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Understanding Real Estate Fees & Commissions
Choices for Sellers - Rebates for Buyers
Here we explain the differences among contingent, discounted, and unbundled fees. But first let's review the role of the agent. According to law, the agent owes his/her buyer or seller client:
- A fiduciary duty of utmost care, integrity, honesty, and loyalty.
- The diligent exercise of reasonable skill and care in the performance of our duties.
- A duty of honest and fair dealing and good faith.
- A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of the parties.
The fiduciary duty is key. It is in this area, directly related to the agent's license, that the agent performs the higher level tasks that are key to the success of the transaction and that affect the financial outcome.
Contingency Fees – The Standard Model
This is where the consumer gets FREE service. Everything the agent does for the client (whether buyer or seller) is FREE, unless there is a successfully concluded transaction, in which case the agent gets paid. But FREE is actually expensive for the consumer, in the same way as a lawyer’s contingency fee is expensive for the client.
Why are commissions so high? For the same reason that personal injury attorney fees are so high. The real estate commission is really no different in kind than the outcome based contingency fee that a client pays a personal injury attorney.
The personal injury attorney is paid a high fee because of the risk he or she takes that a case may not be successful. If the attorney is unsuccessful, the client has received “free service.” If the attorney is successful, the client pays through the nose. It is all about the allocation of risk.
Nothing is really FREE. When you pay a high commission on a successfully closed real estate transaction, you are not just paying for the service you received, you are also compensating the agent for all the work that s/he did for other clients on other (failed) transactions, where the agent did not get paid.
It is the same as the successful personal injury attorney’s client paying a very high fee to compensate the attorney for the many hours and resources spent on unsuccessful cases.
So in the current contingent fee dominated real estate commission system, you agree to pay a high fee to your agent for him or her to assume the risk of failure in the transaction. And it’s not only your transaction. Check out some of the things your agent has been doing for others without recompense:
1. He has spent many hours creating free CMAs in the hope of obtaining listings that have gone to other agents.
2. He has spent time and gas driving uncommitted buyers all over town for free, only to find that the buyers decide to use another agent, or not buy at all.
3. He has spent time and money (free to the client) on promoting and advertising listings that do not sell.
But who ends up paying for these failed endeavors? You do, because it so happened that your transaction successfully closed and the commission you paid the agent also paid him or her for all the abortive FREE effort spent on listings that did not sell and buyers that did not buy.
Hence the industry saying, "The transaction that closes makes up for all the others that didn't."
Some years back a National Association of Realtors® survey showed that a median-sized brokerage in a median-sized marketplace spends between $1,200 and $1,500 per listing, even if the listing does not sell. This includes the agent’s time and costs, coupled with those of the brokerage, a pro-rata share of overhead, signage, advertising etc.
This is an indication of the true cost to consumers (both buyers and sellers) in a real estate transaction. We say buyers and sellers because, although technically it is generally the seller that pays the real estate commission, it is after all the buyer that funds it.
Whether and for how much a property is sold is determined by market factors beyond the control of the agent. So, paying a real estate agent contingent upon an outcome that he or she cannot control has to be expensive. You are asking the agent at his or her own expense to provide insurance against an unsuccessful outcome. But that insurance comes at a stiff price.
This is not to say that the industry standard contingent fee arrangement is inherently a bad thing. Many people are risk averse and feel more secure with the traditional arrangement. The only “bad thing” about the industry standard is that until recently it has been the only way of doing business.
But now there are alternatives. Let’s look at them
Discounted Fees – The “Bargain Basement” Model
Perhaps the biggest misconception today in real estate is that unbundling is the same as discounting. Discounting is providing an entire package of services and tasks, but charging LESS for them.
Think of it like a trip to the bakery. It's Monday and you purchase a pie for $8. (That's bundling.) Additionally, the baker offers pieces of pie for $1.50 each. (That's unbundling.) On Tuesday, you again stop by the bakery to find that the baker is offering the day-old pies at $6. (That's discounting!)
In order to compete with today's pies, the baker dropped the price. But, in reality, the day-old pies used just as many ingredients and cost the same to make as today's pies. In fact, refrigerating the pie overnight, the plastic wrap used and/or additional handling and personnel costs would actually make the day-old pie more expensive than the fresh one.
How then, do discounters compete? They go for volume. But, in going for volume, they have to trim their service wherever they can, even if they claim to offer “full service for less.” Unfortunately, since the agent has to look busy to the client and has to keep chasing other listings in order to achieve volume, what usually gets trimmed most is the most important Level 2 fiduciary element of the service (see below) .
So, while the discounted fee is on the face of it attractive, in practice all it means is that you get discounted service as well. So it really is not such a bargain after all. And it’s not so great for the agent either, since the commission is both smaller and still contingent on the sale. The only thing saving the discounted fee model is the recent run up in home prices. A discounted fee today is worth twice as much as it was four years ago.
Fee for Service – The Unbundled, Consulting Model
This is where risk, together with greater control and reduced cost, shifts towards the client. This is also where the focus is on what the real estate consumer wants, not what the real estate industry wants to provide.
In providing service to the consumer, the agent employs two skill patterns. We will call them Level 1 Skills, used to perform functionary tasks and Level 2 Skills, used to perform fiduciary tasks.
In the standard contingency fee service model, these skills are merged together and sold as a long laundry list of "bundled" services, such as appears in the Marketing & Action Plan.
But in the consulting model these skills are distinguished, separated out, “unbundled” into individual component parts and purchased separately.
Level 1 – Functionary Skills
Level 1 skills are those that involve information gathering, fact-finding, administration, follow-up, ad-writing, taking digital photographs, installing a sign and lock box, holding open house, finding homes, running paperwork around, making appointments, data entry, and support. These are marketing, sales and organizational skills needed to perform the functionary tasks needed for the job.
Level 2 - Fiduciary Skills
Level 2 skills are those related to analysis, drafting the contract, ensuring disclosures are made, and trouble shooting the transaction. When you examine the 12 (6 each) Buyer's Roadmap and Seller's Roadmap components, you will find that very few actually require a real estate license for their execution. (Compare also those areas asterisked in the Marketing & Action Plan). Level 2 skills require the application of advocacy, negotiation and interpretation. It is in these areas that the license is involved and that the fiduciary tasks are undertaken.
There are in fact only three consumer-based activities permitted / mandated by virtue of a real estate license. Those activities are:
1. Facilitate/Provide disclosures
2. Fill-in pre-printed contracts for consumers
3. Deal fairly and honestly with all consumers
So, it is in the Level 2 Fiduciary area that the true value of the agent comes into focus. The highest and best use of the agent from the point of view of the client is his or her ability to negotiate the best possible bargain in the transaction, deal with contract terms, and troubleshoot the transaction during the escrow period. This is where the judgment, experience, and negotiating skills of the agent come into play.
So the fiduciary tasks are those the least visible but actually the most important to the client, because they directly affect financial outcomes. While the client is looking to the performance of the more visible functionary tasks to gauge whether the agent is performing, in fact these tasks can for the most part be carried out by the agent’s assistant, by technology, or by the client.
This is where we get to the crux of the rationale behind “unbundling” real estate services. This is where the client saves money by assuming responsibility for as many of the Level 1 functionary elements of the enterprise as possible, while leaving the critical Level 2 fiduciary elements in the hands of the agent.
This is also where the FSBO purchaser of our Flat Fee MLS, CMA & Knowledgebase Package saves even more by consciously assuming responsibility for the fiduciary tasks involved in the transaction.
Pareto's 80/20 Theory and its application in many fields maintains that, in breaking down the components of any endeavor, a few (20%) are vital and many (80%) are trivial. In the process of buying and selling real estate, the Level 2 fiduciary elements form the critical 20%. This is where the agent’s specific expertise, knowledge and experience come into play.
The merits of unbundled services are many. Not only can they be tailor-made to fit each individual and his/her situation, but they show differences between consultants--one of the sorely missing components of the traditional contingent fee based real estate brokerage business.
For an example of how "unbundled services" work, let us return to the legal profession. We have already seen the rationale for the contingent fee, where the attorney is rewarded highly for taking a high risk case.
But there are other areas of the law where a client may seek advice on a legal issue and will compensate the attorney based upon an hourly fee. In still other situations, an attorney may agree to a flat fee for, say, drafting a set of legal documents.
So, unbundling the sale and purchase services offers the consumer choice. What is even more beneficial is that it allows the Realtor® to develop additional “for fee" services that are outside the standard sale and purchase transaction. This can include, for example, consulting on “buy or lease” decisions, “best bang for buck” remodeling decisions, and property tax challenges. Such expertise has rarely been available to the consumer outside magazine articles.
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