Why are real estate commissions 6%? – and why that’s about to change


Washington, DC
CNN
 — 

Here’s how paying for a real estate agent to sell your home has long been done: A seller hands a percentage of the sale price to their broker, who then splits it with the broker who brought the buyer.

The commission is typically between 5% and 6%, which is usually tens of thousands of dollars out of the seller’s proceeds. But the seller also factored that cost into what they listed their home for, so indirectly, the buyer is paying the cost, too.

How did that become the standard? And will this process continue?

Changes may soon be on the horizon for real estate commission rates after a Kansas City jury determined – in a $1.8 billion judgement in October – that commissions had been inflated and that brokerages and industry groups conspired to keep them that way. This landmark antitrust court case, along with similar lawsuits like it, could overhaul the standard 6% commission and who pays it.

A shift could allow home buyers and sellers to negotiate not only commission rates with brokers, but also who is responsible for paying them — the buyer or the seller. It’s already happening in New York City, where the fee structure is set to change on January 1.

Many thought the internet would eventually kill the 6% real estate commission. But it has yet to put much of a dent into the share home sellers pay, which is about double the percentage that is paid in other countries, according to a report on commissions from the Brookings Institution. Even as the ranks of stockbrokers and travel agents have dropped in recent years as commissions petered out, the number of real estate agents has grown and their typical commissions are bigger than ever as home prices have risen. That is largely because of the power of the National Association of Realtors, an influential lobbying group that represents 1.5 million real estate agents.

While the NAR is appealing the recent decision and emphasizes that its members’ commissions are always negotiable, there appear to be some emerging cracks in the current way a home is sold.

How real estate commissions work

Home sellers are usually on the hook for their real estate agent’s commission as well as for paying the agent that represents the buyer. Brokers typically split the commission, which, depending on the market, is usually between 5% and 6%.

A $500,000 home sale with a 6% commission means the seller pays their broker $30,000 upon settlement, which that agent splits with the buyer’s broker, so each side earns $15,000 on the sale. (There is an additional split on each side with the participating brokers sharing their cuts with the agents who inked the deal, so an agent’s actual pay is less than their side’s share of the the total commission.)

Real estate agents will tell you commissions are negotiable — and they are. And there are other models to sell a home including using flat-fee or discount brokers. But there are strong structural forces at play in the industry that keep many sellers from offering less than the typical 6%. Agents’ compensation is included when the home is listed on a regional database known as a multiple listing service, or MLS. Some MLSs will not allow a seller’s agent to list a property that offers nothing to the buyer’s agent.

Sellers may worry agents will “steer” them away from a home that will earn the agent less. And that fear is not unfounded.

A recent academic study of properties listed on Redfin found that agents who offered commissions that were less than the market rate for an area had less traffic and took much longer to sell.

“The people who are most hurt by this are sellers who offer going-rate commissions because they are worried about steering,” said Jordan Barry, a professor of law and taxation at the University of Southern California, and a co-author of the study. “For most homeowners, their house is by far their largest asset. Giving up 6% of the sale price in commissions is a real burden.”

A historic practice

The shared commission structure was set up in 1913 and appeared in the first Code of Ethics of the National Association of Real Estate Exchanges, which had been established five years earlier and later became the NAR.

A section of the code, entitled “Duties to Other Brokers,” stipulated that an agent should “always be ready and willing to divide the regular commission equally with any member of the Association who can produce a buyer for any client.”

The NAR’s current Code of Ethics (Article 3) allows commission sharing but does not require it.

Prospective buyers attend an open house at a home for sale in Larchmont, New York, on Sunday, Jan. 22, 2023.

Until the Supreme Court put a stop to it in 1950, commission rates were set in a schedule by regional boards of realtors. Boards specifically forbade undercutting the prevailing rate, which was climbing.

In the 1920s in the Boston area, for example, the typical commission rate was 2.5%, but by the 1940s it had reached 5%, according to a study published in November 2015.

Agents argued the commission rate was fair because they held access to the listings unavailable to the public on the MLS. Agents put their listings in the MLS databases where only other agents could see them. These databases were — and sometimes still are — managed by NAR member organizations.

In an update to members following the recent verdict, NAR said the possibility of commission sharing has “always has been in place to protect and serve the best interests of consumers, support market-driven pricing and advance business competition.”

A history of litigation

Tension over NAR’s gatekeeping for listings would again spill into more litigation in 2005, when the Department of Justice filed a civil antitrust lawsuit against NAR challenging policies and related rules that obstructed real estate brokers who used “innovative internet-based tools” to offer better services and lower costs. In a 2008 settlement with the DOJ, NAR-affiliated MLS were no longer allowed to withhold listings from brokers who serve customers online.

Broadening access to the MLS would later allow online property listing behemoths like Zillow and Redfin to flourish. But as the internet became a critical part of home shopping, the commission rate stayed constant even while home prices surged.

The median priced home in 1950 was $7,354 (about $93,000 adjusted for inflation), according to the US Census, making a 6% commission $441 (about $5,500 in 2023). By 2000, the median home price was $119,600 (about $215,000 in 2023), allowing agents to split a fee of $7,176 (about $12,800 in 2023.) In October, the median home price was $391,800, according to the NAR, and the 6% commission paid by a typical seller was $23,500.

Up next for NAR is an appeal of the $1.8 billion lawsuit from October, which won’t be decided anytime soon.

“Typically antitrust cases like this take about a decade,” said June Babiracki Barlow, the general counsel for the California Association of Realtors. But, she added, that “we’ve never seen a damage award this big.”

If the commission structure shifts to separating the commissions, it could mean big savings for home sellers because they’d only have to pay for their own agent. But it could make buying a home even more expensive because buyers would either have to pay out of pocket for representation or go without a broker, if they didn’t negotiate for the seller to pay the fee.

The rash of cases brought recently against the NAR and other brokerage firms may result in separating seller commissions, said Vasi Yiannoulis-Riva, a partner at the New York real estate team of international law firm Withersworldwide. She added that the changes could create more competition amongst agents, as well as having “a profound effect on how brokerage commissions are paid across the country.”

Changes already

Some incremental changes have already taken place in the way residential real estate is done, with some of the MLSs allowing a wider variety of commission arrangements to be represented in listings even before the verdict.

In August, Bright MLS, which covers markets in the Mid-Atlantic, changed its requirements so that listings could offer compensation of any percentage or amount for a buyer’s broker — including $0.

In October, the NAR said it is neither requiring nor encouraging MLSs to change their data fields to permit $0 fees, but they were advising that doing so would now comply with the NAR’s MLS policy, which was a change from prior policy.

In an indication of what may be coming for the rest of the country, the Real Estate Board of New York — New York City’s leading trade association — rolled out a new policy it called the “future of how residential real estate is transacted” that will decouple agents’ commissions and require any compensation for the buyer’s broker that is coming from the seller to come directly from that seller, not another broker.

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