How do Real Estate Commissions Work?

This is one of the most common questions I am asked.

There are a lot of misconceptions out there about how do real estate commissions work, and what they entail. Add to the fact that most real estate websites avoid the question all together and that leaves people guessing so they end up asking friends, family and others. While they may get an answer, it doesn’t always explain the whole situation.

Below I will explain some major points about the commission, without getting into industry or legal lingo.

1. Real Estate Commissions are not Fixed, Set or Regulated

There are no set rules regarding  real estate commissions, and it is illegal for companies conspire to fix prices. Brokerages (and their sales representatives) are free to charge whatever they want for their services, just as the consumer is free to negotiate a commission that suits there needs. Having said that, there are industry norms that have evolved over time and the market of supply and demand ultimately dictate real estate commissions in your area . This will be discussed further on in this article.

2. Fee For Service Versus the Traditional Commission Based Model

Traditionally and still in common practice today, real estate commissions are paid as a percentage of the sale price of the home. There are also a smaller number of brokerages that charge a Fee For Service model.

Fee For Service

While they have been around for some time, Fee for Service Brokerages have received much more exposure over the last few years due to the recent changes in MLS rules regarding the posting of listings. Fee for service simply means that a Brokerage is charging a fee to perform a certain duty upfront, instead of receiving compensation based on the sale price and outcome of the transaction. Many For Sale by Owner companies use this model.

Fee For Service Pros

  • The consumer can pick and choose what services they want, allowing them more freedom to control the cost and experience.
  • This model appeals to Home Sellers who are confident of the process and comfortable doing it themselves.

Cons of Fee For Service

  • Money is paid upfront by the consumer with no guarantee of sale. Unlike the traditional model where the broker is paid only on a successful outcome, you will have to pay money upfront.
  • Since the brokerage’s revenue does not rely on your outcome (whether you sell or not, and whether you had a good experience) you may not get the results you were looking for.
  • Not every house sells. Home owners risk money out of pocket.
  • Consumers may not understand that the services provided and the duty of care owed to them is lower than with a traditional Client Relationship.

Commission Based Model

Traditionally, real estate commissions have been paid out of the sale of the home as a percentage of the sales price. This is the most common way real estate commissions are paid all over Canada and the United States. In my opinion this is still the best model because it protects the home owners while only rewarding the broker for a successful outcome- the sale.

Commission Pros

  • No money is paid unless there is a successful sale- limited risk.
  • No upfront costs for the home seller.
  • The costs of marketing a home can be a lot in terms of time and money. These are covered by the listing broker.

Commission Cons

  • For a consumer, it is sometimes unclear what is included in the commission, and sellers today are more educated. Many of them do their own research and want to know what they are getting.
  • Every realtor is different in the services, experience and knowledge they bring to the table.

Now that I have gone over the two most common commission structures, I am going to explain how commissions ‘normally’ work in reality. From here on in I will be only talking about the most popular model- the Commission Based Model.

The Home Seller Pays a Commission to the Listing Brokerage

When you hire a brokerage to sell your home, you agree to pay a commission for the successful outcome- a sale. Pretty strait forward. Sure, agents will perform tasks to market the home such as open houses, home staging and advertising, but ultimately you are paying for the result.

The Cooperating (buyer) Broker

When you list your home for sale on the MLS, you agree to allow your broker to pay a commission to any other brokerage who brings their buyer client and they purchase. Contrary to popular belief that the MLS is simply an advertising website, it is actually designed to promote cooperation between real estate brokerages.

Out of that total amount of commission agreed to, in the listing agreement there is a spot where you will have to designate how much of that your broker will pay the cooperating brokerage who brings a buyer. Again, there is no set standard on how much you have to pay. Cooperating brokerage commissions will range from 0.01 cent all the way to 4% and beyond of the sale price. Some listings will offer a flat fee. Just keep in mind that if you offer less than the other homes in your neighbourhood, you may not get as many buyer agents working hard to sell your home. On the flip side if you offer more, it can get you a lot more exposure.

How Real Estate Commissions Work in Common Practice

Here in Mississauga and the GTA, it is common to see a scenario where the commission is split 50/50 between the listing broker and cooperating broker. For example, 5% total paid to the listing broker, and out of that 2.5% will be paid to the Cooperating (buyer) broker. In the event that your agent brings their own buyer client, or an unrepresented buyer ends up purchasing, the whole commission amount is still payable.

It’s important to note that average real estate commission rates will change based on the market and supply and demand. For example, in a slow market where there aren’t a lot of buyers you may see higher commissions being paid to buyer brokers. Common commission trends are dictated by market conditions, and not set by any organization, board or company.

I hope you found this article interesting. Do you have any questions about real estate commissions? Would you like a quote on the cost of selling your home? Let’s talk!