The economics of commission
I probably won’t make new friends or win favours with this article. While this article is based largely on my own experiences and observations, it is in part inspired by a book that I read some time ago titled ‘Freakonomics’ by Steven D Levitt and Stephen J Dubner (they also have a website http://freakonomics.com/).
Freakonomics analyses human behaviour in every day situations and interestingly, examples used in the book were very similar to what I’d been observing with my clients over many years. One example in particular relates to the motivation of real estate agents, and this article focuses on what my clients have and continue to experience, regardless of whether they’re buyers or sellers, whenever they find themselves negotiating on price with agents.
Although it’s not such a common concern in the current market with offers and purchase prices often going above the asking price, there will still be cases when not just buyers need to be sold to, but also sellers need to be sold to as well. Agents try to make sure sellers are ‘reasonable’ about their price and value expectations otherwise it may be extremely difficult if not impossible to close a deal. I’ve seen a few situations in which agents who aren’t able to get a higher offer from a buyer and are unable to get the vendor to agree to a lower price will cut their commissions on sales just to get a sale across the line.
I’ll qualify this next part by saying that I don’t profess to be an expert on property, and I don’t provide advice on price or valuations – even though clients often ask me for an opinion on whether the ‘price is right’. I provide professional legal services, which include conveyancing services, and limit my professional advice accordingly. However, there’s one thing that I comment on regularly and that’s the role that some agents play in either encouraging buyers to make higher offers or encouraging sellers to accept lower prices. An important point to take from this part is that by the time buyers and sellers have reached the end of their price negotiation, the sure winner is always going to be the agent.
If a buyer and a seller are only $5,000 apart in price and assuming the agent receives a fairly standard 2.5% commission on the purchase price, the difference to the agent’s commission is only $125. If the purchase price is $500,000, then the agent’s commission is already $12,500 and in comparison, the additional $125 is really not much difference for the agent – although the difference to the buyer and seller is still $5,000 or so.
If we extend this example to a $10,000 price difference, then regardless of whether the eventual purchase price is $495,000, $500,000 or even $505,000, the agent’s commission potentially only varies by $250 while the price difference for the buyer and seller can be up to $10,000. Do you see where this is going?
The disparity in financial consequence between buyers, sellers and the agent highlights the potentially conflicting interests. Economics suggests that when the price negotiation reaches the final stages and there relatively small increments in the price, the agent may now be more concerned with closing the deal (quickly) rather achieving a specific purchase price.
Consider whether you would be more or less motivated to more to earn or save $10,000 than you would be to earn $250? As you’re trying to negotiate the last $5,000 or $10,000 to the purchase price, and the agent is trying to convince you to make a higher offer (if you’re the buyer) or persuading you to accept a lower price (if you’re the seller), do you know whether they’re advancing your interests or their own? On the other hand, if you’re $10,000 apart in your price negotiation and it’s unlikely that either buyer or seller will move, do you think an agent who offers to cut their commission to close the sale will offer to cut their commission by $10,000 to bridge the gap between the parties or by only $250 being the difference in the commission? If I’m a buyer or a seller, I’d be more motivated by the $10,000 than the $250. Either way, it’s an interesting proposition which I’m sure you might want to test if you’re in the market.
Let’s be clear, I’m not suggesting for a moment that all agents are motivated solely by money. I only encourage my clients, buyers and sellers alike, to understand the dynamics of their relationship with each other and with the agent. It’s not always obvious who is really selling and who is really being sold to, but at least with some understanding of the different interests at play, you’ll be better informed and more aware when it comes to price negotiation on your next property transaction.
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Director – Property Lawyer