12/15/09: When is a Real Estate Commission Earned?
By Benny L. Kass
Q: We plan to sell our house early next year, and have been talking with a number of real estate agents and brokers. We believe we can sell our house for about $600,000. We have been advised that the real estate commission will be between 5 and 6 percent, which could cost us up to $36,000. When exactly do we have to pay this to the broker?
A: When a homeowner decides to sell his/her house, they have several options. The most common approaches are to try to sell it themselves, without using a real estate agent or a broker, or to engage the services of a real estate company.
If you opt for the latter approach, you should make sure that you are satisfied with the person who will be your agent. Inquire of that person as to his/her experience, and knowledge about the area where your house is located.
Once you have selected a real estate agent to help you sell your house, you will be asked to sign a "listing agreement" with that person or company. There are different kinds of listing contracts:
1. Open listing -- this means that you agree to pay a real estate commission only to the broker or agent who finds a buyer for you. If you personally sell your house by yourself -- or through some other agent -- the holder of the open listing is not entitled to any commission.
2. Exclusive listing -- this means that you have given the exclusive right to an agent or broker to sell your house. Regardless of who sells the property, the person holding the exclusive listing is entitled to a commission.
While brokers periodically do enter into open listings, the exclusive listing is most commonly used. Brokers and agents do not want to spend a lot of time -- and money -- marketing your house, only to learn that no commission will be earned because you or someone else has sold it.
A signed listing contract is a binding, legal document. You should read it carefully before it is signed. Some standard form listing agreements provide that the commission is earned when the broker presents a ready, willing and able purchaser to the seller and a real estate contract is entered into. Accordingly, whether or not the buyer actually goes to settlement, the real estate agent would be entitled to his/her commission. However, in the Washington Metropolitan Area, the listing agreement specifically adds that the commission is only earned if "the buyer performs and settles on" the real estate contract.
Keep in mind that often there are two agents involved in a real estate sales transaction -- the listing agent and the selling agent. The selling agent may have had no previous contact with the seller; he or she is working with the potential buyer. (They could also be buyer's brokers, which will be the subject of another column).
What happens if the buyer is not able to go to closing? First, you have to determine the reason why settlement did not take place? Was the buyer rejected for financing and does the contract contain a financing contingency? If so, then the buyer may be entitled to a full return of the earnest money deposit and the broker will not be entitled to anything.
On the other hand, if the buyer just decided not to buy the house - or did not comply with lender's requirements - then the buyer would be in default. In that case, you as seller have three alternatives.:
- You can keep the earnest money deposit. Keep in mind that the escrow agent holding this money cannot automatically release the funds to you unless the buyer signs a written release.
- You can sue for damages. Let's say that the sales price was $400,000, and after the buyer defaulted, you were only able to sell the house for $350,000. You have $50,000 in damages, plus any carrying costs that you incurred before the second sale, such as mortgage interest payments, real estate taxes and insurance
- You can sue the buyer for specific performance. You go to court and ask the Judge to force the buyer to go to closing.
Litigation is time consuming, expensive and always uncertain. Accordingly, most sellers - when facing a default situation - will opt just to keep the deposit.
But under the listing agreement you signed, the brokers are entitled to half of this money.
The listing agent may very well be willing to waive its claim for a commission if the buyer does not go to settlement, since the seller may allow that agent the opportunity to try to sell the property again, thereby earning a commission.
However, the buyer's agent - and/or the selling agent -- will not have this opportunity, and will in most cases demand that the seller pay a commission, based on the language of the listing agreement.
Accordingly, even though the language is included in many listing agreements, it is recommended that sellers add the following language into the basic listing agreement:
The commission will not be earned until and unless settlement actually takes place, unless the buyer defaults in which case the brokers are entitled to one-half of the earnest money if forfeited. However, if seller has to litigate, the broker is not entitled to any commission.
I know this is controversial. However, if the seller has to spend a lot of money in court to get damages or the deposit, I do not believe it is fair nor appropriate for the brokers to get a commission unless they are prepared to contribute to the cost of the litigation.