Incentivization is what drives us to achieve all manner of goals, it is the reward we are given for successfully completing a task. In the workplace the more entrepreneurial the role the higher ratio of compensation to goal achievement is realized. A Realtor is a great example of this entrepreneurial compensation system, as are other sales focused roles that might appear to be compensated by salary, but are frequently substituted for something called Draw. Draw is a loan from the company, and is found in compensation plans for Mortgage Brokers, Recruiters and Law Firm Partners.
These compensation plans are necessary because each of these roles are also self contained profit centers – in other words it is frequently little more than infrastructure, such as an office, technology platform and occasionally collegiality that are offered by the employer to such people, and should they be sufficiently motivated rolling their job into a self employed operation would require minimum effort.
Incentivization is a fascinating subject, it is one where the employer is constantly striving to motivate their revenue producing employees to perform more effectively and increase overall profits, which are from some to degree shared on a percentage basis. The key in creating an incentive program is to find one that rewards employees for completing their tasks and generating revenue. When there is any form of misalignment problems occur.
For example, the Realtor needs to produce an advert to display online or in their window to make the property known to prospective buyers, it is part of their job, but without someone closing the deal there is no revenue. As such, most firms will not compensate a Realtor for making a pretty advert, it is a means to an ends. Those that are larger and have a dedicated person to do this will compensate that person for their task as that is the extent of their job.
Whilst an essential part of the equation for the house sale, the advert alone will not create revenue, and as such the person who is just making adverts will be incentivized on a much lower level in relation to sale revenue generated.
A Realtor must close the deal to get paid
Here is where the current incentivization dynamic should be considered strongly by a person engaging with a realtor. They don’t close the deal, they don’t get any revenue, if they are receiving a monthly loan from their employer, and their indebtedness increases, there will be pressure from management to produce, and their goal is sell.
Surely you need a hungry sales guy driving your listing? Well, no. Since Realtors are compensated as a percentage of sale price, typically 5-6% split between the buyers agent and the sellers agent you have to ask, are they being incentivized to close the deal, or are they being incentivized to get the best value for your property. I know when I want to sell I want a person getting the highest possible price for my apartment, not working against me to lower the price to the point where it is a bargain for the buyer.
In 2013 the average house price in America is $152,000 if you consider 3% (sellers agents incentivization) of that is $4,560 then think of this what if your Realtor drops that average by 10%, making it highly attractive to buyers,at a price of $136,800 and uses all of their sale skills to convince you it is the right thing to do. Sure, their commission would drop from $4,560 to $4,080, but when you consider the increase in buyer demand, they would be closing so many more deals, and the winners in this would be the Buyer and the Realtor.
The loser would be the Seller. Ironically, the sales commission always comes from the Seller side… this is broken system, and one that encourages the Realtor to not act in your best interests.
Fixing the system
The solution has to be incentvization that encourages the seller’s Agent to use all of their skills to increase the price of the sale. And the way to do it is very simple: have the seller and the sellers agent to agree a minimum price, and for every dollar they receive above that price they receive a vastly accelerated commission schedule. You could easily offer to incentivize them for 1% of the total sale, plus 75% of all profit above agreed acceptance price (which could be distinct from asking price) and still come out way ahead of the game. It sounds like a ludicrously high amount, but if they are actually achieving your goals and working in your best interest the 25% left over for you is all a bonus.
Example – I want $500,000 from my property. Using the old model if they received full asking 3% would be valued at $15,000, though they wouldn’t care if it went for $465,000 ($13,900) commission a long as they closed the deal. We set a sales price of $525,000.
Should they close at $525,000 the commission would be:
- 1% of 525K for $5,250
- 75% of 25K (amount over what I wanted) $18,750
- As a seller, you would net $525,000-$18,750-$5,250= $501,000
Now, the savvy reader will be asking, what about the Buyers agent? How do they receive compensation. Well, here is where I would suggest that we cut out the sellers agent all together, list the property on the MLS (a charge of $400) and invite Buyers Agents to market this to their clients, but using the incentivization plan listed here.
In some ways, you could say that this switch would just tilt the imbalance in the other direction, encouraging the Buyers Agent to not act in the best interests of the Buyer, but what it would really change is the Agents commission now, if they want to just ‘close the deal’ they are only able to claim 1% of the property value as commission. However if they are able to sell it effectively and get above the price that the seller wants, they can gain a lot more value from the property using aggressive compensation for their performance.
The current system is clearly broken, and should you decide not to operate such an unothodox plan to compensate your Realtor please think hard if they are just trying to close the deal and get any commission that they can, or if they are actually trying to get you the best value for your asset.
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