Table of Contents
Sharing Commissions
The Economics of Commission Sharing
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.
return to top Typical Commission Sharing Issues
Commission Sharing Agreements
Commission sharing is central to the day to day practice of real estate in the existing real estate services market. Central to commission sharing are multiple listing services. That is the case because it is through the MLS that individual market participants share commissions. Commission sharing is a matter of contract. It has nothing to do with license status, which represented whom, procuring cause or anything else. Being the “procuring cause” is relevant only if you can point to a contract in which someone promises to pay you for being the procuring cause.
Listing brokers point to their listing agreement with the seller to establish the legal right to a commission upon procuring a buyer. A cooperating broker has no agreement with the seller. Typically, they have no agreement with the buyer. To collect a coop commission, the cooperating broker must be able to prove the existence of an agreement with the listing broker. No contract with the listing broker means no coop commission. This simple truth is often missed by agents.
The reason agents miss the importance of commission sharing agreements is that usually the agreement is handled automatically by the MLS. Every MLS has a provision in its membership rules that requires members to state as a sum certain the amount of money they will pay another MLS member in a coop transaction. This rule results in brokers who file a listing with the MLS making a unilateral offer of compensation to all other members of the MLS. The terms of that offer are stated in the MLS filing for the listing.
A unilateral offer is one that can be accepted only by performance. Most contracts, including contracts for the purchase and sale of real estate, are bilateral contracts. A bilateral contract is one in which the parties exchange promises for performance. I promise to pay you the listed price for your home if you promise to transfer title to me. That’s a bilateral offer. A unilateral offer contains only one promise. When it comes to commission sharing that promise is: I will pay you a specific percentage (or specific amount of money) if you procure a buyer for the listed property. A unilateral offer cannot be accepted by promising to find a buyer. Instead, the offer is accepted and becomes binding when the buyer is actually procured.
Although extremely efficient, there are a number of consequences to using unilateral offers through the MLS to create commission sharing agreements. The first is that the offer is only made to and enforceable by members of the MLS because the offer is made only to MLS members. For most of the history of real estate, this has not been a problem because real estate was broken up into many small isolated markets with little or no overlap. As market isolation has broken down, multiple listing services have consolidated to create larger cooperative real estate service markets. Today, there is talk of state-wide and even national multiple listing services. This talk is driven by the continued perceived need to facilitate cooperation through commission sharing.
There are, of course, tremendous counter pressures to MLS consolidation. Real estate is still mostly a local market business. Maine is the only state to create a state-wide MLS and even there the largest metro area continues to run its own MLS. In most states, the consolidation of multiple listing services has stalled at the regional or metro level. Yet, increasingly, agents are operating outside regional and metro boundaries. When they do, it is absolutely critical that a commission sharing agreement be separately negotiated.
Getting a signed written commission sharing agreement with the listing broker is always the safest way to proceed when operating outside your MLS. When it is not possible or practical in the circumstances to get a written agreement, entitlement to a coop commission can be evidenced by a confirming letter or e-mail. Before showing a listing not in your MLS, call the listing broker and discuss the coop commission. Always arrive at a specific percentage or dollar amount. Then, follow the telephone conversation with a letter or e-mail that memorializes the agreement you reached. Here is an example:
Dear Bill:
This is to follow up on our conversation today regarding your listing #____ at _________, [any street], [any city]. As we discussed and agreed, you will pay a coop commission of ____ % if my buyer purchases your listing. I look forward to working with you to complete a transaction that benefits both our clients. Please do not hesitate to call me if you have any questions or there is any change in the status of the listing.
If you end up writing and closing a deal on the property, your confirming letter will be sufficient to prevent any serious argument over the coop commission.
return to top Determining the Split
Notwithstanding the contractual basis of coop commissions, battles over the amount owed a selling broker are everyday occurrences. They should not be, but they are. Much of this fighting stems from not understanding the legal source of coop commissions. That source, as detailed in the section of this topic on Commission Sharing Agreements, is a contract. Because compensation agreements must state a sum certain to be enforceable, there should be no fighting about coop commission. That such fighting exists is evidence that the existing system is breaking down, being ignored or is simply not understood.
Because the coop commission is earned by performance of a unilateral contract that states a sum certain, there should be no opportunity to fight about the split. The split is whatever was offered, period. That is the case because the offer becomes binding on its maker at the moment the called for performance takes place. Assuming the deal closes, that moment is the acceptance of the buyer’s offer. Unless there is some other source of agreement or modification, determining the coop split simply requires looking at the MLS filing and reading the sum certain expressed there.
Notice the caveat: unless there is some other source or modification. Commission split fights invariably devolve into fights about the source of the commission offered, or some modification to that source. Common dispute patterns involve oral or implied sources of agreement or modification of the offered split being indeterminate. Oral or implied source or modification fights are, for the most part, evidence battles. Evidence battles are generally so difficult to win that without some sort of confirmation letter or other contemporaneous evidence of contract or modification; such fights are rarely won or even undertaken.
Implied contracts and implied modifications to existing contracts are no easier to prove than oral contracts. What must be implied is not some new split or new circumstance but an agreement to pay or change the existing split. You will sometimes see listing agents try to reduce the commission to the cooperating broker based on a seller price concession or give back to the buyer. Such changed circumstances do not, however, automatically change an existing coop agreement. To change an existing agreement like the unilateral offer of compensation made in the MLS, you must have evidence the other party agreed to the change, not just that you had good reasons for changing it.
A perceived source for changing the coop commission expressed in the MLS has been the buyer and seller’s sale agreement. Until very recently, sale forms used by REALTORS® in Oregon contained a provision at the very end of the document where agents could fill in the names of the listing and selling firms and state the coop commission. The provision was intended to provide information to escrow regarding commissions already agreed to separately.
Coming, as it did, after the signatures of the parties and having nothing to do with parties’ agreement itself, the provision was not a term of the sale agreement. At the same time, the provision itself contained no words of promise. The blanks were typically filled in by the selling agent, not the listing side who was offering the coop commission. Because it contained no promise to pay and was not even authored by the listing side, the coop provision was not an agreement to pay anyone anything.
Notwithstanding the informational purpose of the coop provision in the sale agreement, selling agents were often temped to fill in the coop commission they wanted or expected rather than the one published in the MLS. This practice, of course, produced nothing but disputes. As a result, the company that publishes the sale form used by REALTORS® in Oregon removed from the form the blanks for stating the coop commission.
The original escrow information function of the coop provision is now fulfilled by a provision directing escrow to the pay the commissions in accordance with the listing agreement, buyer service agreement or other written agreement for compensation.
The sale agreement shifts the coop focus back to the MLS unilateral offer of compensation or to separate coop commission agreements made outside of the contract. Incredibly, some brokers, evidently not understanding the source of coop commissions, have begun attaching “addendums” to their client’s offers purporting to establish their right to a coop commission. This approach is both ineffective and dangerous.
Commission addendums are ineffective because the coop commission comes from the listing broker, not the seller. The listing broker is not a party to the sale agreement and, therefore, not bound by its terms. At most (and this is what makes the approach dangerous) what is accomplished is confusion and controversy at the time of offer. An agent who, for their own purposes, creates confusion and controversy over their client’s offer, runs the risk of breaching their duty to their client. Click HERE for a detailed discussion of agency duties.
Because the use of addendums to dictate or change commission agreements between the agents is ineffective and dangerous, it has been suggested that the listing and selling brokers should sign and submit a commission form to escrow for each transaction. Although the idea has appeal, care must be taken to not create a commission re-negotiation vehicle. The purpose of making unilateral offers of compensation through the MLS, or having compensation agreements before showing the property or writing the deal, is to keep the deal from becoming hostage to commission negotiations. A separate escrow form that must be signed by both listing and selling side will quickly become the vehicle for just such conduct as either or both agents maneuver after the fact based on the existence and terms of their clients’ contract.
Maneuvering after the fact based on the existence and terms of the clients’ contract means trying to find a way around expressing compensation as a sum certain in the unilateral offer of compensation. A recent vehicle chosen by brokers who wish to avoid making a unilateral offer of compensation before they know the terms of the deal or the firm they will be dealing with is misuse of the MLS “variable commission” rule. Under MLS rules, a broker who agrees to a variable commission with their seller must designate the commission with a “V” to signal cooperating brokers that the commission the seller pays will be less if the sale is in-house.
Almost as soon as MLS rules were changed to require notice of a variable commission being paid by the seller, a few brokers began using the “V” to mean that the coop commission was variable. These few brokers evidently believed they had found a way to modify the coop commission based on the terms of the transaction, or the coop rate offered by the cooperating broker on their own listings or whatever criteria they might desire.
This flagrant misuse of MLS rules demonstrated a fundamental misunderstanding of cooperation and raised very serious antitrust issues. Click Here for a detailed discussion of commissions and antitrust issues. Fortunately, the phenomenon has proved short lived because multiple listing services cracked down on the practice. Still, a wise agent will make inquiry if they see a “V” appended to the coop commission instead of just expressing the fact that the total commission paid by the seller may vary.
return to top Commissions and Antitrust
Antitrust laws are designed to promote business competition and prevent the creation of illegal monopolies. Antitrust laws are public protection laws but they are often used by business competitors and rivals as weapons. The operation of antitrust laws can be extremely complex. They are easy to violate and they are enforced by both state and federal agencies. Antitrust laws allow citizen lawsuits. The penalties are very stiff. REALTORS® need to understand enough about these laws to avoid walking into an antitrust action.
Antitrust laws are, for the most part, Federal laws. Chief among these Federal laws are the provisions of the Sherman Antitrust Act. Sherman Antitrust statutes prohibit any “contract, combination or conspiracy which unreasonably restrains trade or tends toward monopolization of a market; discriminates with an anti-competitive effect; or constitutes an unfair or deceptive trade practice.” Most states, including Oregon, have what are called “Little Sherman Acts.” These are state laws modeled after and enforced in the same way as the Federal laws.
A “contract,” for antitrust purposes, is any agreement with anyone. The agreement can be written or oral or implied. A “combination” is an agreement among separate entities to act as a single entity. A “conspiracy” is a combination for an illegal purpose. i.e., to restrain trade or create a monopoly or to discriminate or commit an unfair or deceptive trade practice.
A conspiracy to fix prices is the most common of antitrust violations. In real estate, that means a conspiracy to fix commissions. Price fixing is what the courts call a “Per Se” violation. That means there is no defense to having fixed prices. The court will not inquire into the reason prices were fixed or the effect of price fixing on the market. Price fixing is simply illegal.
Because price fixing is illegal without regard to intention or effect, REALTORS® must establish fees unilaterally without consultation or discussion with competitors. Commissions should never be discussed in a manner that would suggest the services are not independently priced. For instance, an agent questioned by a seller about their commission rate should never say: “Everyone charges that.”
Trade associations are called “walking conspiracies” by antitrust lawyers. A trade association is by definition made up of competitors. That creates an opportunity to conspire that just wouldn’t be there if there was no trade association. Given the ease with which competitors can conspire through a trade association, it is critical that certain subjects be avoided in Association meetings. Chief among these subjects is commissions.
As late as the 1960’s, local REALTOR® boards actually published a “board commission rate.” Board fixed commission rates ended when the Federal government started suing boards and winning. In its place, however, some brokers in some areas of the country started using board meetings or board facilities to “discuss” commission rates. This conduct resulted in a second round of Federal price-fixing suits. As a result, REALTORS® are, and should be, very paranoid about any discussion of commission rates.
Because commission rates are set individually, there is no “proper” or “traditional” or “expected” commission. As with any market, the market for real estate services will tend toward a market price. There will, however, be variations in that market. Discounts, promotions and price differences based on service differences are an ordinary part of any market. Commissions must always be viewed as a market phenomenon, not as what the industry charges or local brokers charge and never “what everyone charges.”
Price fixing is mostly an issue on the listing side. That is, historically, the price fixed was the commission charged to sellers by listing brokers. That is the case because coop commissions affect a much smaller, more integrated market and, therefore, show less variation. Because market participants are on both sides of the deal, there is little incentive to conspire to drive coop prices up or down. Instead, on the coop side the incentive is to engage in group boycotts.
A group boycott happens when two or more firms agree not to cooperate or to cooperate on less favorable terms with a third firm. Like price fixing, group boycotts are a “Per Se” violation of antitrust laws. Group boycotts involve ganging up on competitors to drive them out of the market. There is nothing more human - especially when it is existing firms getting together to drive out newcomers.
One way to drive out newcomers is for existing market participants to have an agreement not to cooperate with newcomers or to cooperate on less favorable terms. Real estate has historically depended on cooperation among participants. Without cooperation in the form of commission sharing, small operators simply cannot compete. Click Here for a discussion of the economics of commission sharing. It is for this reason that MLS rules make it difficult to refuse to cooperate with other members of the MLS or to cooperate with some members on less favorable terms.
Under MLS rules, a coop commission must be stated as a percentage of the sale price or as a sum certain. This is done so the MLS cannot be used as a vehicle for group boycotts. If everyone is offered the same coop rate before the listing broker knows who they will be cooperating with, there is no opportunity to refuse or to cooperate on less favorable terms. Recent attempts by some MLS members to misuse the “variable commission” rules to avoid having to make a uniform offer of compensation raise serious antitrust issues because of the group boycott potential they create. Click Here for a detailed discussion of variable commissions.
Cooperative commissions have also become antitrust matters when brokers attempt to control cooperative rates by publishing their cooperation policies. For instance, brokers sometimes publish statements that say they will pay cooperating brokers only what the cooperating broker pays on their listings. Thus, if a cooperating broker pays 1.5% on his listings, they will receive the same 1.5% when they are the cooperating broker. A broker who pays 3% on their listing will receive 3% when cooperating. This manner of doing business depends on either misuse of MLS rules (typically by misuse of the “V”) or stating low coop rates in the MLS and then having side deals with other “favored” brokers to pay them more than listed in the MLS. These side deals are conspiracies in restraint of trade.
Unfortunately, the real estate industry has a long history of antitrust activity. As this risk management tool is being developed, the Federal Department of Justice is suing the National Association of REALTORS® for adopting MLS policies the Department considers in restraint of trade. Whatever the merit of the suit or NAR’s conduct in the case, the suit should remind us that real estate and antitrust are not strangers. Brokers and agents alike should carefully consider their actions and policies with respect to commissions in light of this historic fact.
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