What Is a ‘Variable Commission’ and Why Should Home Sellers Demand It?

This week’s column is intended to help those who might benefit from a better understanding of how real estate brokers are paid.  If you’re already well versed in this, please bear with me while I share some information with those who aren’t as well informed.

Before I explain what a variable commission is, let me explain who pays — and who receives — the commissions in the typical real estate transaction.

Normally, sellers pay the full commission to the listing agent, who then compensates the agent representing the buyer. How commissions are paid and shared is the primary purpose of the Multi-List Service, or “MLS” — to provide a system of  “cooperation and compensation.” If you’re a member of an MLS (a must if you want to do more than just word-of-mouth real estate), you commit to putting all your listings on it so that other MLS members can show and sell them. MLS listings disclose how much the “cooperating” broker will be compensated by the listing agent for procuring the buyer. 

Real estate firms may not dictate, share or discuss the commission rates that their agents charge sellers. To do so would constitute price fixing, a federal offense under the Sherman Anti-Trust Act of 1890. Brokerages may, however, dictate the amount each agent offers to other agents who sell their listings. At Golden Real Estate, we, like most brokerages, require that our broker associates offer a minimum 2.8%  “co-op” commission.  Offering less could result, I’ve found, in fewer showings by other MLS members.

There’s some history behind that 2.8% co-op commission.  Before the Justice Department forbade  the real estate industry from engaging in the fixing of real estate commissions, the Denver Board of Realtors fixed the rate at 7% and pegged the co-op commission at 40% of that, which is 2.8%. Listing commissions began falling due to competition once Realtors could no longer tell sellers there was a “standard” commission, but the  co-op commission remained at 2.8% to assure their listings got shown by agents.  As a result, it’s not uncommon now for listing agents to receive less at closing than buyers’ agents, even though they absorb all the costs of listing a home — signs, advertising, photos, video tours, showing service, staging consultations, etc.

Perhaps you’ve seen ads offering a “1% listing commission.” Such ads conceal (except in their fine print) the fact that an additional 2.8% is added to compensate the buyer’s agent.  As noted above, the listing commission includes what the listing agent will pay the buyer’s agent, so promoting a “1% listing commission” is, quite simply, misleading or deceptive advertising.

That said, let me now explain what a “variable commission” is and why sellers should demand it.

A variable commission is one which is reduced when the listing agent does not have to compensate a buyer’s agent — in other words when the listing agent sells a listing to his own buyer or to an unrepresented buyer, such as an open house visitor. Listing agents like to “double-end” a listing, because doing so can double what they earn on a given transaction.

Sellers certainly want their listing agent to be motivated to sell their own listings, but when that happens,  should the agent share his good fortune with the seller?  That’s the purpose of the variable commission.

Typically, I list a home for 5.6%, committing half of that (2.8%) to paying a co-op commission, but I reduce my commission to 4.6% when I sell the home myself. That way, I still earn more, but my seller pays less.  I want it to be a win/win.

MLS rules requires that each listing disclose the existence of a variable commission, so that brokers representing buyers know what they are up against in the event their buyer must compete with another buyer who doesn’t have his own agent.

Before submitting an offer, buyers’ agents typically ask the listing agent if there are other offers in hand. If the MLS indicates that there is a variable commission, the buyer’s agent will want to know whether any of the offers are from unrepresented buyers and, if so, the amount of the variable commission differential.  If the differential (as with my listings) is 1%, then the buyer’s agent knows that his client’s offer has to be 1% higher than an unrepresented buyer’s offer in order to be of equal monetary value to the seller.

Likewise, when meeting with unrepresented buyers, the listing agent can advise them that the variable commission makes their offer worth 1% more if they don’t engage an agent to represent them.

At Golden Real Estate, we have other rewards we can offer the unrepresented buyer, including “totally free moving” — free use of our moving trucks, free moving labor, gas and packing materials — if they choose to work with us instead of hiring a buyer’s agent.

As a matter of principle, I believe that a variable commission should be part of every listing agreement. However, my own research of sold listing on the MLS found that less than 20% of them indicated a variable commission.  In other words, more than 80% of sellers signed a listing agreement that allows their agent to keep 100% of their commission if they double-end the sale.

My research has also shown that roughly 7% of all real estate sales are double-ended. Thus about 7% of that 80% missed out on a multi-thousand-dollar discount in their real estate commission that they might have enjoyed by listing with, say, a Golden Real Estate agent.

Many homes are sold before they are made active on the MLS. Some, but not all, are put on the MLS after closing, showing zero days on market. I mentioned above that 7% of MLS sales overall are double-ended, but that percentage jumps to roughly 31% for MLS sales with zero days on market. Of those, 70% did not indicate a variable commission.  Many of those sellers, one can surmise, not only did not get as high a price for their home as they might have if it had been put on the MLS as an active listing, but also lost out on a discounted commission.

It should be noted that while the MLS considers a variable commission worthy of having its own data field, the standard listing contract lacks any place to specify a variable commission. If the contract had a section to enter that information, more sellers might ask about it before signing. Instead, unless your agent offers it proactively, as we do, you may not think to ask about including it as an additional provision.

The Way Real Estate Agents Are Compensated Confuses Many Buyers & Sellers

The real estate industry is unlike any other industry in the way its sales personnel are compensated. Since it is a persistent source of confusion for the general public, allow me to explain.

Imagine you went to a Ford dealership and described what you need in a car or truck. The salesman goes to his computer and pulls up his own inventory and the inventory of all the other dealers in the metro area.

It turns out that Chevrolet or Toyota might have a vehicle that better fits your needs, and the salesman knows that he’ll earn just as much by taking you to their lots and selling you one of their vehicles, so you get in his Tesla and go car-hunting. He even takes you for test drives without a salesman from the other dealership being involved at all. You go back to the Ford dealership, where a purchase offer is signed and emailed to the dealership which has that vehicle. The salesman helps you arrange financing with a trusted lender and sends proof of cash or financing with the offer.

Although there are some “auto brokers” who function as I’ve described above (in fact, I bought my Chevy Volt using an auto broker), that’s not how most car sales transactions work. It is, however, exactly how real estate works.

You’ve probably heard of the Multi-List Service (MLS) on which real estate listings are posted. The central premise of the MLS is “cooperation and compensation.”  To be a member of the MLS — essential if you’re in the real estate business — you must agree to cooperate with every other member of the MLS and to offer compensation if another member sells your listing. The percentage commission offered to other members is called the  “co-op” commission. In the Denver market, that commission is typically 2.8%. There’s an interesting history of MLS-type “exchanges” dating back as far as the 1880’s, which you can read at www.NAR.realtor.

The listing contract which every agent prepares for a seller specifies the total commission (typically between 5 and 6 percent) and the co-op which the listing agent is offering to other MLS members. In the “old days,” before Taft-Hartley anti-trust laws were enforced in our industry, the Denver Board of Realtors prescribed a 7% listing commission, and prescribed that 40% of that commission (or 2.8%) be offered to other agents as a co-op.  Under that formula, sellers would pay 4.2% commission to the listing agent and 2.8% to the selling agent at closing.

Once the Department of Justice said that anti-trust laws apply to the real estate industry, the Board of Realtors and the MLS could no longer dictate commission rates, and listing rates began their inevitable decline as agents competed with each other for listings. This is a good thing for sellers, but it has no real meaning for buyers. Indeed, when listing agents have tried to pay less than 2.8% co-op commission, they have found that buyers’ agents are less likely to show and sell their listings. As a result, listing agents now earn less than buyers’ agents in a given transaction, even though they are the ones laying out money for photographs, brochures, staging consultations, advertising and other expenses associated with maximizing their listings’ exposure to potential buyers.

Now and then, this commission model — wherein the entire commission is paid by the seller — is challenged, but it endures almost universally, if for no other reason than “it works.”

Where this business model causes confusion is when a broker or brokerage advertises a 1% or 2% “listing fee” in order to get a listing appointment, at which time the seller learns that this does not include the requisite (or at least recommended) 2.8% commission to the buyer’s agent.. These brokers and brokerages know that honestly advertising a 3.8% or 4.8% listing fee would garner them far fewer listing appointments.

Another source of confusion is what’s known as the variable commission. This term applies to a commission that is reduced if the listing agent doesn’t have to pay a co-op commission because the buyer has no agent of his own. However, most listing agents — 85% by my calculation — don’t mention reducing their commission in their listing presentations and hope that the seller won’t ask them about reducing their commission if they don’t have to pay a co-op commission. At Golden Real Estate, it is office policy to offer a variable commission.

As real estate values continue to increase, it’s reasonable to ask whether the commission rates — which I’ve said are typically between 5 and 6 percent) should be reduced on the theory that it takes little more money and effort to market a million-dollar home than it does to market a $400,000 or $500,000 home.

The extent to which listing agents can reduce their commission, however, is limited by that 2.8% co-op commission that we feel obligated to offer. After all, if we reduced our commission to, say, 4%, we’d only earn 1.2% after giving away 2.8% to the buyer’s agent.

Where we can be more accommodating on those higher priced homes is in agreeing to a lower variable commission. My practice is to reduce my 5.6% commission to 4.6% when I don’t have to pay 2.8% to a buyer’s agent, but I’m willing to adjust both those numbers on a higher-priced listing.  By the way, that appears to be the practice of most broker associates at Golden Real Estate.  Because of Taft-Hartley, I can’t dictate what they offer.

About 5% of transactions are double-ended, although that percentage is much higher at Golden Real Estate because of our more extensive marketing of listings and the fact that we offer Totally Free Moving to Colorado buyers when they are unrepresented.