Sharing commissions is a peculiarly REALTOR® thing. It is also one of the oldest practices in real estate. Real estate commissions have historically been paid only by sellers. Although other methods of payment exist in the industry today, commissions paid only by sellers continue to dominate. The seller pays tradition, and its continuance, are a consequence of a “sales” based approach to real estate services. If the industry continues to be more about client services than about sales, in the future you can expect tremendous changes in commissions and how they are shared.
Commissions are a transaction cost. No different than marketing costs, or taxes, repairs, insurance or any other transaction cost. Such costs are normally paid by the seller of goods. They are, of course, to the extent the market will bear, included in the price paid by the buyer. It is, therefore, no simple matter to allocate commission costs between buyer and seller in a transaction. About all that can be said is that the cost is assessed to the seller who will, to the extent possible, try to recapture those costs from the buyer.
This background understanding of commissions is critical to understanding commission sharing. Sellers hire brokers to market the property, find a buyer and help close the deal. How much a seller is willing to pay a broker for those services, all things being equal, depends on the market for such services. Supply, in the form of number of brokers providing services, and demand, in the form of sellers seeking service, will set the commission rate. It will not, however, determine the structure of the real estate service market.
The structure of the real estate service market will tend, like all markets, to be driven by efficiency. Efficiency is a way to lower costs and thus capture market share. As in any business, there are economies of scale. Sure, every market will have its niches where special abilities or circumstances create opportunities for small operators but, generally, size matters in markets.
Real estate has, until very recently, been a “mom and pop” or “cottage” industry. “Mom and pop” industries are made up of many small operators. Small operators lose potential business simply because they do not have the resources or personnel to provide the services necessary to capture or sustain a larger market share. If you apply these economic ideas to the real estate industry, you will see that commission sharing is simply a mutual help program intended to increase total volume in a particular market.
Brokers offer to share the commission they earn from the seller with other brokers because they believe that at the end of the day they will make more money by sharing commissions than they would make if they serviced every potential client or customer themselves. Suppose, by way of example, an individual broker-owner can close twenty transactions a year by working alone. In the parlance of the industry, that is forty “sides.” If the market is such that by sharing half his commission the broker can get more than forty sides a year, then that broker will cooperate and share commissions. Modern franchise companies, who run “in-house” numbers well above fifty percent, are beginning to reassess commission sharing.
In the past, the “mom and pop” structure of the real estate services market was such that commission sharing was of huge economic benefit to almost every real estate service provider. The only problem with this kind of economic “bootstrapping” is the transaction costs associated with creating cooperation among many small brokers. Those costs include the cost of sharing the information necessary to make cooperation possible and the cost associated with negotiating commission sharing agreements repeatedly among many different parties.
Cooperation transaction costs are managed in the real estate industry by creating multiple listing services (MLS). An MLS is nothing more than a vehicle to make possible cooperation and commission sharing among competing brokers. The fees paid by brokers to multiple listing services are a measure of the actual cost of cooperation. As long as the cost of MLS services does not exceed the total benefit the broker gains from cooperation MLS services will remain central to the practice of real estate. Cooperation and commission sharing will last exactly as long as it continues to be true that the majority of real estate service market participants make more money sharing commissions than would not sharing commissions.
Many of the difficult issues in the real estate industry today revolve around the economics that have structured the existing market in real estate services. The rise of large franchise offices and the reduction of transaction costs made possible by modern communication and computer technology are putting tremendous pressure on the existing structure. It is hardly surprising that at the center of these pressures is the MLS. Every change in MLS operations and rules reflects real changes in the real estate services market. A wise participant in the market will consider these changes in the context of the basic economics of commission sharing.
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