Friday, July 25, 2008

Where Does The Commission Go When I Sell?

In metro Phoenix where I work, sellers typically pay the Realtors' commissions. Buyers don't pay any Realtor commissions. The biggest chunk of change buyers come up with is their down payment. For sellers, the biggest hit you take on closing day is the Realtors' commissions.

Comissions are negotiable. So not every scenario will fit this one exactly, but this is pretty common.

Let's say the seller agrees to pay a Realtors' commission of $12,000 for selling her house. I can almost hear readers screeching already -- "Wow! That sounds like a LOT of money! How could it possibly cost anybody that much money to sell a home?!@?!  Realtors make too much money!"

That's why I'm posting, to explain where all that money goes.  Let's skip ahead to closing day. The title company subtracts $12,000 from the seller's proceeds at sale. It goes to the seller's Broker. Not the Realtor with whom the Seller dealt every day, but to the Realtor's "employer", the Broker (see below about how Realtors aren't really employees at all).

Usually there are 2 brokerages involved in 1 deal, the Seller's Broker and the Buyer's Broker. The Seller's Broker splits the commission with the Buyer's Broker according to what was agreed between them in the MLS advertisement. In metro Phoenix in today's market, the Brokers usually split the commission 50%-50%. In this case, the Seller's Broker gets $6,000 and the Buyer's Broker gets $6,000.

Then the Brokers turn around and split that commission with their respective Realtor agents. Again, the way they split it up is determined by individual employment agreements between the Realtors and the Brokers. Sometimes the Realtor gets 80% of the commission and the Broker takes 20%. Sometimes the split is 70% - 30%, 60% - 40%, or even 50% -50%. Sometimes the Realtor gets 100% of what the Broker 'earned', but in that case the Realtor paid the Broker a fee every month in lieu of splitting the commissions when they come in. I've never worked for this type of Broker, but I've heard other Realtors talk about fees from $500 a month to fees approaching $2,500 a month.

In any case, that $12,000 was split into two 6's. Now it's split again; let's say in this case it's split 70% - 30% between Realtor and Broker.

The Broker gets 30% of $6,000, or $1,800. From that, the Broker pays for the cost of running an office, providing phones, computers, printers and toner. The Broker also provides Errors and Omissions Insurance for the Realtors. Brokers have to pay the clerical staff who handle data entry, phone service, and general document and transaction managment. Most Brokers are so busy managing the business that they do very little in the way of conducting actual real estate deals. So they have to take a big enough split to create a salary for themselves. This scenario probably describes the big boys like Coldwell Banker, Prudential, and a few others. Smaller brokerages do things with fewer staff but the jobs listed here still have to get done & paid for. Whether the Broker takes a split or a monthly fee, they pay the bills somehow off of the work their Realtor agents do.

What about the Realtors? In this scenario the Realtor in the example got 70% of 50% of the $12,000 it cost the seller to hire that Realtor. Seventy percent of half of $12,000 is $4,200. Already, the Realtor who did all the work of selling the house watched his "paycheck" get whittled down from $12,000 to $4,200! Out of that, the Realtor must pay for:

  • Federal Taxes - Realtors are independent contractors and, unlike W-2 employees who only pay 6.25% of their gross wages to Social Security, Realtors pay about 12.50% of their income to the feds (I might have my percents a little off but the idea is dead-on, we pay double whatever wage-earning employees do);

  • State & Local Taxes - don't forget 'em!;

  • Liability Insurance in case a client gets hurt while they're together;

  • Auto insurance at above-normal rates because Realtors drive a lot with other people in the car who aren't covered by their own auto or medical insurance;

  • Medical Insurance - Realtors are independent contractors and don't usually get medical insurance through their employers;

  • Dental Insurance - same as above;

  • Vision Insurnace - again, same;

  • Disability Insurance - same again;

  • Annual MLS dues;

  • License renewal fees (in metro Phoenix, we renew once every 4 years);

  • Annual lockbox access dues;

  • Individual lockboxes for use at listings;

  • The cost of attending various seminars to continue learning and growing as a Realtor;

  • Staging Supplies, if any (I have a bedroom closet & dresser filled to bursting with towels, soaps, baskets, shower curtains, sofa-sized art, fake greenery and decorative tchotkes);

  • Website developer fees and monthly or annual maintenance fees;

  • The costs of buying and installing yard signs, sign riders, posts, and so forth to put at listings (and the cost of removing them all at the end);

  • Advertising costs including web, print, billboards, radio, TV, newspaper, supermarket checkout divider thingies and whatever else the Realtor threw into the ad mix;

  • The costs of maintaining a home office complete with color printer/fax/scanner/copier, computer with high-speed Internet access, data backup resources, hi-quality digital camera & supplies;

  • Buying your own business cards if your Broker doesn't provide them (most don't);

  • Maintaining a big car that holds lots of people;

  • Open house supplies like drinks & snacks, pre-open advertising and buying the actual open house signs;

  • The cost of client entertainment and closing gifts;

  • Referral fees to other agents who sent you business based on your good reputation;

  • The costs of various supplies for printing flyers, postcards and the like as well as buying general office supplies; and finally

  • Astronomical monthly cell phone bills - because you've gotta have unlimited data, text, web if you're going to compete in today's mobile market

Not every Realtor pays for every item on this list every time he/she sells a property or works with a buyer. Me? I run a medium sized business on a very tight ship with minimal expenses. For the past 3 years running, it's cost me about $30,000 each year to be in business. Big operators spend more. Russell Shaw wrote a post a while ago in which he revealed he'd plowed $500,000 into his business by May 18 of this year. For me, I've got to make at least $30,000 in gross commissions before I can begin thinking about my earnings in terms of a salary instead of overhead. That's a lot of houses sold at $4,000 to $6,000 a pop.

I guess my point is that Realtors pay for all the above out of their own pockets, and do it because doing so helps us service our clients' needs better. If we don't focus on our client's needs, that shows over time and pretty soon we're out of business.

In any case, next time you catch yourself thinking that Realtors make too much money, remember this post.

And please don't let this post give you the mistaken impression that I spend all day, every day thinking about me and how much I earn. In fact, I don't. This post took me longer to write than most because I had to go through last year's tax files to compile the list of my expenses.

I spend my days and nights just like my clients do - thinking about about how I can get your house sold, or whether now is the right time for you to buy. In short, I spend my days thinking about my clients and their needs. The money follows.