Understanding Commission Cap in Real Estate

When managing real estate investments, it is important to properly understand the concepts used in the industry.

Sales commission is among such concepts.

Sales commissions refer to a percentage of a transaction shared between the agents who handle a property’s purchase.

In the case of a brokerage and an agent, commission (also known as split) is the percentage of an agent’s commission that goes to the brokerage.

Continuously splitting commissions from earnings can become cumbersome for agents, and many eventually become demotivated and discouraged.

Hence, many companies decided to cap sales commissions.

But what exactly is a commission cap? How does it work? What are its benefits and drawbacks?

We’ve provided a comprehensive answer to these questions.

What Is a Commission Cap?

In real estate, commission caps refer to a limit on how much money a real estate agent can pay their brokerage within an allocated time.

Once the real estate agent hits that ceiling, they won’t need to pay commissions off any sale they make. They’ll only be required to pay a processing fee to the brokerage.

Unlike most other instances of commission caps, which impose a limit on the money that sales reps can earn, in real estate they are one of many sales incentives designed to encourage agents to close more sales.

Consider this example:

Let’s say Mr. A works in a real estate brokerage with a commission cap of $12,000.

The commission rate is 70/30, i.e., the agent takes 70%, and the broker takes 30%.

In his first deal, Mr. A sells a house, makes a real estate commission of $10,000, and gives his brokerage $3,000.

In the same year, he sells another home and makes a commission of $15,000. This time he gives his broker $4,500.

In his third sale for the year, he makes a total sales compensation worth $30,000.

Ideally, he should remit $9,000 to his broker. However, his commission cap is $12,000.

So instead of giving his broker $9,000, he’ll give his broker $4,500 and keep the rest of the commission.

Any other sales he makes within that year will also be all his. He won’t have to pay commission again.

Let’s take another example of Mr. B. He works in the same brokerage as Mr. A. Even though he closed 5 deals that year, he only remitted $10,000 to the brokerage.

Mr. B’s inability to meet the commission cap means he had to pay a percentage of the commission he earned that year to the brokerage.

Commission caps differ with brokers and are usually reset after a year. This is typically the beginning of a work year or on the agent’s anniversary.

Types of Commission Caps

Different commission caps exist depending on the model implemented by the brokerage and the market conditions.

Individual Agent Cap

In this sales compensation plan, every agent is responsible for hitting their commission cap alone.

This commission cap is best for high-performing agents who are very sure of their ability to close enough transactions.

Team Caps

Team caps are usually applied to a group working as a sales team.

In this case, the goal is for the team’s collaborative effort to reach the commission cap.

Once they do, each team member starts keeping 100% of their earnings.

This model is best for high-volume markets. It’s also a good way for new talents to ease themselves into the market.

By partnering in teams with experienced agents, lower-performing agents can fine-tune the skill of closing deals.

Market-Based Caps

Market-based caps are most common when a brokerage has several properties with varying values.

In such cases, the market value and conditions determine the commission cap.

Variable Caps

Some brokerages offer variable caps. In these scenarios, an agent’s commission cap is determined by their sales performance and work experience.

For instance, a brokerage may offer a commission cap of $30,000 to an agent and a commission cap of $20,000 to another.

Brokerages use this when they have agents with varied experience levels.

Advantages of Commission Caps

Commission caps offer several benefits to brokerages and agents.

Higher Earning Potential

Commission caps allow agents to earn more money annually.

Once a real estate agent hits their commission cap, they no longer have to split their earnings with their broker, increasing their annual income.

Motivation for Agents

The potential of hitting a ceiling where they no longer have to pay commissions encourages peak performance.

It motivates them to close more deals at a faster rate. Motivated agents also provide better services to investors, as they are eager to hit their cap.

Access to Top Performers

Top-performing real estate agents are more likely to opt for capped commissions.

This is because the more deals they close, the closer they are to not having to split their commission with their broker.

As a result, brokerages that offer commission caps are more likely to attract high performers.

Encourages Collaboration and Teamwork

Team caps encourage collaboration and teamwork among agents. It also makes it easy for team leaders to scale their operations.

The possibility of everyone enjoying 100% commission once they hit the cap pushes them to collaborate more effectively.

Boosts Business Growth

Commission caps boost business growth. This structure gives agents more incentive to close high-ticket deals to hit the cap faster.

Because there is an obvious reward for their efforts, they are more willing to invest in the tools and development they need to grow in their career.

Disadvantages of Commission Caps

Despite the advantages, commission caps can have adverse effects.

High Initial Commission

To make up for agents reaching the cap and stopping sharing their commissions, brokerages tend to request high commission splits.

The percentage slip can range from 30% to 40% of the agent’s earnings.

Unhealthy Pressure to Perform

A flip side of high motivation is an unhealthy pressure to perform. Some agents may struggle to reach the cap, leading to frustration.

If care isn’t taken, commission caps create a competitive and stressful work environment.

Affects Brokers Revenue Generation

Capping commissions can lead to the brokerage earning less revenue.

Setting a cap on commissions means the broker will continue to provide services to the agent even though the agent’s commission payouts cease once they reach the cap.

As a result, applying a commission cap may not be sustainable for small or upcoming brokerages.

If agents cap too early in the year, the brokerage may find it hard to run operational costs for the rest of the year.

Potential for Hidden Costs

To reduce potential revenue losses, brokers may insert hidden charges like advertising fees, monthly desk fees, transaction fees, etc.

These additional fees, in the long run, can hurt the agent’s financial turnover if they hit their cap and stop remitting commissions.

Challenging for New Talent

New talent and moderately skilled agents may struggle with closing deals and hitting the commission cap.

These talents may end up with the short end of the stick, i.e., remitting a significant percentage of their earnings without benefiting from the commission cap.

Effects of Commission Caps on Real Estate Investing

Commission caps are a vital part of real estate investment.

For an investor, caps can significantly affect the transaction costs and the quality of service you receive from an agent.

An agent may be more willing to reduce their commission percentage once they’ve hit their commission cap.

This gives you, as an investor, more negotiating power.

This also means that you, as an investor, may end up paying lower closing costs.

Final Thoughts

Commission caps give high-performing agents a chance to boost their earnings while allowing brokerages to attract top talents.

As an investor, commission caps may give you more negotiating power and help you save on transaction costs.

Physicians Thrive has a pool of finance experts who can help you with the guidance you need to make quality decisions.

Contact us today, and we’ll provide expert advice on real estate investments.