Why are real estate commissions 6%? – and why that may be changing

By Anna Bahney | CNN

Washington, DC  — Here’s how paying for a real estate agent to sell your home has long been done: A seller hands a percentage of the sale price to their broker, who then splits it with the broker who brought the buyer.

The commission is typically between 5% and 6%, which is usually tens of thousands of dollars out of the seller’s proceeds. But the seller also factored that cost into what they listed their home for, so indirectly, the buyer is paying the cost, too.

How did that become the standard? And will this process continue?

Changes may soon be on the horizon for real estate commission rates after a Kansas City jury determined – in a $1.8 billion judgement in October – that commissions had been inflated and that brokerages and industry groups conspired to keep them that way. This landmark antitrust court case, along with similar lawsuits like it, could overhaul the standard 6% commission and who pays it.

A shift could allow home buyers and sellers to negotiate not only commission rates with brokers, but also who is responsible for paying them — the buyer or the seller. It’s already happening in New York City, where the fee structure is set to change on January 1.

Many thought the internet would eventually kill the 6% real estate commission. But it has yet to put much of a dent into the share home sellers pay, which is about double the percentage that is paid in other countries, according to a report on commissions from the Brookings Institution. Even as the ranks of stockbrokers and travel agents have dropped in recent years as commissions petered out, the number of real estate agents has grown and their typical commissions are bigger than ever as home prices have risen. That is largely because of the power of the National Association of Realtors, an influential lobbying group that represents 1.5 million real estate agents.

While the NAR is appealing the recent decision and emphasizes that its members’ commissions are always negotiable, there appear to be some emerging cracks in the current way a home is sold.

How real estate commissions work

Home sellers are usually on the hook for their real estate agent’s commission as well as for paying the agent that represents the buyer. Brokers typically split the commission, which, depending on the market, is usually between 5% and 6%.

A $500,000 home sale with a 6% commission means the seller pays their broker $30,000 upon settlement, which that agent splits with the buyer’s broker, so each side earns $15,000 on the sale. (There is an additional split on each side with the participating brokers sharing their cuts with the agents who inked the deal, so an agent’s actual pay is less than their side’s share of the the total commission.)

Real estate agents will tell you commissions are negotiable — and they are. And there are other models to sell a home including using flat-fee or discount brokers. But there are strong structural forces at play in the industry that keep many sellers from offering less than the typical 6%. Agents’ compensation is included when the home is listed on a regional database known as a multiple listing service, or MLS. Some MLSs will not allow a seller’s agent to list a property that offers nothing to the buyer’s agent.

Sellers may worry agents will “steer” them away from a home that will earn the agent less. And that fear is not unfounded.

A recent academic study of properties listed on Redfin found that agents who offered commissions that were less than the market rate for an area had less traffic and took much longer to sell.

“The people who are most hurt by this are sellers who offer going-rate commissions because they are worried about steering,” said Jordan Barry, a professor of law and taxation at the University of Southern California, and a co-author of the study. “For most homeowners, their house is by far their largest asset. Giving up 6% of the sale price in commissions is a real burden.”

A historic practice

The shared commission structure was set up in 1913 and appeared in the first Code of Ethics of the National Association of Real Estate Exchanges, which had been established five years earlier and later became the NAR.

A section of the code, entitled “Duties to Other Brokers,” stipulated that an agent should “always be ready and willing to divide the regular commission equally with any member of the Association who can produce a buyer for any client.”

The NAR’s current Code of Ethics (Article 3) allows commission sharing but does not require it.

Until the Supreme Court put a stop to it in 1950, commission rates were set in a schedule by regional boards of realtors. Boards specifically forbade undercutting the prevailing rate, which was climbing.

In the 1920s in the Boston area, for example, the typical commission rate was 2.5%, but by the 1940s it had reached 5%, according to a study published in November 2015.

Agents argued the commission rate was fair because they held access to the listings unavailable to the public on the MLS. Agents put their listings in the MLS databases where only other agents could see them. These databases were — and sometimes still are — managed by NAR member organizations.

In an update to members following the recent verdict, NAR said the possibility of commission sharing has “always has been in place to protect and serve the best interests of consumers, support market-driven pricing and advance business competition.”

A history of litigation