What is a Real Estate Compensation Agreement?
A real estate compensation agreement is a legally binding contract between a broker and a buyer or seller. It outlines the terms of payment for services rendered by the broker, based on a percentage of the sale or purchase price. This agreement is designed to protect both parties involved in a real estate transaction by ensuring that the broker receives fair compensation for their efforts, while also ensuring that the buyer or seller does not overpay for these services.
In most cases, real estate agents and brokers require compensation agreements for every property they sell or help a buyer purchase. This allows them to receive payment for their negotiated commission percentage, which is generally included in the compensation agreement. Since these agreements often last only until closing , they are not considered long-term contracts, which would otherwise be prohibited for real estate agents and brokers in many states.
Most real estate firms do not charge clients for real estate brokerage services provided prior to a purchase or sale. They do not pay brokers until after a sale is made. The only instance in which a real estate broker may provide services in advance is if the client has paid a nonrefundable advance fee that is subject to drawdown by the broker upon completion of the services. A real estate agent will not authorize commission to be paid until the transaction is complete and all conditions of the sale are satisfied according to the compensation agreement. Once the deal closes and all parties have signed, the broker is paid within a few days.
Types of Compensation Agreements
The types of compensation agreements that are most common in real estate transactions include fixed commission, percentage-based, and hybrid models. A fixed commission is a flat and non-negotiable commission amount which has been established by the parties in a prior agreement or by the guidelines applicable to the broker’s professional association. These commission amounts, such as a flat $1,500 or $2,500, are commonly found for co-operative arrangements between realtors and are normally reserved for low dollar commercial or rural land transactions. The main positive attribute of this type of compensation agreement is that the amount of the fee is predetermined and known to both the realtor and the client at the outset. Accordingly, the client can make a reasonable calculation and expectation with regards to the impact of the commission on the amount of the purchase or sale cost.
The second type of compensation agreement commonly used is the percentage-based commission agreement. By far the most common of such is the real estate commission agreement, where the seller agrees to pay the real estate agent and any agent that co-operates a commission fee which is essentially a percentage (typically between 2.5% and 7%) of the "gross sales price" (without having to account for expenses and taxes). In some cases, there is a sliding scale, so that the agent may receive a higher percentage (for example 6%) for the first $250,000 and a lower percentage (for example 3%) for the balance over $250,000. The meaning of "gross sales price" needs to be interpreted carefully in a Canadian law context since it may mean a price exclusive of taxes, which may significantly alter the commission calculation if the total amount of tax is large and the commission percentage is not reduced in such a case.
The main advantage of a percentage-based agreement is that it is a true fair-market value determination of the value of the service and is proportionate to the levels of effort expended. However, this can result in disputes unraveling as to what the "gross sales price" actually is, or how the calculation should be pro-rated or otherwise calculated over time (e.g. into stages such as when the home is readied for sale, marketing is undertaken, the crown has been transferred, etc.).
Components of a Compensation Agreement
The key elements of a compensation agreement are the parties’ names, the type of compensation to be paid (i.e., retainer, commission, finder’s fee, etc.), the commission to be paid to whichever of the parties is compensated for the transaction (buyer, seller, broker, sub-broker, agent, finder), and the timing of payment(s). The agreement must also address contingencies specific to the transaction. For instance, the compensation agreement might include a provision requiring the buyer to retain the services of the broker or other parties who located the property as property managers (or property and casualty insurance agents) for a specific period of time. Most commercial transactions include written compensation agreements; most residential transactions do not.
Legal Considerations and Regulations
The legal implications and regulations governing compensation agreements vary by state and can be complex. At their core, however, compensation agreements are contracts and as such are subject to all of the general rules of contract law, including requirements for consideration, legality of content, and the like.
They are also subject to the general rules that apply to the hiring and agency relationships between agents and consumers, namely that of fiduciary duties to the consumer and certain disclosure requirements about the terms of the relationship. Hence, regardless of the state in which you are operating, the basic agency disclosure laws will play some role in any compensation agreement you enter into with your clients.
Compensation Agreements that operate as listing agreements or buyer representation agreements are usually exempt from state consumer protection laws prohibiting unconscionable contract terms. But they still run the risk of being overturned if they are found to be unreasonable or unfair. Mainly this refers to the terms of the agreement, including pricing and length of service, which can be subjective. However, you should also be concerned about the effect of any compensation agreements you enter into on your professional liability coverage. Be sure to check on any restrictions on compensation agreements in your state, as well, such as these rights of the consumer at the time of signing.
Advantages of Having a Compensation Agreement
For real estate agents and brokers, compensation agreements can assure them that they will be paid for work performed. Recognizing a compensation agreement for the value it presents for the real estate industry, some states permit the service of a notice to the attorney for sellers to the effect that a broker is involved in a transaction and that the agent and the broker may direct payment of the sales commission.
For clients, the absence of a compensation agreement may cause some difficulties in the event disputes arise over fees and commissions paid or due to a party claims entitlement to a fee or other compensation notwithstanding the fact that no written compensation agreement exists . The client may be unaware of an allegedly enforceable claim against it until after it has settled with a party such as a broker or real estate agent. The absence of a compensation agreement may leave the client vulnerable to paying a double commission or fee, and it may have little or no recourse in a legal claim against a broker or agent with whom the client has had no prior dealings.
Consumers are vulnerable to the loss of their money and the failure to receive full value for the services they are requesting, and should take care to enter into compensation agreements with those providing significant services on their behalf.
Strategies for Negotiating a Real Estate Compensation Agreement
The negotiation of a compensation agreement in real estate can be a pivotal point in any transaction, and while there are many moving parts to consider, not to mention the inherent complexities that may surround a sale, there are a few strategies that can help guide the parties towards reaching mutually beneficial terms that they can both agree upon. Many compensation agreements have been relatively standard across the industry for a long time now, although the nature of the market itself and the accompanying competition may cause the terms of an agreement to vary. Either way, knowing what to expect from the process can help eliminate any confusion during the negotiation process, and help trends towards a speedy resolution.
As a general rule of thumb, compensation agreements for real estate should always be in writing. Although a verbal agreement may be sufficient in rare instances, this would typically be the situation where consistent, repeated actions can draw a reasonable conclusion of the parties’ intent. Written agreements, on the other hand, are much clearer, can be set out in detail and can be used as evidence if any disputes involving the agreement are later brought to the courts. Writing down the agreement is also an effective way of helping both parties understand their obligations, and to provide a clear picture of what the terms are. These are all important factors to a good compensation agreement and should all be borne in mind before you proceed any further with negotiations.
Another key strategy that should be considered when negotiating a compensation agreement is that it should be done with the assistance of a legal professional, as they can offer insight into anything that needs to be addressed or factored in, into the final version of the agreement. The benefit of having legal expertise during the drafting process is that you are able to address any concerns that may not be obvious, and pay close attention to any sped-up timelines or potential pitfalls that could be affected by the current climate. A legal professional will also have the experience needed to assess how the market may shift in the future, so that the agreement can be drawn accordingly.
Lastly, it is key to remember that a compensation agreement is a bilateral contract, which means that each party has the right to include specific terms into the agreement. For example, a seller may want to alter their usual payment structure in line with their own budgeting needs, by offering a lower rate at the sale and a higher one at the close, or vice versa. While a buyer, on the other hand, may want to push back payment for a longer period and opt instead to tie the additional payment to the number of tenants a seller can secure. These types of negotiations may be more or less common depending on the region, but they are a starting point for determining what may work best for either party, and three general examples that both a buyer and a seller can consider when determining the structure of a compensation agreement for themselves, as they will both shape the agreement to meet their individual needs.
Common Issues and Solutions
One of the most common problems in real estate transactions is a conflict with respect to commission and/or referral fees – who is owed what. Think of it this way: before any real estate takes place, commission agreements are triggered. This is often why, when I represent a buyer or a seller, I have to deal with at least two or three brokerages (and agents) if there is more than one real estate transaction. The seller typically has to pay his or her agent and his or her broker, and then separately the buyer has to pay his or her agent and broker. That alone is four commissions or referral fees and almost always leads to fairly routine challenges by one or more of the parties involved at some point. For example, in a typical retail deal where I act for the landlord, there is a long discussion with the landlord’s representative to make sure that the landlord is satisfied. The representation agreement almost always grants the landlord the right to receive full disclosure of all commissions/fees/expenses, and, as part of my normal process, I prepare a full accounting. Sometimes, there appears to be an issue between the agent and his or her broker, or between the agent and the agent’s client. Just as easily, while representing a purchaser I will review commission agreements that have been executed by my client and the prospective vendor. There is sometimes a challenge with respect to the money , regardless of whether the purchaser was actually represented by his or her agent. In Canada, he or she is not the same as a lawyer in the United States, and may or may not be representing the buyer in an affiliated sense. The point of all this is that the longer the chain of representation, the more challenges there can be with respect to compensation issues. The more compensation agreements there are, the greater the chance that one or more of them will be problematic. How do you deal with these issues? There are two approaches, either or both of have encountered challenges like this during the course of a transaction. 1. Disclosure is always better. From a seller’s standpoint, using me, the lawyer, as a filter can clearly be advantageous. I deal with compensation issues all the time, and almost never is the conflict "surprise!" to me because we have had a discussion at the outset of the representation. 2. Set the terms up front. This is the most obvious approach when acting on behalf of a client. Making sure there is a good explanation of the fees, commissions, referral fees, etc., that will be charged for representation, is the best way of ensuring that challenges will not arise in the first place. Be clear, be understandable, and most importantly be conscious of the fact that disclosure in advance is more likely to avoid a later problem.