12/11/07: Defining Sales Price To Determine The Commission

Housing Counsel

By Benny L. Kass

Q: We engaged a real estate broker to sell our house and signed a listing agreement. We were obligated to pay a 5 percent commission based on the sales price. The broker found a potential buyer, but in order to convince him to sign the contract, we agreed to give a 3 percent “seller concession”.

As we understand the situation, in order to allow the buyer to get a larger loan, the deed will be recorded at the $500,000 price, and the $15,000 will be shown as a seller credit. Now, our broker has advised us that his commission will be based on the full $500,000 price, even though we will not be receiving that amount. Is he correct?

A: This is a hot real estate topic, especially in areas where sales are sluggish. Many sellers are discovering that if they want to sell their house, they have to provide some sort of monetary concession to their buyers.

In my opinion, if your broker did not discuss and explain the commission difference before you signed the contract, you only have to pay him based on the lower price.

The amount in question is only $$750.00. No one wants to go to Court on such a small amount, and to my knowledge, there are no court cases on this specific issue. There are, however, many court decisions involving the definition of “contract price” – but not really helpful to this discussion.

But it is a matter of principle – as well as principal. Why should you pay a commission on money you will not get at the settlement table?

For many years, the amount of the real estate commission was included in the sales contract. In recent years, however, the real estate industry has taken the position that the contract should only recite that a commission will be based on the terms of the listing agreement. This is a separate legal document entered into between the seller and the real estate broker, which spells out the terms and conditions – including the amount of the commission- under which the broker will be working.

Many real estate brokers take the position that by including the commission as part of the sales contract, that makes the broker a party to the contract, which they do not want. Brokers also argue that it is unethical to include the amount of the commission in the contract.

Accordingly, many real estate contracts now only state that the commission to be paid is based on the listing agreement. For example, the Regional Sales Contract, drafted by the Greater Capital Area Association of Realtors (GCAAR) for use in the Washington metropolitan area, contains the following language:

Broker’s Fee: Seller irrevocably instructs the Settlement Agent to pay the Broker compensation (“Broker’s Fee”) at Settlement as set forth in the listing agreement…

But there is a counter-argument to the Broker’s position, namely that the only reason that the commission is not spelled out in the sales contract is to hide that information from both buyer and seller. One real estate broker from Virginia advised me that “the brokers did not want the buyer to see what the brokers were getting paid as the buyer might think he was overpaying and back out of the deal”.

I was curious to learn what the industry’s position was on this issue, so I sent the question to a real estate related computer “list serve”, monitored by law Professor Pat Randolph from the University of Missouri at Kansas City. The responses were numerous and varied. Some real estate brokers insisted that the commission be based on the price which was recorded in the local country records – in other words the full $500,000. One broker advised me that the listing agreement was a contract, and since the seller agreed to pay the commission based on the sales price, the Seller was legally obligated to pay on the full $500,000. This broker suggested that sellers “avoid a litigious dispute and pay the brokerage based on the gross price”.

Professor Randolph responded: “Don’t you question the ethics of a broker who negotiates a discount in the price in the form of a “concession” and then demands a commission on that amount? Maybe the broker ought to avoid a ‘litigious dispute’ and take the commission it deserves.”

Perhaps the most constructive response came from a New York real estate broker. He wrote: “I usually base the commission on the net amount after Seller’s concession unless my Seller client directs me otherwise. I know my Listing Agreement states that I am entitled to a percentage of the Selling price, but I find it is good business to make adjustments as necessary.”

What are seller concessions? In our example, the seller was prepared to reduce the price the $15,000 (3 percent) in order to keep the buyer. This is a common marketing tool, which has been in existence even before the “subprime mortgage meltdown”.

It should be noted that most lenders will allow a concession to be given to the buyer so long as it does not exceed a certain percentage of the overall purchase price. Usually, the ceiling is between 5 or 6 percent.

There are other “concessions” that are involved in a real estate transaction. The seller may pay some or all of the buyer’s closing costs; the seller may escrow funds for repairs to be made to the property. The seller may pay the recordation and transfer tax on the entire property. Clearly, all of these expenses take money out of the pocket of the seller.

If before you signed the sales contract, the real estate agent gave you a sample settlement statement showing that the commission you will have to pay will be based on the full $500,000, that would be acceptable. Disclosure solves most disputes, and in my experience many real estate professionals do provide such advance information to their clients.

But if there was no discussion before you were legally obligated to sell your house, I believe that you should only pay the broker based on the reduced price. Setting aside any legal arguments, that, in my opinion, is the only fair way to resolve this matter.

– Boilerplate –