Understanding the New Compensation Structure in Real Estate Transactions: An Explainer for Our Clients

We wanted to explain to you the issues that have developed with the new compensation systems in real estate transactions. Because of a recent litigation settlement by the National Association of REALTORS, all brokers have had to make some changes in the way that we structure compensation for services to our clients.

First, though, we wanted to tell you what has NOT changed. At Howard Hanna, we have always prided ourselves on providing all our clients — whether they are buyers, sellers, tenants, or landlords – with true fiduciary representation of their best interests. What does that mean?

We always act in your best interests to get you the most favorable deal possible.
We are always loyal to you over anyone else in a transaction.
We keep all your private information confidential.
We fully disclose anything we know about your deal to you.
We obey you when you direct or instruct us.
We keep careful accounts of any monies you entrust to us.

None of this is changing. We have always acted in your best interests, and we will always do so.

So what is changing? Simply put, what’s changing is how we get paid for our services. Traditionally, listing brokers signed agreements with sellers providing that the seller would pay the broker a commission when and if the house sold, usually a percentage of the selling price. Then, to market the home to the rest of the local brokerage industry, the listing brokers would make an “offer of compensation” to agents representing buyers, offering to split that commission with the buyer agents if they successfully helped sell the home. The commission would then normally be paid out of the proceeds of the sale – the buyer and the buyer’s lender would give the seller the purchase price for the home, and the seller would take the commission out of those proceeds and pay both the listing broker and the buyer’s broker.

But the system had some problems that have now been addressed. One problem was that the National Association of REALTORS, through the local MLS, mandated that sellers make an offer of compensation to buyer agents. The sellers didn’t have a choice. They had to offer something. Conversely, buyers had limited choices as well, because they never had a direct opportunity to negotiate the commission for their buyer’s agent. The “offer of compensation” to buyer agents was decided by the seller and the listing broker in their contract, before anyone even knew who the buyer would be. Maybe the buyer didn’t want to pay their buyer agent as much as the seller was offering – they didn ‘t have that choice.

Indeed, buyers sometimes misunderstood that the services they received from their buyer’s agent – fiduciary advice and confidentiality, screening properties, scheduling and guiding showings, negotiating the deal, and managing the transaction through the closing – they misunderstood that all those services were free, since they didn’t have to pay “out-of-pocket” for them. But they still paid for those services; they just paid them through the seller out of the proceeds of the sale.

That’s part of what those lawsuits were about – giving buyers and sellers more choices and more clarity about their compensation arrangements with their agents. And that’s what the settlement now provides. Accordingly, starting this summer, you’re going to have some new choices to make, whether you’re a buyer or a seller. If you’re a buyer, you can decide how you wish to compensate your buyer agent. And if you’re a seller, you can decide whether you’re going to make an offer of compensation to buyer’s agents – and how much to offer.

So what should you think about when making those choices?

For Buyers

If you’re a buyer, you should think your options for paying your buyer’s agent. The one benefit of the old system was that the commissions were all paid out of the proceeds of the sale. Buyers paid compensation to their buyer’s agent, but they almost never had to come “out of pocket.”. Instead, they essentially got to finance that commission over 30 years through their mortgage. They paid the seller the purchase price, and the seller took part of that purchase price and paid the agents. Now, with the system changing, you need to understand the options in front of you.

So what do you need to know now?

First, you will need to sign a representation agreement with your buyer’s agent. Under the settlement, the agreement is now a legal requirement, because we now need to confirm the terms of our representation of your interests. In that agreement, we’ll disclose our legal obligations to you, and the limits of our representation, and you’ll be able to negotiate the compensation terms directly with your agent. After all, your agent still deserves to get paid for the services they’re providing to you even if the seller isn’t making an unconditional offer of compensation.

Second, you should be aware that you don’t necessarily have to come out of pocket to pay your agent. We realize that most buyers take on a lot of financial obligations when they purchase a home, and might have difficulty paying that buyer agent compensation directly. But your agent will use every effort to structure your deal so that you can pay that compensation out of the proceeds of the deal, rather than coming out of pocket.

We can do that in one of two ways:

We believe many sellers are going to continue to make offers of compensation to buyer’s agents. Even though the offer is no longer required, most sellers understand how tough it is for buyers to come out of pocket for the buyer side compensation, and they’ll offer a concession to take that obligation off your hands. It’s no different than if they offered to pay some points toward reducing your mortgage rate, or if they threw in furniture, or any other concession – the seller is allowed to offer you attractive terms for buying the home. And picking up the cost of your buyer’s agent is a very attractive term.

If the seller is not offering compensation, we can still shift your obligation to the seller in the offer to purchase. We just need to make your offer conditional on the seller paying your buyer agent’s compensation. For example, an offer of $500,000 where you have a 3% (as an example) buyer agent compensation obligation would become an offer of roughly $515,000, with the seller rebating $15,000 back to you as a concession to pay your buyer’s agent. It’s the same offer, just structured to allow you to roll the commission into the purchase price and finance it with your loan – rather than come out of pocket. Indeed, these “conditional offers” are likely to become common practice in the industry, to prevent situations where buyers refuse to consider homes that don’t make offers of compensation because they don’t want to have to come out of pocket to pay their agent.

Third, we want to warn you about foregoing a buyer’s agent and purchasing directly from the listing agent. We know that some of our clients are going to consider doing this, because they think they might save some money. That’s your choice, but just realize what you’re giving up. When you have a buyer’s agent, particularly with Howard Hanna, you get a fiduciary representative who is legally required to look out for your best interests, to get you the best possible terms on your deal, to give you the best possible experience. These are the same types of fiduciary duties that you get from attorneys.

Just remember that if you go directly to the listing agents on a property, you’re going to be totally unrepresented. No one is working for you. Listing agents are fiduciaries of the seller. They’re legally required to get the best possible deal for their seller, not for you. That’s their job. You might be thinking that you’re saving money not hiring a buyer’s agent, but you never know how much a great agent could save you through negotiating the purchase price, handling problems with the inspection, overcoming transactional delays, and managing all the other complicated aspects of home purchases.

That’s why we really recommend that you hire a buyer’s agent when you’re purchasing a home. If you don’t have a buyer’s agent, then buying a house is like buying a car. Think about it:

First, when you buy a car, you don’t have someone who can take you to see everything on the market. Instead, you have to go from dealer to dealer, all by yourself, without anyone to help you screen and sort your preferences.

Second, when you’re negotiating the price of the car, you get zero information about what similar cars have sold for. You’re flying blind. But when you buy a home, your agent can get you all the information on any recent relevant sales in the market, so you can prepare the right offer.

Finally, at every dealership, you don’t get someone who’s your fiduciary to represent you. Far from it — you’re working directly with someone whose job it is to make the best possible deal for their boss. And you’re not their boss!

Yes, you can work on your own. But why would you do that to yourself?

For Sellers

If you’re a seller, you can decide whether you’re going to make an offer of compensation to buyer’s agents – and how much to offer. You don’t have to offer anything if you don’t want to. But as we discuss earlier in relation to buyer options, you might find that making an concession to buyers to cover the costs of their buyer agents will be an attractive feature. If you don’t pay the buyer agent’s compensation out of the proceeds of the sale, then that buyer will have to come out of pocket to pay their agent, which might be difficult for buyers who are already stretching to come up with a down payment, lender’s fees, and other closing costs.

That’s why you should strongly consider making an offer of compensation. It’s just an attractive feature you might offer a buyer to incentivize them to make an offer, similar to concessions like paying for some closing costs, paying down a mortgage so they can get a better rate, throwing in furniture, and things like that.

Indeed, even if you don’t make an offer of compensation, you might find that buyers will present offers that are contingent on you covering their obligation to pay their buyer’s agent. For example, if you’re not making an offer of compensation, a buyer who has a buyer agreement requiring them to pay their buyer agent 3% (as an example) might be willing to pay $500,000 for your home, but they’ll structure their offer so that it’s roughly for $515,000, with a condition that you pay that 3% or make a $15,000 concession to them in the purchase price. It’s the same offer, just structured to allow them to roll the commission into the purchase price and finance it with their loan – rather than come out of pocket. Indeed, these “conditional offers” are likely to become common practice in the industry, to ensure that buyers who don’t want to come out of pocket to pay their agents will still consider listings that do not make offers of compensation.

Conclusion

Finally, two last thoughts we wanted to share. First, we want you to know all commissions, whether on the list side or the buy side, are fully negotiable. They’re not set by state law, or by the industry. You are free to negotiate them with either your listing or your buyer agent.

Second, we want you to know that all our agents are always going to provide you with fiduciary representation, looking out for your best interests and working to get you your best deal possible. You deserve nothing less, so don’t accept anything less.

We hope you found this explainer helpful. If you have any further questions, you should ask your Howard Hanna agent, or get in touch with us at our corporate headquarters. Thank you for giving us the opportunity to work with you on your purchase, or sale, of your home.