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[FREB] Thoughts On Commission Splits

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As many of you already know, we officially published our Black Paper on the Future of Real Estate Brokerage on Friday. The response has been gratifying, to say the least.

But in an effort to keep the Black Paper an actual paper, instead of a paperback book, we (that is, Sunny) cut a lot of words out. They should have been cut out, of course, but the nice thing about having a website is having the ability to expand and expound on some concepts that aren’t as central to our thesis, but are useful and interesting to discuss.

So the [FREB] tag — Future of Real Estate Brokerage. I plan on using this to talk about ideas and concepts from the Black Paper and expand on them.

First up is one of the most important issues, as it came up time and time again during the research, feedback, and initial discussions of our idea: commission splits. We understand that it’s difficult for many experienced brokers to wrap their minds around the whole 7DS Firm model. It’s such a different way of looking at things. And this is the topic where we’ve seen it the most.

Let’s get into it.

The Difficulty of Thinking Differently

Thanks to Steve Jobs and Apple, we celebrate those who think differently. I mean, that was the actual marketing slogan for Apple for years, right?

But it’s not easy to do, because we’re all creatures of habit and experience, and we get set in our ways… because they work and always have.

With real estate brokerage, the single biggest mental block for broker/owners who think about the 7DS Firm model is the idea that they would voluntarily lose agents. They have spent so much time and have gotten so good at recruiting and retaining agents that the notion of actively trying to get smaller just boggles the mind.

For example, during our development of the Black Paper, we corresponded with a few broker-owners. One talked about one of his agents — we’ll call her Susie Soccermom — who is a new, part-time agent. (I’m calling her Soccermom because the broker literally described her as the “ideal, perfect soccer mom.”) Susie isn’t going to make partner; her production and rainmaking abilities are not there, and it isn’t likely to get there while she’s focusing on raising a family. Susie herself doesn’t want a full-time job, because her priority is her family.

Susie did $5 million in sales, and the broker made $40K from her production, because she is on a very broker-friendly split as a new part-timer. Why would he get rid of her? And $5 million isn’t chump change; Susie is driven and ambitious and an excellent agent; she’s not going to join some top producer’s team, or go on salary. He didn’t see (and won’t see) why he’d forego not just Susie’s $40K, but all of the $20K, $30K and $40K pieces his brokerage makes from these “diamonds in the rough” since to the extent that his brokerage is profitable at all, it’s due to these decent-but-not-great agents he has managed to recruit at a broker-friendly split ($40K from $5 million in production at 2.5% commission rate is 68/32… so we’ll call it 70/30 split).

This broker has a point. Why leave that $40K on the table?

Think of Splits Differently

The core issue here is that this broker and we think of  splits differently. He thinks of the broker split, and sees it as revenue. We think of the agent split, and see it as expense.

Susie did $5 million in production. The GCI is $125K. On a 68/32 split, Susie’s piece is $85,000 and the brokerage piece is $40,000.

The broker looks at that and thinks, “We made $40K on Susie!”

We look at that and think, “You paid a part-timer $85K!”

I feel like brokers and brokerages have been beaten down so much by the Re/Max agent-centric revolution that they don’t think of the GCI as “theirs” anymore. The GCI belongs to the agent, and the broker is taking a piece of the agent’s commission. But the rest of the business world thinks of the GCI as belonging to the broker, and the agent split as a Cost of Revenue.

Take Realogy’s NRT as the best example of this. In Q3/2017, the NRT posted $1.3 billion in revenues and $52 million in EBITDA. That $1.3 billion in revenues is the GCI from all of the production. (Realogy claimed splits in the 70% range in its earnings call, by the way.) At least to Wall Street, Realogy can claim all $1.3 billion in GCI as revenue.

But mentally, I wonder if local NRT management thinks, “We made $390 million in revenues!” since that would be the NRT’s split on a 70/30 basis. Like the broker above, NRT managers are experienced, accomplished brokerage operators who grew up in the system we have today.

Beyond Glass Half Full and Glass Half Empty

There is a part of me that thinks, maybe this is just an optimist-pessimist deal, where the broker sees the $40K and sees revenue while I see the $85K and see expenses.

But only a part, because that mentality, that mindset, of the broker infuses everything about the brokerage industry.

When you think of the broker split as revenue, it’s because you know that business isn’t yours. The agent generated the lead, the agent has the relationship, the agent did the deal, the agent closed the transaction, and you took a piece of it. Maybe you reviewed the contract to make sure it’s copacetic. Maybe you did some rah-rah exhortations, or gave some advice to the agent, but really, the agent did everything and you benefited by taking a piece of the action.

That’s pretty much how real estate brokerage works today. Brokers recruit and retain; they don’t actually manage, because the business isn’t theirs to begin with.

Conversely, look at how the Team Leader of an agent team thinks. Without her, without her listing, there is no lead to send to a buyer agent. Accordingly, the agent team leader mentally (subconsciously maybe, or very consciously) thinks of the lead/client as belonging to her. So she thinks of the buyer agent split as an expense (consciously or otherwise), because the business is hers to begin with. That’s a big reason why agent teams don’t do crazy 95/5 splits.

This isn’t just a half-full/half-empty deal. It really is a different way of looking at the business, coming from a different reality about the business, and resulting in different outcomes. The brokerage is lucky to have 3% profit margins; the agent team often has 25-30% profit margins.

Rethinking Commission Splits

Let’s go back to the case of Susie Soccermom above.

If you rethink commission splits as expenses rather than as revenues, a few things happen.

Evaluating Potential

First, you look at Susie’s actual situation at the beginning, before she did $5 million in production. She’s the “ideal, perfect soccer mom” as the broker said. Is she deeply and widely connected? What’s her background before becoming the ideal suburban soccer mom? What’s her personality like?

Susie Soccermom could have been a big time corporate attorney before having kids and choosing to stay home, with a rolodex full of wealthy people, whose husband is the mayor of the town and the president of the local bank, whose network is both wide and deep. Maybe she’s an outgoing social connector type personality who everybody can’t help but like.

Or she could be a young woman who never worked, is kind and sweet and wonderful… but is a little bit shy, introverted, with a few close friends. Her network is limited to her church and a few neighbors.

Those are two different profiles in terms of potential for real estate success. Maybe the first Susie is someone the broker can estimate would do $5 million before she did it. Is the second Susie?

Evaluating Past Performance

Second, you look at how Susie got to $5 million in production.

Whatever Susie’s profile is, how she got to $5 million in production is important to think about.

Was it a single $5 million deal that fell into her lap because she won the Zillow lottery? That’s not likely to be replicated time and again.

Or did she door knock neighborhoods, work the phones ceaselessly, and got to $5 million in $300K chunks? That’s very much replicable.

Did she get to $5 million because of leads from the broker? From her best friend who is a super listing agent at another company? Did she source the leads herself?

There are hundreds of factors to evaluate past performance, and the objective is to determine whether Susie’s performance was a fluke or a consistent trend.

Projecting Future Performance

Third, you project forward into what Susie could become. After all, you think of her split as an expense to you, so you have to think about ROI, like any expense.

If her $5 million was because of a single lucky deal, there is no telling whether she can replicate that. If it was because of hard work and a deep network, then she can.

Now add in proper management. Is Susie the kind of person who can be managed effectively? Or is she a lone wolf type who has to have things her way or the highway? Those personalities are not the easiest to work with, whether as an employee or not, and the psychological cost to you and the cultural cost to the office is something to consider as well.

The Critical Question

Having done all of that, now you have to ask yourself the critical key question: How much am I willing to pay Susie?

If Susie walked into your office today and asked for a $85,000 annual salary as a part-timer, would you agree? That’s what you paid her last year; are you willing to pay her that for this year?

If you’re not, then you overpaid her with the commission split.

You spent too much to get the revenue. And that’s how you end up with 3% profit margins on 15% Company Dollar.

The Lose-Lose

What makes this situation even more bizarre is that the commission split is a lose-lose situation for Susie and for the broker.

Susie’s split was $85K; the broker’s split was $40K.

What was their actual take home pay?

I guarantee that Susie’s take-home pay wasn’t $85K. Because she had to pay for all of the expenses for that $5 million in production, whether that’s yard signs, dues and fees, marketing costs, advertising and promotion costs, technology costs, driving people around her personal vehicle, and all of her taxes.

As we wrote in the Black Paper, the average agent team leader claims 25-30% in profit margin after all expenses are paid. On that basis, Susie’s actual net take-home pay was $21,250 on $5 million of production. That’s $425 a week, working 20 hours a week on a part-time basis.

It’s not bad for a part-time gig, and Susie can have some spending cash or add to the family budget… but she’s not supporting a family of four with that. It’s below the poverty line of $24,600.

The broker makes 3% profits on 15% Company Dollar, or 1:5 ratio, so that $40K the broker got from Susie translates to $8K in profits (or 6% of GCI, since he has her on a high 70/30 split… for now…) after the broker has paid for all of his expenses of running the brokerage.

That $5 million in production suddenly looks pretty crappy, doesn’t it? Because it is. It’s a lose-lose for both Susie and for the broker.

This isn’t just speculation and extrapolation from the case of Susie and this broker. It’s real life.

Sunny recently worked with an agent who closed 30 transaction sides in 2017, her third year in the business. That’s remarkable, isn’t it? Her Sales Volume was over $4.5 million, and her GCI was over $110K. Her net take-home after all was said and done? $31,000. She made just over $1,000 per transaction.

This woman, unlike Susie, is full-time. She worked her ass off, like most full-time agents do, averaging 60 hours a week because Realtors don’t get weekends off.

She could have worked at the local Buc’ee’s (a Texas tradition you need to experience) as a hourly Team Leader and made more, with health care and benefits.

That’s a lose-lose.

The Win-Win

Flip that around to the 7DS Firm model.

Would Susie take $40K in salary as a part-time W2 agent? It’s double her net take-home. Unless she’s driven by ego — in which case, you have to ask whether you want that kind of personality in your company at all — of course she will.

Now the broker isn’t paying $85K and keeping $40K; he’s paying $40K and keeping $85K. Now his profits aren’t $8K but $17K, even at the crappy 3% on 15% margins. Except, the broker has scale, operates a business for a living (unlike Susie), already has infrastructure in place, and can generate far better incremental margins.

That is a win-win scenario, and that’s what our model preaches and predicts.

Conclusion & Takeaway

Obviously, your situation may be different because your market is different from Susie and the broker’s market. Your competitive situation might be different. We can’t say for sure without running our analysis on your financials.

But the point is that all of this analysis, all of the changing a lose-lose to a win-win begins with embracing that simple yet difficult thing: thinking differently about the commission split. Far too many brokers think of it as revenue, focusing on the broker split piece; far too few think of it as an expense, focusing on the agent split piece.

To be fair, it was never the broker’s business to begin with, so the way they think of commission splits makes perfect sense. Again, the comparison to the agent team is illustrative, because for the agent team leader, it was her business to begin with.

We’ll tackle that issue in a future post, to more clearly explain how the 7DS Firm model changes that dynamic by leveraging partners. But it is all there in the Black Paper; go ahead and take another read-through if you’d like.

Thanks for reading, and all your questions and feedback are, as always, welcome.

-rsh

 

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Rob Hahn
Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

1 COMMENT

  1. Great article Rob. I would add this to the mix. To cause any change in the issues surrounding “splits”, brokers need to make a fundamental change in branding. Not in the style or look of the brand but in terms of what the brand stands for in the eyes of the consumer. Agents control millions of consumers because they have built a brand or created a relationship directly. With just one or thousands of potential consumers. If a broker wants the business of any of those consumers they need to “go through” the agent. As long as the agents control those consumers – albeit with their fragmented brands and random offerings – the broker is forced to hire the agent in order to access that agent’s sphere of consumers. And to sustain the expense of the extent of the split that results when that sphere does business with the agent at that brokerage. If on the other hand, a broker were to create something more meaningful and of greater value for the consumer, something that is formatted that is promised and provided by their brand, the broker might be able to build its own sphere of consumers. Independent of the agents. Consumers that “show up” at the brokerage in this case would in contrast be assigned to an agent as directed by the broker. Think relocation, REO, new homes business models. Control of the consumer through a corporate relocation offer, the offer of a unique new home product or the offer of a distressed property under management and sourced on Wall Street. Today the industry is almost totally void of any such unique brokerage offering – but if that were to change – so would many other factors that today have to do with shared revenue or expense.

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