UNDERSTANDING TRANSACTIONAL COSTS IN A REAL ESTATE TRANSACTION
This article is geared towards buyers of real estate but may provide sellers some insight into the costs of the services being provided to them and the impact those costs have on the sale of their property.
When asked who pays the commission in a real estate transaction, nearly 100% of buyers unequivocally say "the seller". Even buyers who hire buyer buyer agents believe wholeheartedly that it is the seller that incurs the cost of the buyer's agent.
While most buyers believe that it is the seller who pays the commission, it is ultimately the buyer, and not the seller, that pays for the commission in a real estate transaction.
Every real estate transaction has "transactional costs". Transactional costs are those costs that are incurred in connection with the purchase of the home but that are not directly paid to the seller of the home. Transactional costs in a real estate transaction include but are not limited to inspection fees, bank fees, legal fees, taxes, town recording fees and wiring fees. Buyers must add these transactional costs to their budget when deciding how much they can afford to pay for a home.
Rarely if ever do buyers consider fees to real estate agents as a "transactional cost". However, just like the fees to the bank, lawyers, town, etc..., the fees to the real estate agents are a transactional cost. Like these other fees, it is a cost paid to a party other than the seller in connection with the purchase of the property.
The only difference between "traditional transactional costs", such as fees for an inspection, and agent fees is that "traditional transactional costs" are paid directly to the party providing the service. In the context of the real estate agents, the buyer pays the seller and the seller turns around and pays the agents.
If you think about, the buyer could just as easily pay the agents directly and simply pay less for the property. The seller and both agents would be left with the same amount of money in their hands at the end of the transaction, but it would just be paid in a different manner. Thus, the money in the agents hand at the end of the transaction is really the buyer's money and a cost to the buyer.
The easiest way to see that real estate agent fees are a cost to the buyer is to look at the sale of a home with 2 agents that charge commissions versus 2 agents that charge a flat fee for their service.
COMMISSION BASED TRANSACTION: Seller will only sell their home if they can walk away with $325,000. The seller has agreed to pay real estate agents a 6% commission (3% to listing agent and 3% to buyer's agent) as part of the sale. Buyer agrees to pay $346,000 so that seller can walk away with $325,000.
FLAT FEE BASED TRANSACTION: Seller will only sell their home if they can walk away with $325,000. The seller agrees to pay listing agent a flat fee of $3,500 and buyer's agent a flat fee of $3,500. Buyer agrees to pay $332,000 so that the seller can walk away with $325,000.
As you can see, when the real estate agents work for a flat fee, the buyer pays $14,000 less for the property and the seller recognizes the same profit for the home.
While there are few full service brokerage firms that are willing to work for a flat fee at this time, Flat Fee Real Estate of Burlington does. We even work as a buyer's agent for a flat fee.
When we represent a buyer as a buyer's agent, we refund the amount of our commission that is above our flat fee of $3,500. In the "Commission Based Transaction" above, we would have received $10,380 as a commission. We would have then refunded $6,880 to the buyer. Thus, the buyer would have paid $339,120 rather than $346,000.
Even though we are not able to save our clients the entire $14,000 from the two examples above, we are able to help save them a significant portion of that amount. Thus, our clients end up paying less and in some cases are able to afford more house than they otherwise could have thanks to the savings we provide.
Below is a more detailed example of a typical transaction to help illustrate the points above.
Jane and John Doe are interested in purchasing a home. They hire a buyer's agent to help assist them in their search and purchase. They are looking for a home priced between $325,000 and $365,000. They would like to be on the lower end of the price range but are willing to spend a little more if the value is there.
Paul and Mary Smith would like to sell their home. They hire a real estate agent to assist them in the sale. Before listing their property, Paul and Mary review their finance and discuss their needs with the real estate agent. They tell the agent that they need to walk away from the closing table with $325,000. They estimate that the closing costs (before any real estate commissions) will be approximately $1,000. They have no mortgage on the property and so they need $326,000 to walk away with $325,000 after closing costs.
The agent tells Paul and Mary that he believes that their property is worth between $325,000 and $350,000. The real estate agent's contract with Paul and Mary says the agent will receive 6% of the sales price as a commission for selling their home. He says that in order for them to walk away with $325,000 as they desire, they will need to factor the 6% commission into their sales price. Thus, they will need to sell their home for approximately $347,000 in order to walk away with $325,00.
Paul and Mary put their house on the market for $349,00. Jane and John view many houses over a 2 month period, including Paul and Mary's home. Jane and John decide that of all the houses that have seen, they like Paul and Mary's home the most. It has everything that they have been looking for in a house.
After consulting with their agent, Jane and John decide that the Paul and Mary's home should sell for $335,000. They make an offer of $335,000 to purchase the home. Paul and Mary review Jane and John's offer and determine that they must reject it because after they pay the closing costs and real estate commission of 6%, they will be left with $313,900 which is $11,100 short of their desired amount.
Paul and Mary make a counteroffer to Jane and John of $347,000. While Jane and John believe they are overpaying for the home, they decide to purchase the home for $347,000. Paul and Mary are pleased because they will now be able to walk away with $325,000.
At the closing, Jane and John are given a statement which shows all of the costs that they owe. In addition to the $347,000 to purchase the home, they also have legal fees, title insurance fees, taxes and bank fees. Their total costs for purchasing the home are $355,000. They receive a mortgage of $200,000 and pay $155,000 out of their pocket.
After Jane and John deliver their check, the closing attorney disburses checks to the various parties around the table. The attorney delivers a check to each real estate agent in the amount of $10,410 (total $20,820). While the fund may have come at the closing, these funds actually came from the money provided to the closing attorney by Jane and John. Therefore, it was the buyer and not the seller that paid the commissions.