intend to downplay those who may use a different approach. Creativity, change and disruption are all essential to the progress of any industry.
Okay, having said all that, here’s what you probably know about real estate commissions. If you list your house for sale with a licensed REALTOR® (yes, it’s required to be all caps), you are hiring a professional to work for, represent and advocate for you in the sale of your home. You (the seller) hire the agent and between the two of you, there’s a compensation agreement.
At the same time—again, in the traditional model of real estate sales—the seller also extends an offer of compensation to any and all buyer agents. On the other side of the transaction (assuming the seller accepts an offer which proceeds to closing) is a buyer, who is often represented by their own agent. This agent is acting on behalf of the buyer and in their best interests. If and when the property closes, that buyer agent is paid for their buyer representation—by the seller.
Now, you may ask yourself: why would they do such a thing? What has the buyer agent done to merit payment by the seller? Which is an excellent question, and necessitates us returning to the start of real estate agency in America. Let’s go back 100 years ago. (And for some reason, whenever I say that to clients, in my mind I see covered wagons and dirt streets and saloon doors… is that just me?)
In the early 1900s, the way real estate agents worked was thus: the agent knew some folks who wanted to sell their homes, and he or she also knew some folks who wanted to buy a home. (I say “folks” because, well, early 1900s.) A real estate “agent’s” main goal back then was to connect their buyers with their sellers. Pretty simply, you had middle men who arranged (or brokered) deals among their friends.
Eventually, home sellers said, “Wait a minute… I want to sell my house, and get the most money I can for it, but you (the agent) are only telling YOUR friends about it. I want ALL agents to know my home is for sale and show it to all THEIR clients too!” Sellers rightly wanted access and exposure, not just to a small pool of buyers that only their agent knew, but to every buyer in every agent’s pool.
Now, what would incentivize one agent to bring their buyers to another agent’s listing? Why would he go outside his own little pool? Well if the seller offered to pay him, that’s why. And thus the practice began of sellers offering compensation to buyer agents, in an effort to expose their home to the widest possible market.
So, while a home seller has an arrangement with their agent, exclusive to them and that relationship… the seller also has an open offer of compensation to any and all buyer agents, saying: “If you are willing to bring your buyer to my home, and they agree to buy it, here’s what I’ll pay you.” One agreement is between the seller and THEIR agent, the other is between the seller and EVERY OTHER agent.
As I mentioned, there are variations and alternatives—every agent is free to charge whatever they want, and every seller is free to offer whatever they choose. But in simple terms, that’s the origin story of real estate compensation.