Real estate commissions can create perverse incentives Iowa

Realty commissions are among the best-kept secrets in home sales, perhaps because the subject is akin to asking brokers and agents how much money they make and, like most people, they consider their own income to be a private matter.

Yet savvy home buyers should educate themselves about commissions and ask questions that are pertinent to their own situation. The commission may provide the brokers’ and agents’ incomes, but the buyer brings the money to pay that commission to the deal.

Brokers and agents are compensated only when someone buys a home. That means if an agent shows you 10, 20 or 200 houses, but you never buy one, he or she will have invested a lot of time and effort for no reward.

This reality places intense pressure on agents, who sometimes transfer that pressure to buyers. A good agent should allow you to make decisions without undue pressure since otherwise you might be too petrified to act or you might experience deal-breaking buyer’s remorse afterwards.

(If you don’t know how commissions work, read more about real estate broker and agent commissions.)

An agent probably won’t pressure you to buy a more expensive house than you can afford just to earn a bigger commission since the additional compensation wouldn’t outweigh the risk that you might not buy a home at all.

An example illustrates this point:

House price: $250,000
Offer to cooperating broker*: 3 percent
Agent’s split: 65 percent
Agent’s compensation: $4,875

House price: $255,000
Offer to cooperating broker: 3 percent
Agent’s split: 65 percent
Agent’s compensation: $4,972
Additional compensation for $5,000 higher price: $97

House price: $260,000
Offer to cooperating broker: 3 percent
Agent’s split: 65 percent
Agent’s compensation: $5,070
Additional compensation for $10,000 higher price: $195

* Remember, the listing (seller’s) broker offers a share of the commission to the cooperating (buyer’s) broker and each agent earns a split of the broker’s share.

However, the compensation system can create an incentive for agents to prioritize the sale of houses for which sellers have agreed to pay larger commissions and listing brokers have offered larger shares of those commissions.

Again, an example illustrates this point:

House price: $250,000
Commission: 4 percent
Offer to cooperating broker: 2 percent
Agent’s split: 65 percent
Agent’s compensation: $3,250

House price: $250,000
Commission: 5 percent
Offer to cooperating broker: 2.5 percent
Agent’s split: 65 percent
Agent’s compensation: $4,062
Additional compensation for .5 percent higher share: $812

House price: $250,000
Commission: 5 percent
Offer to cooperating broker: 3 percent
Agent’s split: 65 percent
Agent’s compensation: $4,875
Additional compensation for 1 percent higher share: $1,625

A practice of showing a buyer only higher-commission houses violates some industry ethics codes, and most agents are honest dealers who would rather sell a house and earn a lower commission than not sell a house and earn no commission. For those reasons, this practice doesn’t occur as often as it otherwise might. But not often doesn’t mean never.

Some sellers, listing agents and builders add a cash bonus or other incentive to sweeten the cooperating agent’s compensation. A bonus doesn’t necessarily mean you shouldn’t buy that house, but you might want to know an incentive is part of the deal. Ask your agent whether an incentive has been offered on any of the homes you’ve been shown.

The best protection against realty commission shenanigans is to interview several agents and choose someone who you feel is trustworthy and whose reputation is beyond reproach.