How is Real Estate Agent Compensation Calculated?
When buying a home, it’s common for a real estate agent (“agent”) to tell you there is no cost for their help house hunting and negotiating a price for a home. Here is a direct quote from an agent’s website “It’s FREE to hire a buying agent!”
Yes, FREE was in all-caps on this website.
Nobody works for free. So who is paying for the services they provide to buyers and should you be concerned? As a buyer, does your agent have any incentive to betray your trust? This article will explore the qualities you should look for in an agent, agent compensation, the resulting incentives, and the potential issues you should know about.
Before diving into the details, let’s recognize that up to 90% of agents are ethical and honest. The purpose of this article is simply to help you understand the factors in play and how to spot the bad ones.
What is the Real Estate Agent’s Role?
Some key advantages to working with a buyer agent are advice on the intricacies of real estate transactions, help with negotiation strategies, and access to new listings 2 days before they show up on Realtor.ca and other public websites.
Most real estate agents will want to work with you, but you want to find the agent that is the best match for you. If you're a first-time homebuyer, you are about to make the largest purchase of your life, so you need to trust that your agent has your best interests at heart and is competent. At Mortgage Sandbox we believe that after you know they are competent; you should look for these key qualities in an agent:
They are ethical and share your values.
They have a work style that that is agreeable to you.
They are local to the area where you are searching for a home.
They are busy enough to have a good feel for market conditions.
They are not so busy that they can’t dedicate enough time to finding you the best property for your needs.
They work with you personally and don’t hand you off to a member of their “team.”
Our platform matches you with local, pre-screened, values-aligned Realtors and brokers because shared values make better working relationships.
How Important is the Agents’ Firm?
You may be wondering about the firm they work under, and whether you should use a well-known brand. Although the brand may bring you some comfort, most agents can affiliate with any brand they choose. Agents choose big brands because they know some consumers pay attention to branding. In the end, all listings are posted on an agent website called MLS and all agents have access to them. On the ethics front, if you review the published disciplinary actions by province, you will see that none of the big brands are untouched. It’s the individual that you're working with who is knowledgeable and trustworthy, the brands mostly provide administrative, technology, and marketing support to an agent. The biggest difference between brands is how much the agent must pay to the brand to be allowed to use the logo.
CAUTION: A lot of people use a recommendation from family or a friend. Although it is helpful that someone else you know has worked with an agent in the past, an agent who is from your circle of friends is more difficult to fire, if your working relationship is not working out. Just consider how it would feel to see the agent you stopped working with at your next family gathering
How real estate agents are paid
Buyer agents make money in a few ways:
The Seller’s Agent pays the Buyer’s Agent a share of their commission.
The Developer pays the Buyer’s Agent a finder’s fee for bringing them a buyer.
1. Share the Seller Commission
Real estate commissions vary but are typically 7% of the first $100,000 and then 3% on the balance. The commission is usually split 50/50 between the buying and the selling agent. The fee to the buyer agent is negotiated between the two agents so some sellers could be more profitable to your agent than others. Let’s look at the commission on a benchmark priced $683,000 apartment in Metro Vancouver:
| 7% on first $100,000 | = | $7,000 |
| 3.5% on the remaining $583,000 | = | $17,500 |
| Total | = | $27,405 |
| Each agent's share | = | $13,703 |
They would need to help someone buy 8 of these condos a year to surpass $100,000 in commission before expenses.
On the other hand, according to Scott Simmons, a B.C. based agent at One Percent Realty, “it only costs an agent 25 bucks to list a home on the MLS system. How can anyone justify a $30 thousand commission to sell a home in a hot market?”
Low Commission Real Estate Brokerages
In Canada, we have low-percent and flat-fee low commission real estate agencies. In the low-percent category, some heavy hitters include 1% One Percent Realty, founded in 1999, and the similarly named 2% realty which was founded in 2007. Low-percent commissions usually have a minimum commission, so for lower-priced properties, a seller is actually paying a flat-fee but they will get the benefit of a full-service brokerage. If you’re interested in the flat-fee agencies, you can work with One Flat Fee or For Sale By Owner (FSBO). These flat-fee brokerages are self-service DIY “do-it-yourself” with some help from the firm to help you be a successful first-time seller.
Low commission brokerages have had their bumps along the way but they’ve been growing consistently for years. Some of their agents rank at the top of their regional tables based on the size of their business. There is however a challenge faced by low commission models in an industry dominated by higher commissions. Buyer agents will benefit financially if a home buyer chooses a full-commission listing instead of a discounted commission listing. Given the choice between two similar homes in the same neighbourhood, they would prefer that their buyer would select the home where they earn half of +3.5% instead of half of 1%. Ethically the buyer realtor should not discriminate between listings but low-commission agencies in an industry dominated by higher-commissions raise two important questions.
1. If commissions are not adjusted - are sellers getting the highest possible price?
This would be a concern for home sellers. Do buyer agents consciously or subconsciously put more emphasis on full-commission listings? If they do, this means a home sold by a low commission service provider may get slightly fewer visits to open houses. Or when a buyer realtor puts together a list of properties to look at, they might spend more time learning about the full-commission properties.
In a hot market, all homes can get sold for a reasonable price, but we do not know if they could have sold for more if there had been a full commission for the buyer agent. There is no formal academic research examining the relationship compensation structures and final sales prices and in a hot market one or two extra people at your open house may not matter.
Kate Jackson, with One Percent Realty, North Shore, is in the top 2.6% of all sales agents in Greater Vancouver, measured by the number of homes sold and she says that on all of her sales “no commission adjustments were paid to buyers agents. They ALL took the .5% I paid them happily.”
On the flip side of this equation, sometimes seller agents and developers offer extra buyer agent bonuses and commissions with the intention of influencing buyer realtors to bring their clients to view a property. Again there is no academic research to show that it works.
If we have full trust in the ethics and integrity of real estate agents and we believe that buyer agents are unlikely to exhibit an unconscious bias in favour of full-commission properties then this is not a concern.
2. If commissions are not adjusted - are Buyer agents only representing buyer interests?
This would be a concern for home buyers. Commission adjustments are one way in which low commission brokerages can mitigate the risk of buyer agents discriminating against low-commission listings. According to Scott Simons, with One Percent Realty, buyer agents know they can ask for more commission in the purchase contract but sellers can counter-offer. In his experience, if the property price offered is low then sellers will usually refuse to pay the extra buyer agent commission. The challenge with this situation, that the seller is negotiating the buyer agent commission directly with the buyer agent. Even though the home buyer is included in this process, it implies that a buyer agent, in this situation, has an incentive to encourage the buyer to offer a higher purchase price or make other concessions that will make the seller more likely to agree to their higher commission.
In an industry dominated by high-commissions that are split between buyer and seller agents, the low commission models add some complexity and challenges. However, well-informed sellers and buyers, who have benefitted from reading this article, and have trustworthy Realtors should be able to navigate the challenges presented by low-commission structures and benefit from paying less commission.
Here is some other relevant reading:
Is Flat-Fee MLS the Right Way to Save on Commission? (MoneyWise)
The Pros And Cons Of Flat Fee Service Vs. Real Estate Agent (Toronto Storeys)
2. Fee from a Developer
With developers, the real estate agent commission is set by the developer of the new homes. Even though the standard commission shown above may be common, a developer who wants to sell their homes quickly can offer agents a higher fee. What’s significant here is that an agent who puts you in a pre-sale or new home has the potential to get paid more commission while the buyer pays sales tax on the purchase.
For argument’s sake, let’s explore the possibility that they are offered 100% of the commission that was previously split 50/50 on the benchmark $683,000 apartment:
| 7% on first $100,000 | = | $7,000 |
| 3.5% on the remaining $583,000 | = | $17,500 |
| Total | = | $27,405 |
Since they earned double the commission, they would need to help someone buy 4 of these condos a year to surpass $100,000 in commission before expenses. Sidenote, since its a new build, the buyer will pay 5% GST in B.C.(In other provinces GST or HST will apply) at a cost of $34,150. When you buy an existing home, it is not subject to sales tax.
How Much are Real Estate Agent Expenses?
Critics of agent commissions tend to focus on the gross commission but that ignores significant agent expenses.
Oh yes, brands like RE/MAX and Colliers cost a lot of money. They sponsor the Home Show, run ads on HGTV, rent out beautiful offices, and charge agents 30% of their commission to pay for all of this.
Of course, there are also auto expenses for driving buyers around to open houses, other promotional expenses, and the fees paid to their network for referring customers to them.
If we factor 30% expenses into the equation, an agent needs to help a minimum of 11 people buy or sell a benchmark priced condo annually in order to break $100k in net before-tax income. That’s almost 1 per month.
What Agent Incentives Should You be Aware of?
Regardless of the strength of an agent’s ethics, there will always be a voice in the back of their head trying to influence them to do what is best for themselves. Sometimes what is good for an agent is also good for the buyer, but sometimes it’s not.
| Make More Money | Spend Less Effort |
|---|---|
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The buyer doesn’t pay the commission, but the buyer agent will get paid more if the buyer:
|
A buyer agent is paid the same whether the buyer visits 3 homes or 30. How realistic are HGTV shows where the buyer is presented with 3 options and must pick one before the end of the episode? The agent has an incentive to create a sense of urgency to your buying decision and gloss over problems with a home. The sooner you buy a home, the sooner they are paid. Likewise, a seller agent is paid roughly the same commission whether you sell in one week or 3 months, so they would rather you accept an offer sooner than later. |
What Behaviours Should You Look out for?
Agent incentives can lead to some unfortunate behaviours.
The eternal optimist
They never point out problems with the homes they show you. Whether the home needs a lot of work, it’s in a noisy location, or it’s in a rough neighbourhood, you’ll hear words like “needs some TLC”, “lively neighbourhood,” or it’s “gentrifying.” Yes, sometimes this is a way to buy a bargain but don’t feel that you should make an offer on every place you see.
In a survey conducted by Inman, a U.S. based trade magazine for agents, 60% of respondents felt that withholding critical information is a common occurrence. The commission structure in Canada resembles the U.S. so there is a real risk of the same behaviour here.
An agent may also under-represent the difficulty of obtaining a permit to move or install interior walls, plumbing, electrical or gas lines. They may make it sound easier than it is. As well, getting approval for changes from a strata council can be a political gauntlet.
Minimizing costs
An agent can casually minimize the impact of a higher-priced home. If a house is $30,000 over the buyer’s budget, an agent might say, “It’s only an extra $100 per month.”
Another might encourage the purchase of a more expensive home with a mortgage helper (A basement suite to rent out for example), even if you would be happier in a smaller home with more privacy and without the responsibility of being a landlord.
There is also a conflict of interest when you use a home inspector recommended by your agent. If this inspector wants to continue to get referrals from the agent, they will be tempted to report small problems but ignore big and expensive ones. These CBC News reports illustrate the worst-case scenario with examples from Kelowna and Toronto.
Most agents should recommend at least 3 options for a home inspector, but you need to keep in mind the inspectors get repeat business from the agent and will only deal with you once. That means there is still a potential for conflict.
A similar conflict exists with property appraisals and that is why lenders select the appraiser instead of the borrower or real estate agent.
The Upsell
The agent begins by showing homes that are within budget but need a LOT of work. Then suddenly the agent suggests looking at some beautiful homes that are well over budget. If the buyer raises the budget issue, the answer may be, “Well, it’s only 1 block out of our way, why don’t we look anyway?”.
Most buyers are trying to find good value so they should expect that many of the homes in their budget range will be unimpressive. Since the buyers are expressing disappointment with the homes seen so far, it is natural for an agent to recommend increasing the budget, not necessarily for a bigger commission. Buyers are often unrealistic about their budget, so the agent must show them what an extra $50,000 gets. But the extra $50,000 will also pay them an extra $1,000 commission.
If you are firm on your budget, then refuse to visit a home that’s listed above your maximum price.
Pressure tactics
Agents know that buying a home is often more of an emotional purchase than a rational one. How often do you hear about someone “falling in love with a home”?
Good agents will use this to the buyer’s advantage. As a buyer, your agent may help you lock down a home by applying pressure to the seller. Immediately after a property is listed, you make an offer with a tight deadline (e.g., 4 hours to accept or reject the offer). Since the seller hasn’t had a chance to gauge interest yet, they may be inclined to take the offer. Keep in mind the agent for the seller may also recommend it because they will get a commission without having to stage the home and host open houses.
It can also be used to disadvantage the buyer. Buyers often visit 15 to 20 houses over the course of a couple of months before they buy. As time passes and the number of open houses climbs, some agents may apply pressure. Have you ever arrived at a house while another potential buyer was touring it? Have you ever been sent a listing the night before a tour only to find the home sold before you had a chance to see it? While this can be a coincidence, sometimes agents will collaborate to intentionally double-book viewings and create a sense of urgency. Some will even surreptitiously ask a friend or colleague to pretend to be interested in the property you happen to be viewing. This is a really dirty tactic.
The most alarming behaviour involves an agent who arranges fake buyers to create a false bidding war so that the “true buyer”:
Feels competitive and wants to win the property from the “other buyers”
Offers more than they would if they believed there was less competition
TIP: This is a lot of money you’re dealing with. If your agent is making you feel uncomfortable you should end the relationship. You should never feel pressured when spending or selling for hundreds of thousands of dollars. Your agent is supposed to make you feel comfortable and confident you are making the right decision at the right value.
Values Matter
There are rules against unethical behaviour and agents can receive a written warning, a fine, or have their license revoked if they’re caught doing something unethical. Unfortunately, the proof is often hard to establish.
Some have argued that agents should earn lower commissions, but realistically very few agents are getting rich. According to BCREA there are approximately 25,000 licensees in British Columbia and in a given rear they sell roughly 100,000 existing homes and nearly 30,000 newly completed homes. If there is an agent on each side of a transaction, then the average agent completes 10 transactions per year. In truth, some agents are talented and do well while others don’t make much money at all. It’s unfair to try to compare commission incomes to salaries because commission income is never guaranteed.
To put the risk of this industry in perspective, between January and February 2018 the number of real estate transactions in Greater Vancouver dropped 20%. Even though prices stayed buoyant for buyers and sellers, there was 20% less income to be shared among agents from one month to the next. Being an agent can be a very tough job with unpredictable income, working weekends and evenings, and driving clients for hours from one house to another.
Mortgage Sandbox feels that more could be done to protect consumers from unethical practices. We have developed an easy to use, data-driven, matching tool that will connect Canadians with pre-screened, local, ethical real estate professionals who share their interests and values and have complementary ways of working.
