With the real estate industry finally lowering commission rates after August 17, 2024, a battle is brewing among brokerages and agents to win business. For example, Sotheby’s has decided to charge 2% to the seller and 2% to the buyer—or even less—to stay competitive. Other brokerages will likely follow suit.
For individual real estate agents, there’s now a ceiling on how much they can charge a seller. However, top agents can still command incentive-based commission rates that might exceed 2% per side.
To do so, these agents will need to believe in merit-based compensation. The better a real estate agent performs for their client, the more they should get paid, and vice versa.
This principle aligns with the essence of capitalism and America, which is why there’s been controversy over Diversity, Equity, and Inclusion (DEI) initiatives. If a person is hired based on diversity but lacks the skills to do the job, they are being set up to fail. Everybody loses in such a scenario.
Performance-Based Commission Pricing: A Path for Great Real Estate Agents to Earn More
The most common complaint from real estate sellers and buyers is that commission rates are too high. With the rise of the internet and technology, it’s surprising that real estate commissions have remained at 5%–6% for so long, hence the NAR price-fixing lawsuit. After all, commission rates in other industries have dropped, with some even reaching 0%, like for buying and selling stocks.
At the very least, real estate commission rates should decrease as home prices increase. It doesn’t take twice as much effort to sell a $400,000 home versus an $800,000 home. Charging a flat-fee commission is fair but would reduce industry profitability.
With performance-based commission pricing, a real estate agent can further prove their worth. The agent charges a higher commission for exceeding certain price thresholds, while sellers save on commissions if the home sells at a lower price.
Example of Performance-Based Commission Pricing Before August 17, 2024
Below is a performance-based commission pricing offer I received from a real estate agent in July 2024, before the legal changes in the real estate industry took effect:
- For a contract price of $2,900,000 and above: 5% commission
- For a contract price between $2,750,000 and $2,899,000: 4.75% commission
- For a contract price between $2,650,000 and $2,749,000: 4.5% commission
- For a contract price of $2,649,000 and below: 4.25% commission
This structure ensures that the commission percentage decreases as the contract price decreases, providing a tiered approach based on the property value.
I only received this offer after telling the agent that I was considering renting out the property instead. This offer was better than the three other offers I had, all of which stuck to their 5% commission fee.
Example of Performance-Based Commission Pricing After August 17, 2024
Now that the August 17, 2024, deadline has passed, I’m only willing to accept the following performance-based commission structure:
- For a contract price of $2,900,000 and above: 4.25% commission
- For a contract price between $2,750,000 and $2,899,000: 3.75% commission
- For a contract price between $2,650,000 and $2,749,000: 3.5% commission
- For a contract price of $2,649,000 and below: 3.25% commission
Given that Sotheby’s and other brokerage houses are willing to charge a 4% total commission to sell, at the very least, this real estate agent working for a competing brokerage must match these rates. If the transaction goes through, I’ll save between $26,490+ in commissions, as the rate is 1% lower for each contract price tier.
Meanwhile, if the real estate agent performs well and secures a sale price of $2,900,000 or more, they’ll earn 0.25% above the standard 4% rate.
Considerations for the Real Estate Seller
If you’re going to pay a real estate commission, you might as well choose the best agent possible. This means selecting an agent with a strong track record, a large network, the best preparation crew, and superior negotiating skills.
However, relationships matter too. You might choose an agent with a smaller network who’s willing to hustle harder by showing up to every open house and reaching out to every lead. Whichever agent you choose, trust them to do the best job possible at a reasonable price.
If you opt for an agent who charges a performance-based commission structure, you must develop your own realistic expectations for how much your property will sell for. The more likely you think the property will sell for less than the agent believes, the more you’ll save.
Calculating Probabilities of Selling a Property at Various Prices
- For a contract price of $2,900,000 and above: 4.25% commission. I assign a 10% probability of this happening.
- For a contract price between $2,750,000 and $2,899,000: 3.75% commission. I assign a 30% probability of this happening.
- For a contract price between $2,650,000 and $2,749,000: 3.5% commission. I assign a 70% probability of this happening.
- For a contract price of $2,649,000 and below: 3.25% commission. I assign a 50% probability of this happening, but above $2.6 million.
My prospective real estate agent believed there was an 80% probability that my rental property would sell for over $2.8 million. As a result, they initially expected to make 4.75%, the commission rate they offered before August 17, 2024. They viewed 4.75% as reasonable, given it was just 0.25% below the industry standard before the rules changed.
Today, if the agent adjusts to the new reality, they would expect to earn a base case commission rate of 3.75%. However, if they manage to get over $2,900,000 for the property, they would earn an additional 0.5% in bonus commission for performance.
My Commission Savings Based on My Real Estate Price Predictions
I only believe there’s a 30% probability of my property selling for more than $2,800,000, and only a 10% probability of my property selling over $2,900,000. As a result, I’m more aligned with the $2,650,000–$2,749,000 price range. This means my expected commission payment is only 3.5%, or 0.25% below what the agent expects for his baseline. In essence, I’ve saved myself another 0.25% in commission if my prediction holds true.
Additionally, since I assign a 50% probability of my property selling for $2,649,000 or less, I won’t be too disappointed if it does. I’ll also be happy to know I saved an additional 0.5% in commission, which could translate to savings of up to $13,245.
What I need to watch out for is if the property sells for exactly $2,900,000. Ideally, the property shouldn’t sell for exactly $2,900,000, as that would mean I’d pay 0.5% more in commission for the entire sale while only gaining $1 over the $2,899,000 threshold. My break-even point for paying the additional 0.5% commission is if the property sells for $2,914,500 or more. Therefore, it’s worth considering adjusting the pricing thresholds accordingly.
Goal as a Seller: Find the Most Optimistic Real Estate Agent
As you can see from my performance-based commission structure, the greater the difference between what the real estate agent expects your property to sell for and what you expect, the more you’ll save in commission.
Therefore, your goal as a seller is to find the most bullish real estate agent possible. A wildly optimistic agent will offer above-market selling price thresholds in their commission structure. If they achieve a pie-in-the-sky sales price, you’re thrilled! If the selling price falls well below what the agent expects but aligns with your expectations, you’ll pay a much lower commission and also be happy.
Real estate agents need to prospect for clients to grow their future book of business. One way top agents market themselves is by presenting a pitch book of past sales, client testimonials, and data expertise to convince you to sell with them. Getting a listing is far more preferred than having a buyer as a client.
During the listing pitch, an agent may be tempted to offer you a high potential selling price to secure your business. It’s similar to a general contractor offering to charge you the lowest price possible to win your business, and then adjust after the contract is signed.
If you decide to work with the real estate agent, this is where you negotiate the performance-based commission structure. If the agent disagrees after using their own numbers, you know they’re just blowing smoke and trying to lock in your business.
A performance-based pricing agreement essentially puts an agent’s money where their mouth is. A savvy agent who wants to maximize their earnings will develop realistic selling price thresholds.
The Risk of Hiring a Delusional Real Estate Agent
Of course, as a seller, you don’t want to hire the most delusional agent to save on commissions. That would be counterproductive, as the agent’s delusion might also indicate incompetence. They might not understand the local market well enough to market the property appropriately. In turn, this could result in the seller not getting top dollar.
This lack of understanding of the local market is why you likely shouldn’t hire an out-of-town agent. Instead, you want someone who has lived in your neighborhood for decades, knows everything about the area, and is aware of upcoming local economic catalysts. As a buyer, you prefer to negotiate with out-of-town listing agents who may price too high and cause their listing to go stale.
As a seller, the best approach is to hire the most experienced, market-savvy, and optimistic agent you can find, and have them agree to performance-based pricing after you’ve done your own market research. Anyone who believes in merit and their own ability will agree. And frankly, that’s exactly what you want in a real estate agent!
If you are having a hard time convincing an agent you want to work with to agree to a performance-based commission structure ask them this simple question: Do you believe in your real estate expertise? I do. Let’s see what we can do!
Reader Questions And Real Estate Suggestion
Do you think top real estate agents will agree to performance-based commission structures if they truly believe in their abilities? What kind of real estate agents wouldn’t agree to merit-based compensation? Doesn’t everyone just want to get paid what they deserve?
If you want to invest in real estate without dealing with agents, consider Fundrise. Fundrise manages over $3.3 billion and allows you to passively invest in residential and industrial real estate across the country. As you get older and wealthier, you might prefer a more hands-off approach to real estate investing. Additionally, as real estate commissions and mortgage rates decrease, demand for real estate should increase.
To expedite your journey to financial freedom, join over 60,000 others and subscribe to the free Financial Samurai newsletter. You can also get my posts in your inbox as soon as they are published by signing up here. Financial Samurai is among the largest independently-owned personal finance websites, established in 2009.
