Why the NAR Settlement Might Favor Sellers of High-Priced Homes

The violinists in an orchestra generally all spend the same time in rehearsals. The musicians’ union establishes the minimum amount they must be paid for this time.

That doesn’t mean all violinists in an orchestra make the same amount. For instance, the union contract specifies that section leaders and concertmasters must be paid an additional amount for the extra responsibility involved in serving in those positions.

The pay differential among orchestra violinists doesn’t end there, however. Although many violinists compete to obtain orchestra positions, orchestras sometimes compete to woo a violinist. A violinist who is in demand as a concertmaster can make well over $250,000 per year in a full-time orchestra. But a recent report reveals that the average pay for a full-time orchestra musician is only $70,000.

Concertmasters must determine bowings in the music and sometimes play solos, so they have a few more responsibilities than section violinists. However, the vast differences between the concertmaster’s and section member’s hourly rate aren't due to the concertmaster spending more than triple the time. Instead, the concertmaster's higher hourly rate is attributable to perceived skill, experience as a concertmaster, reputation, or name recognition.

How Residential Real Estate Commissions Work

Suppose we compare how orchestra violinists are paid to how residential real estate agents are paid. In contrast to violinists, who must spend a fixed amount of time in rehearsals and concerts, real estate agents receive the same compensation for selling a home—no matter how much time they spend on the sale.

Real estate agents' compensation is based on a percentage of the home's sale price. Although a highly skilled agent might obtain a top sale price, there is a ceiling on how much a homebuyer will pay. The real estate market also establishes a floor on the sale price of a home in a specific location. So, a real estate agent with limited experience or skill is guaranteed a minimum compensation if the house is sold.

Let's assume an agent requires at least 50 hours to sell a home, regardless of location or condition. The new home in a desirable neighborhood might sell for $950,000 without the agent needing to procure the sale. The agent still may invest an additional 25 hours with open houses and pay a designer $1,000 to advise the owner what renovations and staging will help get a higher price, let's say $1 Million,

For a fixer-upper in a less desirable neighborhood, the agent might not hold open houses or recommend renovating or staging the home. However, the agent may have to show the home many more times and deal with contracts that fall through due to financing issues, which could double the time the agent must spend selling the home. That home might sell for $150,000 with the agent spending 100 hours to finalize the sale.

Continuing with our example, if both agents receive a 5.5% commission, the seller would pay the agent $55,000 for 75 hours of work and the agent's out-of-pocket $1,000 expense. The second agent would receive only $8,250 for 100 hours of work, a fraction of the first agent's hourly rate. Both agents’ commissions could be reduced any commission seller agrees to pay to a buyer’s broker.

It’s important to remember that these are hypotheticals. Although the 5.5% commission is in the range of a recently reported national average (of combined buyer and seller commissions), commissions vary, and some sellers (particularly those with multi-million dollar homes) negotiate lower rates.  

These hypotheticals also aren’t based on the actual data about the time involved in selling a home. These examples also don’t consider the time agents spend showing homes that don't result in a sale, nor do they consider the time agents spend developing and maintaining market expertise and building relationships.

How Commercial Real Estate Commissions Work

Although the hourly rates in this residential real estate commission example may not reflect the actual hourly compensation of real estate agents, the discrepancy between compensation for selling high- versus low-priced homes exists. This discrepancy reveals something that the commercial real estate commissions have reflected for some time—that it can take as much or more time to sell an undesirable property as a desirable one.

Commercial real estate commissions weren’t included in the recent lawsuits—possibly because those commissions generally are negotiated. As a result, commercial real estate commissions better reflect the seller's bargaining power and the work involved in completing a sale.

A commercial real estate agent might agree to a commission of only 1% or 1.5% for selling a $40 Million, 300-unit  apartment complex that is 95% occupied – a high-profile sale with a seller that likely has significant bargaining power with brokers lined up seeking access to the listing. However, the same agent could insist on an 8% or 10% commission to accept the listing for a $2 Million, eight-unit residential building that is half empty. That seller would have less bargaining power, and brokers might not be as interested in the listing.

Some commercial agents charge a graduated commission for high-priced properties. For example, suppose the property's estimated value is $40 Million. In that case, the broker might receive 1.25% for the first $40 Million in sale price, 1.5% for any additional sale price up to $45 Million, and 1.75% for any amount over $45 Million to incentivize the broker to maximize the sale price.

How the NAR Settlement Could Affect Residential Buyer Broker Commissions

Recently, the National Association of Realtors (NAR) settled a lawsuit that objected to what functionally has been a fixed percentage commission for all home sales. Further, established practices have bundled buyer's agent and seller's agent commissions and required that the seller pay both commissions.

Proponents of the settlement celebrate allowing the free market to establish commission rates and forecast that by introducing competition and the possibility of negotiating commissions, commissions will decrease.

Others note that many buyers cannot afford to pay their own agents. So, unbundling the commissions will discourage buyers from hiring agents and broaden the information gap and negotiating power between sellers, who will have agents, and buyers, who must go it alone.

Those commentators suggest that the buyers most likely to forego buyer's brokers may be first-time homebuyers who can only barely scrape together the downpayment. So, these inexperienced homebuyers, who most need professional assistance, will be those least likely to obtain it.

Many predict seller commissions will decrease and brokers may move to a "menu" of services. Additionally, residential brokers may move to a negotiated commission structure like that used by commercial brokers for years. If so, sellers of low-priced properties would pay a higher commission percentage than those selling high-priced properties.

Some believe the discrepancy in hourly rates among residential brokers isn't justified and would claim that under the current commission structure, sellers of expensive homes have been subsidizing the actual cost of selling starter homes.

Residential Commissions as a “Menu” of Services

Returning to our orchestra example, violinists must compete to become concertmaster based on skill.

Once selected, the concertmaster and the orchestra may negotiate services and compensation. For instance, in addition to regular concertmaster duties, the violinist may be asked to perform in chamber music at orchestra fundraisers, meet with donors, or play a concerto with the orchestra.

A concertmaster who is in demand due to their reputation will fare better in those negotiations than one who is less well-known. After all, there may be a dozen other nearly comparable violinists who would be happy to accept the position.

Applying this example to residential real estate brokers, some agents already get work based on reputation and a history of achieving top sale prices for sellers. Regarding the scope of services, some "discount brokers" already provide only a limited "menu" of services. For example, a broker might offer a reduced commission for listing a home on an MLS, but that broker won’t schedule open houses or help with staging.

From an antitrust perspective, the primary purpose of the NAR settlement is to increase competition and allow for the negotiation of prices and unbundling of services. Creating a “menu” so sellers can select only the services they want furthers these goals and enables sellers to purchase unlicensed services (e.g., staging) from a vendor they choose.

Residential Commissions as a Graduated Commissions Scale

The NAR settlement likely also will introduce more competition into the residential real estate industry. For example, brokers with more experience and a stellar reputation may demand higher commissions than those recently entering the industry.

Although sellers should have more leverage to negotiate commissions, the result may not favor everyone. Going back to our commission example, there likely still will be a minimum amount of time it takes for an agent to sell a house. So, as long as commissions are based solely on the sale price, lower-priced homes will yield less broker compensation than higher-priced homes with the same sales commission percentage.

So, residential brokers may adopt commission structures from the commercial real estate industry, resulting in graduated commission structures that lower the effective commission percentage only for higher-priced homes. Suppose a broker decides the minimum commission amount that makes it worth their time to accept a listing is $8,000. On top of that, the broker asks for a 2% commission on the sale price – a percentage significantly lower than the approximately 5.5% reported current average.

With that commission structure, the seller of the $150,000 home in our example will pay a total commission of $11,000 ($8,000 minimum plus 2% of $150,000 or $3,000). Under this scenario, this unbundled commission structure would produce a 7.3% commission, $2,750 more than the $8,250 commission under the 5.5% commission structure. And if paid by the seller, any buyer broker commission might be added to the total. This seller might opt to pay only the $8,000 for the minimum services to keep costs down. Their commission would decrease, but so would the services they receive.

However, under this commission structure, the seller of the $1 Million home would pay only $28,000 ($8,000 minimum plus 2% of $1 Million or $20,000) – an effective commission of only 2.8%, which represents a $27,000 savings over the higher, hypothetical 5.5% commission structure. But suppose the seller of the $1 Million home takes a lesson from commercial real estate sellers and negotiates a 2% commission for the broker to obtain the privilege of selling that higher-priced home. That would bring the commission on the $1 Million sale down to $26,000 ($8,000 minimum plus 1.5% of $1 Million or $15,000).

Even if the seller agreed to pay an additional 1.5% ($15,000) to a buyer’s broker, both of these hypothetical sales would produce total commissions lower than the hypothetical 5.5% rate in the first hypothetical.

Conclusion

The NAR settlement is designed to bring a free market to residential real estate commissions. It may come that brokers must compete for positions like concertmasters. Those who are selected still may need to negotiate their commission terms.

Just as there are few superstar concertmasters, there are few superstar brokers. Like most violinists seeking concertmaster jobs, most brokers will have only limited negotiating power. And as with orchestras, there will be highly desirable listings that brokers will compete to obtain.

Although the examples in this article are speculative, they reflect pricing structures that developed through competition and a largely free market in the commercial real estate market. Should the residential real estate market respond similarly, individuals selling higher-priced homes are likely to have the most desirable listings and, therefore, benefit the most from the NAR settlement.

© 2024 by Elizabeth A. Whitman

Any references clients and their legal situations have been modified to protect client confidentiality

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