Profitability in an era of post-NAR declining commission percentages

Results

After reviewing the finances in depth for 100 randomly selected companies, AccountTECH found that when commission percentages drop to 2%, then 79% of the brokerages in the study will be unprofitable. Even with a modest drop to 2.5%, then 60% of the test subjects would be unprofitable.

The study examined profitability based on both agent count and the number of storefronts maintained by the companies. As expected, companies with more storefronts are the most challenged. The results show that for companies with 3 storefronts, only 14% will remain profitable if commission rates drop to 2% per side.

The study based its forecasts on 3 assumptions:

• Commission “splits” between real estate agents and their companies will remain static
• total commission volume will remain the same
• operating expenses will remain at current levels

It is not clear that any of these three assumptions are reasonable in the near term. The reality facing real estate brokerages is that commission volume per agent is not likely to remain at current levels - given the buyer-side commission changes that are expected in the upcoming NAR settlement. Additionally, broker/owners are already proactively responding to the expected changes in the market. Both commission split programs and operating expense structures are being examined and re-designed. The industry is well aware that going forward, the market changes are going to make their current business models untenable.

Based on agent count, the data shows predictable patterns in the likelihood of profitability. For larger companies in the study with between 100 - 5,000 agents, the study shows that 88% will be unprofitable at a 2% commission rate. The data shows that for certain sized offices, the impact of reduced commission rates is going to come sooner than expected. For instance, the analysis shows that companies with between 50 - 75 agents only have a 50/50 chance of being profitable when commission rates drop to 2.75%.

Jim Fite, owner of Century 21 Judge Fite, has one of the few companies in our study that is already set up to remain profitable regardless of commission rates. Mr. Fite literally wrote the book on how to be successful in difficult economic times ( Success Through A Recession ). In response to this study, he gave examples of how his company stays prepared for the next real estate market, including:

• We know our numbers – weekly on Thursday morning at 8:00 am we review all numbers from all departments and companies that we own.
• We review each lease when the expiration date is 9 months out – do we renew, move, remodel or merge with another office?
• After the pandemic – we realized many of our staff could and loved working from home, therefore, we reduced our back-office footprint/square footage preparing for the future. NOTE: The service level of our clients and real estate professionals have made every deadline and service levels have actually increased with happy clients and employees.
• Months in advance of a “cycle or outside force” we start seeing where we can reduce expenses even more than above.

Summary

This research underscores the need for most brokerages to undergo a major re-invention of their business models and overhead. For many years, there has been increasing pressure to provide agents with ever increasing share of the commission revenue. This has caused gross profit margins to decrease to a nationwide median of 15%. If commission rates charged to sellers does eventually move downward, the decrease in top line revenue is going to make existing business models harder to maintain. As ICA contracts between brokers and agents have steadily chipped away at gross profit margins, many in the industry believe that the NAR settlement changes will further challenge brokerages with a likely impact top line revenue.

On the expense side, labor and occupancy expenses have been static or trending upwards since the end of the pandemic. While pandemic restrictions taught brokerages that they can operate virtually, that realization has not translated to reductions in staff or occupancy expenditures. Once commission rates begin to decline, it’s difficult to see how US brokerages of any size can be profitable if commission splits stay where they are and operating expenses remain at current levels.

Assumptions

Since every real estate company offers a different value proposition to real estate agents, the study assumes that regardless of the business model, geographic location or operating procedures - all brokerages can be compared by using their Profit and Loss reports.

Brokerages that pay agents very high commission splits will have a high Cost of Sales, but usually lower labor costs and expenses because they need to offer fewer services to remain profitable. On the other hand, brokerages that pay agents a more modest commission percentage will likely have higher expenses because they provide more services and facilities to agents. In either case, the Profit and Loss report reveals the impact of decisions made about a brokerage’s business model and operating overhead structure.

The study was based on a “best case” scenario. This means the study does not assume any reduction in Buyer side commission income. Instead, AccountTECH assumes that the commission volume will remain unchanged and that the commission split between the brokerage and the agent will stay the same. The only change parameter in the study is the percentage charged to the Seller and Buyer. The data examined profitability at every commission rate between 3% and 2%.