Homeowners, Advisors, and Setting Up for Success

Most homeowners aren't well-equipped to sell their homes on their own, which is why they hire real estate agents. However, many homeowners also don't know how to effectively hire an agent, often selecting the first one they speak with and agreeing to commissions of 5-6%. Many financial advisors may not realize that providing a modest amount of education to clients can potentially save them tens or even hundreds of thousands of dollars. Just as an advisor would have an opinion on active vs. passive management or whether private equity belongs in a portfolio, there is an opportunity to add value when a client is selling a home.

Eighty percent of homeowners only speak to one real estate agent before hiring someone to sell their home. One of the largest financial transactions of a person's life, and they don't even get a second opinion. Why?

There are two possible explanations. First, perhaps homeowners believe the agent they hire doesn't really matter. They might assume that with all homes listed on the MLS, the market is so transparent that any agent will do the job just as well as the next. Second, homeowners simply may not know any better. They see hiring an agent as a standard step, reach out to the first agent they find, and they don't give it any further thought.

The first explanation doesn't hold up well under scrutiny. If homeowners truly didn't care who they hired, then why haven't discount real estate brokers taken off in popularity? Why have real estate commissions remained relatively unchanged over the last century, even as home prices have shot higher and technology has made agents more efficient? In an open and transparent market, you'd expect competition to drive prices down, but that hasn't happened. This points to the second explanation: homeowners don't know how to effectively hire a real estate agent. Homeowners' lack of knowledge benefits agents by limiting competition, and it allows agents to maintain greater pricing power. It also explains why agents focus so much on building a personal brand and being top of mind. The less homeowners know, the more agents can charge and get by on image rather than results.

The High Cost of the Status Quo

In general, when the stakes are high, people tend to be more risk-averse. When making large financial decisions or navigating something they've never done before, people tend to play it safe. This natural risk aversion leads many homeowners to stick with what they know when selling their homes, following the traditional path of paying fixed commission rates of 2.5% to 3% to both the listing and buyer's agents. However, what's often overlooked is that the status quo, deeply ingrained by the real estate industry, doesn't necessarily serve the homeowner's best interests.

This creates a unique opportunity for financial advisors and other professionals who help people make smart financial decisions to step in and provide guidance. The problem isn't just the commission cost itself, but the disconnect between the cost and the value provided by the agent. For example, a fixed percentage commission gives agents a bigger incentive to close deals quickly rather than fight for incremental price improvements, even though those small improvements can mean tens or even hundreds of thousands of dollars for the homeowner.

Most real estate solutions today focus exclusively on reducing costs without considering the value an agent may—or may not—bring to the table. A study of nearly 100,000 real estate transactions in the Chicago area revealed that agents sold their own homes for an average of 3.7% more than the homes they sold for clients, largely because they left their homes on the market an average of ten days longer. So, while lowering commission fees may seem appealing, it can also overlook the bigger picture.

Homeowners are best served by partnering with an expert agent who prioritizes their best interests—someone focused on achieving the highest possible sale price while charging a fee that accurately reflects the value they bring. While this may seem both straightforward and challenging to accomplish, changing how homeowners hire and compensate their agents can lead to meaningful and impactful results.

Incentive-Based Commissions: Aligning Interests for Better Results

Financial incentives are powerful forces in shaping human behavior. Homeowners may not realize that the status quo approach of using a flat percentage commission incentivizes agents to close a deal quickly, often with less focus on maximizing the sale price. A better approach for most homeowners would be to use an incentive commission where the agent's commission varies with the sale price. This approach has several distinct advantages:

1. Financial incentive to get the best price: The agent has a strong financial motivation to get the best price.
2. Insight into agent's skill: It allows homeowner to gauge an agent's estimate of how much they expect to sell the property for.
3. Increased accountability: Agents are held accountable for the results they deliver, not just what they say they can do.
4. Greater trust: Financial incentives between the agent and the homeowner are more closely aligned.

As an example, consider a home worth around $1 mm. It's quite likely the home will sell between $950k and $1.05 mm, the exact price depending on various factors. A reasonable incentive commission might be a fee of 1% up to $950k and then 20% of all proceeds above $950k. At $950k, the agent gets 1% or $9,500. At $1.05 mm, the agents gets $29,500 or 2.8%. The agent's pay varies by over 3x depending on how strong of a result they help achieve.

Critics might argue that since the market largely dictates home prices, the agent shouldn't be rewarded disproportionately. However, while the market is beyond anyone's control, the choice of agent is not—and that choice can have a meaningful impact on the outcome. If an agent truly doesn't matter, then minimizing their fee is the goal. But if the agent does have an impact, an incentive-based commission will yield superior results.

For comparison, under a traditional percentage commission structure of 2.5% for the listing agent, an agent would earn $23,750 on a $950k sale and $26,250 on a $1.05 million sale—a far smaller difference. Typical commissions reward mediocre agents and discourage high-performing ones, while an incentive-based system rewards agents who deliver superior results.

Competition and Accountability: Unexpected Benefits of Incentive Commissions

Beyond improving financial incentives, incentive-based commissions offer other benefits, such as increased agent accountability. In the example above, agents who achieve great results earn more, while those who fall short provide the homeowner with a better rate. While some might worry that agents will set a low threshold to increase their incentive payout, this issue can be turned into a feature by introducing competition among agents. Several agents should each be asked to propose an incentive price, knowing they're being compared to others. This forces them to set a price based on what they truly believe they can achieve.

This competitive approach levels the playing field, allowing homeowners to compare agents more objectively. In this way, an incentive-based commission structure encourages agents to take on the risk of their own performance. Their earnings will depend on how effectively they deliver results, and their proposed incentive price reflects their confidence in achieving those results.

For homeowners, this means more transparency and accountability from agents, as well as an objective framework for comparing them. The incentive-based structure creates a win-win situation: agents are financially motivated to achieve the best results, and homeowners benefit from a system that puts their interests first.

Implementing an Incentive Commission Structure

The biggest barrier to adopting an incentive-based commission structure is simply awareness. Homeowners need to understand that not only are real estate commissions negotiable, but they can also be structured in ways that best serve their interests.

Beyond competition, meeting with multiple agents is important to understand what a home is worth. Our research shows that when three agents are asked to estimate the potential sale price of a home, the average spread between the highest and lowest estimates is 8%. Not interviewing multiple agents increases the risk of mispricing a property—either leaving it on the market too long or selling for less than it's worth.

While incentive commissions are great for homeowners, we've found simply asking an agent if they're open to an incentive-based structure can often serve as a litmus test for how willing they are to align their interests with their clients. Additionally, we've found that high-quality agents are often the most willing to use such a structure. These agents appreciate accountability and the opportunity to bet on their own abilities while seeing competition as a means of allowing them to win business from less capable competitors.

At ListWise, incentive-based commissions are our sole focus. We provide a turnkey solution that makes it easy for homeowners to compare agents, create competition, and establish an incentive-based structure with the agent they choose. For those who prefer a more hands-on approach, we also offer a DIY guide on our website that outlines the steps anyone can take to create their own incentive-based commission system.