Question Details

Tom, Home Buyer in Orange County, CA

Why do agents have a compensation structure so mis-aligned to client interest?

Asked by Tom, Orange County, CA Mon Oct 29, 2007

The conflict is that a real estate agent, espec in a busy market, has incentive to have high deal flow at the expense of deal quality.

Example: You are selling a house and have 30% equity. A talented realtor can easily cause your house to sell for 10% more... But this requires a lot more effort than an MLS entry and a few phone calls.

Suppose they spend 50% more effort on your deal to boost your sale price 10%, but then they do fewer other deals. Unfortunately, this 10% sale rise to the client above (after sale costs) comes out to a 40-50% increases in their capital gain on the sale! This is a significant misalignment of incentives -- the agent wants ANY deal and ASAP, the client wants a good one.

The buyers agent situation is even worse. They have the same issue as above, but get LESS pay for doing a good job and getting a low price.

Are there any alternative compensation schemes that are being successfully used for agents that better align client/agent interest?

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Answers

9
Tom,

The real estate process is a lot more complex than most people think. I find your comment that "a talented realtor can easily cause your house to sell for 10% more..." If that were the case, why wouldn't they? A professional in this business knows they have certain obligations to their client (and when I say "professional", I'm talking specifically about those agents (and there are many of them) who KNOW their license law, who take their fiduciary responsiblities to their clients...be they seller or buyer clients...very seriously, and who go to great lengths to help put together the best "package" for their cllient. I am NOT talking about the "Slick Willies" who, unfortunately, appear in every profession, including ours, and who are in it for the "fast buck". There IS a difference!

While it's easy (and human nature) to focus on a sales price, we, as agents, have to insure that our clients understand the WHOLE offer...not just the price...and how the components of that offer fit (or don't) with that seller's specific situation. For example, seller has property on the market for $200,000. Seller has basically outgrown current home and is looking to upgrade. Market prices are rising, and while seller's home's value is increasing over time, SO IS THE PRICING OF THE MORE EXPENSIVE LARGER HOME THAT SELLER WANTS TO PURCHASE. In this case, seller is "motivated", though not "distressed"...factors that the agent must consider when advising the seller.

Now, two offers do come across the table for the seller to consider. For the sake of arguement, let's say that the lenders of both buyers confirm that those respective buyers are well qualified do perform according to the terms of their contracts...which is certainly another major component that the agent must evaluate. Offer #1 comes in at $200,000 - buyer has home to sell which is not yet on the market, will be putting 5% down, offers $1,000 earnest money, wants seller to pay $2,000 toward buyer's closing costs, asks for 60 days to sell their home, with anticipated closing on both properties 45 days later. Offer #2 comes in at $194,000 - buyer has no home to sell or close on, has 15% down, offers $3,500 earnest money, is flexible with their close date so will agree to close in a timeframe most desireable to the seller.

As agents we must point out risks and befits of each component of the offer to our seller. Is a full price offer desireable? Absolutely!!! HOWEVER, what if the home that buyer has to sell DOESN'T sell? It's not even on the market. How much are they going to ask for THEIR home? How SALEABLE is it compared to the seller's home? If that buyer's home doesn't sell, the seller DOESN'T have $200,000...he has NOTHING.

Now, in the case of the buyer #2...the price isn't as good. BUT, the buyer is more of a "sure thing"...he can close when the seller wants, higher down-payment and earnest money (which are "indicators" to the seller as to how motivated and serious the buyer is about making this purchase). And also remember that, as time passes and seller's home is increasing in value, SO IS WHAT THEY WANT TO BUY. At $200,000, a 5% increase is $10,000. If seller is buying "up" 25%, for example (and not at all unrealistic), what started as a $250,000 home could also increast that 5%, or $12,500. In other words, gap between what the seller HAS and what the seller WANTS has just gotten LARGER!

If that seller has selected a particular property they would like to buy, how much is the SECURITY of a non-contingent sale to a qualified buyer in a favorable timeframe worth to that seller? The answer is different for each seller. The important thing is that their agents must help them understand the terms being offered, and the implications of those terms (both positive and negative), so the seller can make an INFORMED DECISION.
2 votes Thank Flag Link Mon Oct 29, 2007
Tom. Your question is whether there are alternative compensation schemes that are successfully implemented. Not in the U.S., to my knowledge. I suggest that buyers start paying their own agent based on the amount of time that the agent spends with the buyer. That way buyers can hop from agent to agent all they want as they'll still have to pay for each agent's time. You pay as you go, sounds fair to me. If buyers pay their own commissions, then sellers can negotiate the compensation with the listing agent separately and the commission that the buyer pays is not pre-determined. This will also eliminate the problem of wasting time with buyers who never buy or who just use one agent to look at other properties and then have a realtor friend or relative write up the offer. The way things are now, all the transactions that close have to pay for those that don't close because we don't get paid when escrow does not close. When you go to the doctor you pay whether the doctor can help you or not. Believe, if you'd only pay if the operation is successful, the cost of surgery would skyrocket. Perhaps, if buyers pay their own commissions, they'll want to pay a lower price to make up for the commissions that they have already paid to their agent(s).

Please don't forget that there's no law that requires a seller to hire an agent . Most sellers who have tried and failed at selling their own home have a much better appreciation for what real estate agents do. There's no amount of telling someone that can make up for that experience.

Lets face it , nobody wants to pay for services. Nobody wants to pay for an attorney and most people don't like attorneys until they need one and the attorney helps them out of a bind or keeps them out of jail. Then, all of a sudden the attorney becomes the hero.

You may also want to check how things are done in Europe. It's my understanding that the commission iseven higher than in the U.S.
Web Reference: http://www.theMLShub.com
1 vote Thank Flag Link Mon Oct 29, 2007
Ute Ferdig -…, Real Estate Pro in Newcastle, CA
MVP'08
Contact
Great Question Tom. As with many other things in life it is all subjective. Meaning it is really hard to answer a generalized question with a quality answer without understanding your actual market. All systems have flaws, and that being said there are always exceptions to every rule. I the system of real estate commission is tried and proven effective for a very long time. Many other systems of flat rates, and discount brokers have spurred up, and not many have gained ground.

I see that as a message in itself, believe me the consumer changes how we all do business. If there were a great enough demand a new system will be being built. The fact remains that with so many agents available to you as a consumer, it is your job to hire the best one that fits your criteria. It is not the structure of commission that is in question. It is your ability as a consumer, to hire those that you see fit to execute your plan on adding value to your listing with time and effort.

There are alot of successful agents that are able to add value and market your house 10% higher without putting 50% more effort. It is just really hard to find alot of them. But they are out there, and busier than ever even in a market like this.
1 vote Thank Flag Link Mon Oct 29, 2007
Tom wrote:
I think there might be better options for sellers, such as a sloping commission that accelerates to higher values if the specific property goes over some value -- i.e. 2% for up to a market price, 20% of everything after that, but that alone has massive issues too, mostly of trust in getting the right valuation in the first place. So it seems very difficult to develop a good system for that.
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20% for everything OVER market price? Market price is what the public thinks the house is worth. I think you mean ASKING PRICE. It isn't' the realtor's fault a particular house doesn't sell for listing price. Not sure how it is in other states but paying the realtor more for getting over a certain price in NY state is considered a "net" listing and is illegal.
0 votes Thank Flag Link Tue Oct 30, 2007
Tom:
I posted this question two months ago and was pleased with the responses:
http://www.trulia.com/voices/Market_Conditions/Should_the_Re…

Then recently I've seen a trend with agents not wanting to present "low" (in their opinion) offers and some consumers like you bringing up interesting issues about the other costs associated with the final sales price. For example, capital gains tax, transfer or revenue tax, property tax and commission.

I know I was very upset 4 years ago when we negotiated a much lower sales price than anticipated but figured we just would NOT give them a credit for the roof after the home inspector would say it needed to be replaced within the next year (no leaks though). Even though we were offering a home warranty on a beautifully rehabbed home, we sold them the house "as-is" meaning that they couldn't negotiate after the home inspection. Well, we had to renegotiate anyway. The home inspections have just become another negotiating tool. I was so mad when I learned that the bank required that $10k credit to be deducted from the sales price (instead of put in escrow and paid directly to the roofers) and yet I still had to pay commission on the original contract sales price of the $10K more. So in reality, the roof cost me $10,500 not counting transfer and capital gains tax.

My current situation is one where the property taxes are extremely high (the home has been overvalued) and will be lowered as a direct result of the sales price. Should the home owner be paying property taxes on $35,000 worth of commission, $5000 in buyers incentive and another $x amount for the home inspection credit every year?

Yes, the system is messed up. I do apologize that I have not taken the time to read the other posts. I will come back and comment on those later. I just doubt that I repeated what anyone else would have said.
Ruth
0 votes Thank Flag Link Mon Oct 29, 2007
Ruthless, Other/Just Looking in 60558
MVP'08
Thanks for the answers. My opinion, despite my post, is that the commission system is bad, but it's better than the alternatives, so it's the right system to have.

I think there might be better options for sellers, such as a sloping commission that accelerates to higher values if the specific property goes over some value -- i.e. 2% for up to a market price, 20% of everything after that, but that alone has massive issues too, mostly of trust in getting the right valuation in the first place. So it seems very difficult to develop a good system for that.
0 votes Thank Flag Link Mon Oct 29, 2007
Tom
I appreciate your points. Before I was in the business I would have felt similar to your post.
From my perspective now I believe the value that a Realtor brings clients is primarily twofold:
1) Knowing the market, which includes the inventory and the current market trends. This provides the Realtor with the key concept of value: what is a property worth?:
2) The ability to negotiate a fair deal. It has been written that the fairest deal is made when both parties would like more, however they will settle for what they agreed. A good Realtor more than pays for their compensation in the negotiating phase of a transaction. Keeping their client out of legal liability, keeping the transaction on track, with all commitments being kept by all parties, and all pertinent facts being disclosed are priceless commodities until something goes wrong. Then, all of a sudden, they have a pricetag. Someone needs to provide advice to help the transaction to successfully close.

I hope this point of view is helpful.
0 votes Thank Flag Link Mon Oct 29, 2007
Keith Sorem, Real Estate Pro in Glendale, CA
MVP'08
Contact
Tom,
First off, I think you are giving agents too much leverage. I don't believe that there is a correlation between the amount of money an agent spends and how much a house sells for. If there is a study done, please someone provide those stats! I spend a fortune on advertising and go above and beyond what most agents do. I can tell you over and over again that it is the PRICING that sells a house. All the advertising in the world won't sell an overpriced house.
Agents don't want any deal, they want the one that is based on market comparative sales. The client wanting a "good one" may mean an unrealistic expectation on the value of the house. Furthermore, it is always the seller's decision of whether or not to accept an offer. The motivation of the seller has a lot to do with what offer they will accept, but the bottom line is what is the seller willing to sell for.
Buyers agents may get less pay for a deal (depending on the split decided by the listing agent) but they also do not have the advertising expense involved. A buyers agent is to get the best price for their buyer. But the listing agent's job is to get the most money for their seller.
Web Reference: http://www.dianeglander.com
0 votes Thank Flag Link Mon Oct 29, 2007
I'm not really sure I understand your question, Tom, but it appears you are frustrated by the pay structure for real estate agents. From the other questions I read from you, I'm not sure you understand what is involved with marketing a home or even with being an agent. I will agree with one thing that (I think) you said above, though. Wouldn't you agree that selling your house has got to be a win-win situation for both of us? You get to sell your house for the most money, in the shortest time, with as little discomfort as possible....and I get to have a chance to be reimbursed for the time and money I put into the house's marketing.
0 votes Thank Flag Link Mon Oct 29, 2007
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