Real Estate Agent – Drawbacks and Delusions
The highest prized benefit of owning your own business is independence. You rely on your skills and have to report to no one but yourself. This is the allure of becoming a real estate agent. Imagine, making a lot of money and working when you want to work. Very appealing to just about anyone, wouldn’t you say? Well, it is all hogwash!
This would also appear as one of the few industries to get in without having to put up a lot of financial capital or have an overwhelming amount of knowledge. The exact opposite is the case. This article will explain to the reader how someone becomes an agent and what it really costs to be in this industry. In addition, I’ll explain all the costs involved and how at the end of the day, you are really not much more than a slave to the broker. I have prepared tax returns for over 60 different agents over the last 20 years and I can assure you, only one was truly financially successful in her career. I did have one that enjoyed his job immensely but he didn’t make a lot of money and was heartbroken when he compared his time input against the final take home compensation.
I’ve divided this article into three sections. The first section provides a short history of the real estate agent and the current duties and responsibilities. The second section explains a typical transaction for the agent and the final net money made off the deal. The third section illustrates how when aggregated on an annual basis, the real estate agent doesn’t really make much money. This third section will also illustrate how an agent has to work the law of large numbers in order to have any chance of making any real money in this career.
Real Estate Agency
The role of the agent dates back to boom in real estate that started in the 1920’s. It further expanded in the late 30’s when the Federal Government got involved in guaranteeing loans on real estate to expand the middle class of the United States. The charter issued to Fannie Mae accelerated the real estate market and of course the Second World War victory fueled the real estate boom. It became the standard American image or what is referred to as the ‘Dream’ to own your own home. The ‘Realtor’ used this image to further instill in Americans the ultimate desire. As the baby boomers came of age, new home construction accelerated the need for more agents.
Unlike most industries, agents work for a broker and are paid a commission. There is no salary, no hourly earnings. It is strictly a business relationship between the ‘Master’, the Broker, and the ‘Apprentice’ the agent.
As the real estate industry expanded so did the duties of the agent. Back in the 60’s an agent would receive a phone call from the broker telling him that a customer has called and desires to sell a home. The agent would then arrange a meeting and get the customer to sign a contract using the broker to list and sell the home. The broker would pay for advertisement in the newspaper and the agent would receive the phone calls related to that listing and show the home. The buyer would sign a contract to purchase the home and at closing, the broker would receive a commission. The broker would then share that commission with the agent.
As the volume of homes for sale began to increase, the brokers changed the relationship and rearranged the duties to gain economy of scale. In the 80’s and 90’s agents began to split into two distinct groups. The first are the listing agents, usually more experienced and senior agents, they would evaluate the home and help set the market price. The contracts changed to a listing agreement whereby the broker agrees to list the house for sale and if sold, make a commission. The less experienced agents would perform the duty of showing the home to potential buyers. The primary driver of this duty responsibility was weekend work. The listing agents were more experienced and had no desire to show homes on the weekends when most of the buyers were available to look at homes. The less experience agents were assigned this task. The secondary reason for this relationship was the amount of time involved. In general, listing work was limited in nature whereas the showing and making a sale was much more involved and time consuming.
In addition to the categorizing of agents into listing and selling, agents were assigned the responsibility to market the homes. In the past the broker paid the fee to the newspaper to ‘list’ the house for sale. Today the agent is responsible for all marketing and in the better brokerage relationships is provided a budget to market the home. No longer applicable, newspaper ads went by the wayside a decade ago and the modern internet presentation is provided. Often video and lots of pictures are posted to a site as a function of advertising. The agent’s duties have broadened to include acquiring the necessary video and images to insert in the listing. Now buyers review many homes online and minimize wasting their time. Now the buyers prearrange the showings via a single agent for a weekend date.
The modern day Multiple Listing Service (MLS’) is used by almost every broker in the United States. Each broker assigns a number to the new listing and this house’s information is accessible by every broker that is a member of this service. Not only is the house on the internet, but it is also in a national database accessible via the internet for anyone to view.
To complicate matters, agents are licensed and must complete an education program. The agent’s license is ‘carried’ by a broker and therefore no agent can list or sell a home without his license actively carried by a broker. Some of the broadening of duties includes:
- Assisting sellers in prepping the home for sale (cleaning, painting, some minor repairs, yard work, etc.);
- Augmenting the marketing and advertising via internet inclusion, additional open houses and community outreach;
- Finding financing for buyers;
- Arranging the various inspections (home, pest, engineering, and lender);
- Conduct seminars and training for the younger agents (notice this falls to agents and in the past was a direct responsibility of the broker).
The key here is to understand that this isn’t your old fashion small town agency relationship. The duties of the agent have expanded dramatically over the last 30 years. Yet, the corresponding financial relationship has not! To appreciate this, let’s explore a typical financial transaction.
Typical Real Estate Agent Commission Deal
During the last 50 years, the real estate agent’s commission has not changed at all. Mathematically, they have yet to receive a raise! This whole financial reward for services rendered is predicated on the final closing on a home. To fully understand how this works, the following is your typical transaction for a deal completed. Just so you understand, the agent typically receives 50% of the broker’s commission. In this example, we are going to look at the deal from two viewpoints. The first is if the broker provides both the listing and the selling of the home and you as the agent did both sides of the deal. That is, you got the listing and you personally found the buyer. The second viewpoint is if you only performed one side of the services. The house is a $240,000 sold home and there were no hiccups in the entire process.
Step One – The house closes and the broker receives a standard 6% commission. In this case, the closing attorney writes a check to the broker for $14,400 (6% of $240,000). Not a bad deal for both parties. If this were a perfectly clean deal, that is no issues, the seller receives $225,600.
Step Two – The broker then agrees based on the relationship with the agent, to split the commission 50/50. This is where the relationship has actually changed over the last 50 years. In the past, the broker absorbed all costs for the sale; in effect the commission was a pure clean 50%. The only costs for the agent were the costs of his suits and the expenses related to using his automobile. Today this is really much different. Now the broker reduces the gross commission by his costs and these include the following:
- The revenue tax assessed by the locality for the business license for the brokerage. A typical tax rate for the business license is around 34 cents per $100 increments. In the above example, the broker assesses $48.96 for the business license.
- A typical broker often has to pay a franchise fee to the state they are doing business in; most states assess around $250 year for the franchise license; thus for the broker, they estimate a flat fee, usually $5 or so per deal.
- Some brokers carry a national franchise name like Century 21 or Coldwell Banker. Most of these franchise organizations charge between 4% and 7% as a franchise fee. Most brokers will assess this fee on the agent’s commission. In this example, the agent receives 50% of the $14,400 and therefore is assessed a 7% fee on $7,200. This is $504. Some brokers will also charge for the national advertising program which is around 2% of every dollar of revenue. Thus, it is possible for the broker to charge the agent the 2% on the commission for this national advertising assessment. In this case, the assessment equals $144.
- Internet and MLS costs. In modern relationships, the broker now assesses either a percentage fee or a flat rate for the internet marketing campaign. Typically, many brokers use Zillow or Trulia to show homes. These large providers of this service charge between $300 or more per zip code zone per month. If a broker is working eight zones, their fees are in excess of $2,000 per month. To recover these costs, the broker now assesses a flat rate fee per deal. Most of the ones I’ve seen range between $18 and up per month of use. If this house were on the market for 4 months, then the broker would assess a $72 fee on the deal. Some brokers, assess this fee against the entire gross before the 50% commission, but most assess directly against the agent’s commission.
- Errors and Omissions Insurance – generally around .25% of the total commission,
- Worker’s Compensation Insurance – this is around 3.7% of the total commission earned; so in this case the charge is $7,200 * .037 or $266,
- Signage – flat rate fees of $50 – $80,
- Lockbox System – flat rates of around $13 to $20 depending on the key issues; i.e. more dollars for any additional keys made.
Step Three – Calculate the net check to the agent for services rendered:
- Commission Earned $7,200 Remember, here the agent has provided both parts of the deal, listing and selling
- Deduction for Insurance:
- E&O (18)
- Worker’s Comp (266)
- Marketing (216) Internet, MLS & National Franchise Campaign
- Licenses & Franchise
- Local Revenue (49)
- State Franchise (5)
- Franchise (504)
- Signage/Lockbox (63)
- Net Check to Agent $6,079
If you are the agent that only does one side of this equation, such as listing only, it is slightly worse. In this case, your commission is 50% of the total allowed agent commission. Effectively, it is 25%. However, since the broker is still responsible for the associated costs, these remain and are assessed against you for the entire related values. Some of the costs are adjusted because the transfer of value to another brokerage such as the insurance and national franchise license fee, but some of the costs do not change such as marketing and signage/lockbox. In this case, the calculation would work as follows:
- Commission Earned $3,600 (25%)
- Deduction for Insurance (142)
- Marketing (216)
- Licenses & Franchise (232)
- Signage/Lockbox (63)
- Net Check to Agent $2,947
Even with all these fees assessed against your commission, you would think that you still did well. It would appear so, but there is more. Often the broker arranges for training and compliance. These costs are also passed onto the agents. If you as an agent sign up for a unique program such as self development or some new marketing campaign, the broker allocates your share of the costs against your commission. Finally, you are still not done. Uncle Sam has his hand extended too! He wants his share of the deal and if you pay your taxes right on the spot, you are looking at around 30% of the net. Why so much? Well, since you are in business for yourself, there is this special tax called self-employment tax. I write in detail what this is about in this article: Self-Employment Tax.
Therefore, the final true take home amounts are $4,050 if you are fortunate enough to do both sides of the deal and $1,970 if you only do one side of the deal. Now bounce this against the volume of hours you invest in a typical deal. Most of the agents I did work for explained to me that about two out of every three deals actually get closed within the contract period. Also, it takes around 80 hours of work for each deal. A typical agent will spend about 100 to 120 hours of work to effectively close a single deal (don’t forget, this includes the amount of time you invest in the deals that don’t close). For all this, an agent generally earns around $20 per hour not including the costs of transportation.
The reality is pretty simple. If you work around 2,000 hours per year doing this kind of work, you’ll earn around $40,000 per year as your take home pay. Think of it as a $3,500 per month job. Don’t forget, odds are that you are working on the weekends and in the evenings when the clients and potential buyers are available. At the end of the day, this isn’t as lucrative as it first appears and in addition, you have some pretty rough hours to work. Why do so many people want to do this? Well, the hope is that they land that $1,000,000 home and get it listed or sold. If successful, you’ll earn about 4 times as much money for the same volume of work. Now we are talking about taking home $80 per hour for the same work.
Based on my experience working with a lot of agents; only those agents that have been in the program for more than three years can get these types of opportunities. Basically, your pay raise is your experience and loyalty to the broker. Those of you starting out, remember it takes time to finally get to the point of making some decent money as an agent. How do some agents do so well in the lower class or middle class sales territory? Many of these agents try to use the economy of scale in earning their money. What does this mean and how do you accomplish this economy of scale to make any real money as an agent? Read on to the next section to find out.
Economy of Scale as a Real Estate Agent
To counter the issues related to a typical deal, many agents exercise the law of large numbers. In economics we use the term, economy of scale. For an agent involved in the $100,000 to $300,000 range of homes for sale, the agent must move volume in order to make any money. Essentially they are reducing the number of hours exerted into each deal thus increasing the value per hour of work. The primary tool used back in the mid 90’s going into the mid 2000’s was to just be the listing agent. Real estate was hot in those days, by the mid 2000’s, all you had to do as an agent was get a signature on a contract, list the home and believe me, it was sold within 30 days. You didn’t need to show a house; often people were buying homes by walking the outside of the house. There was incredible volume and it appeared to be easy money for brokers and agents.
It didn’t last long. The 2008 financial crisis was tied to the mortgage industry. The entire system collapsed like a house of cards and now agents can’t find qualified buyers. Since 2008 many agents have left the industry thereby reducing the competition for the more experienced agents. There are approximately 3 million licensed agents (2014) in the United States and on average each will be involved in 11 deals in a typical year.
To work the economy of scale, many agents have resorted to working in teams, think of it like a mini brokerage firm. This way they can work a geographical territory or a particular class of homes (single family, condo, price range etc.). This allows the members to quickly achieve a threshold of knowledge and by combining resources they can leverage their duties and reduce the overall workload per deal.
Notice how at the beginning of this article I emphasized the value of autonomy as the primary benefit of becoming a real estate agent. The team approach limits this independence and thus the primary benefit is reduced.
Other forms of economy of scale include limiting your own territory to a zip code zone or maybe a particular neighborhood. Others include only working with particular financing avenues such as only VA loans or a particular bank. The key is to exercise this unique knowledge to speed up the process and reduce the workload per deal.
Summary – Real Estate Agent (Drawbacks)
If you are currently considering becoming an agent, you may want to think twice. Economically, it takes years to achieve real financial success as only those with lots of experience and commitment end up with the $1,000,000 deals. The independence aspect is minimal given the need to work together to achieve an economy of scale and furthermore, you have to work weekends when the buyers are available. If you do decide to become an agent, when it’s time to hang your license somewhere, ask questions about the respective fees and costs the broker includes in determining your final commission. Talk with the other agents and find out how much work is really involved and whether this brokerage firm has a cooperative environment. Act on Knowledge.
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