Real estate commission: who pays, who receives and how much

by Kirthi Hewamanna

Real estate commission is a professional fee usually paid by the seller (vendor) to an agent (broker) for successfully negotiating a transaction. This remuneration is a percentage of the sale price, lease price or the exchange value of the property.

The percentage of the commission can vary from three per cent to as much as six per cent as in developed countries where the industry is regulated by the Ministry of Commerce, Real Estate Boards and Realtor's Associations. In these countries, only the registered real estate professionals (agents), real estate consultants, lawyers and developers' sales staff, can legally benefit from a real estate transaction. The commission is shared by the agents involved.

The real estate profession should be based on the agency relationship. When a broker is authorised by a seller to market his property, the broker becomes the agent of the seller. One of the most important terms in any real estate agency agreement is the commission (or fee) which the agent is to receive for his services. The real estate commission and the terms of the contract should be stated in a listing agreement.

The Listing Agreement is a verbal or written contract (agreement) between a property owner and an agent, authorising the agent to offer the owner's real property for sale or lease. In this contract the commission payable (usually a percentage of the amount involved) and the expiry date should be stated.

In Sri Lanka most of these agreements are verbal. It is best if the Listing Agreement is a written contract, for the protection of both agent and the seller. It can be a simple agreement drawn up and signed by the two parties.

When this procedure is not followed, it can lead to confusion and disputes when commission payment time comes. Most fraudulent activities also take place when there are no professional real estate agents involved in property transactions.

If there is no Listing Agreement, a short contract between the seller and the agent should be signed stating the amount of commission payable. This should be done before the seller's acceptance of the purchaser's offer. There are three different forms of agency relationships in real estate and they are Seller's Agency, Buyer's Agency and Dual Agency.

The Seller's Agency is the most traditional and common agency relationship. The seller usually contacts a realtor (agent) when he decides to sell his property.

The role of the seller's agent is to market the property and enlist the help of other agents to sell it. In such circumstances another agent can bring an offer from a purchaser. If the offer is accepted by the seller, the commission will be shared by the two agents. This is where the two agents work together to achieve the goal of selling the house.

In a Buyer's Agency an agent is hired by the purchaser to find him a suitable house. For this service the buyer pays a commission to his agent. The obligation of the buyer's agent is to select the best possible house for the buyer and negotiate the best price for him.

In this case, he should not receive a commission from the seller or seller's agent as he is exclusively working in the best interests of the purchaser. The agent gets adequately compensated by the purchaser for his service.

In Sri Lanka, usually, the buyers do not hire their own agents and depend only on the seller's agent. For example, in one instance, the seller's agent conveyed to the seller that the prospective purchaser had just returned from overseas, and that the money is no problem to the buyer.

Taking the opportunity, the seller immediately increased the price from Rs. 10 m and sold the property for Rs. 14 m as the purchaser had no idea of the market price. If he enlisted the services of an independent agent and agreed to pay three per cent of the value of the property he would have saved a substantial amount. In addition, this created problems when establishing a fair market value for the properties in the area.

In a Dual Agency, the agent will be working for both seller and buyer. In such circumstances the agent must inform the buyer and the seller that he will receive commission from both parties.

This is acceptable if both seller and buyer think it is a 'win-win' situation, and effort by the agent is commendable, and should be rewarded. This usually happens when the property is unusual or special, and will attract only a few purchasers for various reasons, and he has to put extra effort to find the 'right' buyer. In Sri Lanka, real estate commission varies from three to four per cent of the selling price and it is shared among the agents involved in a transaction.

Some agents set their own standards and are selective when they undertake listings. They deal only in properties of a certain price range, in certain areas and certain types of properties (eg. residential, commercial, industrial and plantations) some agents deal only in rental properties.

When a real estate transaction is completed there are numerous hangers on and unauthorised people demanding commissions from buyers, seller and agents. This includes people who give directions to the property, caretakers who open the house for the respective purchasers and other workers who are present when the house is shown, and the list goes on!

There are also people who give the name of a respective purchaser to an agent and expect a substantial portion of the agent's commission, having done nothing to facilitate the sale. They have no idea of the amount of work involved in putting a transaction together.

However, most agents do 'look after' the people who give 'leads' and referrals in appreciation for the help they receive. There are many problems that have arisen in the real estate trade in recent years in Sri Lanka. This is due to the fact that there is no proper procedure followed. This can be avoided if the trade is regulated and more organised.

The buying and selling public and others who are involved in real estate transactions must recognize that the professional realters make a valuable contribution. This will prevent most forgeries and corrupt practices.

Therefore it is time that a professional Realtors Association is formed and a Real Estate Institute is established to train real estate agents in Sri Lanka. In addition the real estate business must be regulated by the Ministry of Commerce. However, these boards and associations must be allowed to function independently.

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