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This article was published on: 01/01/2004

FOR BROKERS: Compensation plans


BY ROBERT FREEDMAN

Looking closer at associate costs
Identifying actual costs
Match splits to costs
Realistic look at savings

Calculating costs: as easy as e=mc2

Janice Grupido, CRB, GRI, would like to rely on a little less art and a little more science in setting compensation plans each year for the 40 associates who work in her two offices in the Troy and Rochester areas of Michigan. Ideally, the broker-owner of Countryside GMAC Real Estate would look at what each salesperson consumes in brokerage resources to generate revenue.

That’s a challenging thing to do. Yet, it’s becoming more important as brokers look more to treating each sales associate as a separate profit center, each of whom comes with a unique set of costs and an ability to generate revenue.

“Start with a view that each associate operates as an individual company; then you try to determine if each individual generates more revenue than it costs to keep the person on board,” says David Cocks, managing partner of Charlotte, N.C.–based Compensation Master, a consultant on real estate brokerage compensation plans.

That approach differs from what’s done typically in residential real estate brokerages, where setting compensation plans requires a bit of alchemy—part art, part science. For the most part, brokers apply a desk-cost approach that might be likened to the way a manufacturer sets the price of a product based on its per-unit production costs. If each unit costs $1 to manufacture, then to earn a profit the manufacturer must charge something above $1 for each unit.

That’s more or less the approach taken by Shorewest, REALTORSŪ, an 18-office independent brokerage based in Brookfield, Wis.—although what goes into the calculation is more complex. “All of our costs are divided by the number of desks,” says Rick Murry, CRB, GRI, a regional manager. “That’s how we establish the minimum income we need.”

In taking this approach, brokers isolate their fixed costs and then peg commission splits to the amount of variable costs associates are responsible for. In general, the more variable costs covered by the broker, the bigger the broker’s share of the commission split.

Thus, you often see brokers splitting commissions on something close to a 50–50 basis at the beginning of the year, then raising that split once associates’ revenue covers their share of fixed costs and they can assume responsibility for more of their variable costs.

Looking closer at associate costs
Treating each associate as a separate profit center goes beyond the desk-cost approach by identifying variable as well as fixed costs.

Although zeroing in on precise amounts is difficult, brokers aren’t entirely in the dark about what their associates cost them.

Marian Benton, GRI, operating principal of Keller Williams Realty in Ann Arbor, Mich., says she needs to generate $18,000 each from at least a third of her 176 associates to ensure her fixed costs are covered. “We look at rent, overhead, leased equipment—everything—to see how much money we need to break even,” says Benton.

To create an income cushion, she sets her annual budget assuming that one-third will earn enough in gross commissions to meet the $18,000 in commission splits to the company, the splits of another third will reach about half that, and the splits of the remaining third—mainly newer associates—will reach a few thousand dollars.

The splits to the brokerage are set annually as a percentage of gross commission income, and there’s flexibility in how the percentage is set. Many associates take a 70 percent split until the 30 percent contribution to the broker equates to $18,000. Once that happens, they get 100 percent of their commissions. They may also opt for a higher, 80–20, split, up front in exchange for guaranteeing the $18,000 to the brokerage before the end of the calendar year. On top of the $18,000, each associate pays a franchise fee, which is capped at $3,000.

Unlike offices in many other real estate companies, though, Benton doesn’t need to worry too much about the amount of variable costs generated by her associates. In the Keller Williams model associates mostly pay variable costs themselves, even making spending decisions collectively through a salesperson council. The council works with the broker to determine the services it wants and how to allocate the costs among the ranks. “If they want a color copier or an extra fax line, they can have those, but they pay for those types of costs,” she says.

Getting the commission split right becomes more important when the broker pays all or a portion of associates’ variable costs. Those are harder to peg to individual associates than fixed costs, which can simply be allocated on a per-person basis.

At the same time, brokers can face market pressures on where to set commission splits, and those pressures can lead to split levels that won’t necessarily accord with what makes sense for your company.

“If every other broker in your area is offering associates a 90 percent split, you must consider offering a 90 percent split, whether or not that makes sense from a cost standpoint,” says Grupido. “About five years ago, we had a 50–50 split that graduated up to 80 percent depending on volume; then there was a big push in the market to drive that up, and that push still hasn’t dissipated,” she says. “Now associates can get up to 90 percent.” But she’s not bringing in new people at that split; they have to work for it.

Identifying actual costs
Getting compensation right becomes particularly important when associates seek help from brokers on big-ticket items, such as personal assistants, or when they have sales teams.

A desk-cost approach to compensating associates with a personal assistant can miss the mark, even if the associates pay the assistants from their share of commissions, because of the way the assistants raise costs to the brokerage.

“The associates may say the assistants don’t cost the broker any more, but those assistants need to have a phone line and they use other services,” says Cocks. “In the accounting department, someone has to cut them a check, and the broker is still responsible for them, even though they’re working under other associates.”

Costs from personal assistants can be even more of an issue if an associate taps a less-productive associate in the office to be the assistant. That’s because the broker’s increased commissions from the associate with the assistant might not be enough to compensate for the loss of the commission from the low producer.

“If the low producer is doing $12,000 in gross commissions a year and is paying the broker a 50–50 split, that’s $6,000 you would need to recover if that person goes to work for another associate,” says Cocks. And that may not be that easy to do. “If the other associate is on an 80–20 split, that person would have to generate much more business from the assistant than $12,000 for the broker to recover the $6,000.”

Match splits to costs
When it comes to top producers, splits can require even more finesse.

To be sure, the large volume that top producers generate can help a brokerage in many ways, including intangibles such as the increased visibility that comes from getting more signage out into the market. Go-getters can also help you up your ancillary income by sending more referrals to, say, your mortgage services. But if splits don’t adequately reflect costs, top performers can still be a losing proposition for brokers.

Cocks recounts one case in which a broker gave a highly advantageous split and other perks, including use of a company car, to a top performer. The salesperson in fact brought in tremendous volume, but when the broker analyzed the arrangement, the findings were startling: The brokerage was absorbing a $45,000 annual loss on the person. It wasn’t until the broker conducted a detailed accounting review that it became clear the cost of the perks were far more than the company splits the associate generated. It made more sense to let the associate go and bring in other associates, at lower splits, to replace the lost volume. And that’s what the broker did.

Realistic look at savings
You need to look carefully at associate savings as well as costs. Clearly, an associate working from home costs a broker less than one occupying office space. But how you price such savings is tricky.
With the exception of lower occupancy costs—maybe a few thousand dollars a year, depending on where the office is and whether the company owns or rents its space—costs tend not to drop, says Cocks. That’s because the associates are still big consumers of brokerage resources, and the fixed costs for such services as phone lines and utilities don’t change.

Plus, the drain on some resources can increase, such as the time a broker spends supervising. “You’re making more calls, sending more e-mail,” says Grupido.

Cocks says it’s possible for brokers to get a relatively clear picture of what each associate costs them and to customize compensation plans to each associate based on those figures. His company sells a proprietary software program that calculates what each associate generates in variable costs. The company also touts a survey it conducted among a sample of its clients, both 100 percent and commission-split companies, finding broker revenue increasing almost by a third in the first year of implementing compensation plans for associates based on estimates of what those associates cost to maintain.

Some of Compensation Master’s findings:

  • Average pretax profit: 6.1 percent (not counting ancillary income)
  • Average company dollar: 39.1 percent
  • Average revenue increase: 31.3 percent

Those are strong figures when pegged against comparable industry figures, Cocks claims. Anecdotally, average company pretax profit industrywide is 2 percent to 3 percent, according to David Colmar, head of Colmar and Associates in Rancho Santa Fe, Calif., a real estate research firm. Average pretax profit tends to be higher, near 6 percent, for the country’s top performing companies, Colmar says.

Limiting brokerage costs to just fixed costs can also produce stronger brokerage profitability.

At Keller Williams, average brokerage share of gross commission income is considerably less than in the 500 largest brokerages in the country—16.8 percent at Keller Williams offices compared with 29.2 percent for other companies—according to Dave Jenks, vice president of research and development at Keller Williams Realty International, based in Austin, Texas. Jenks compared Keller Williams figures with industry figures compiled by REAL Trends, a residential real estate information provider.

But Jenks says the company’s pretax profits are higher because its brokerage expenses are lower. For the 500 largest companies, brokerage costs average 25.7 percent, leaving a 3.5 percent pretax profit. Costs at Keller Williams offices are 9.6 percent of GCI, which leaves a 5 percent pretax profit after 2.2 percent of income is taken off the top for a company profit-sharing program.

The analyses suggest that accounting for variable costs is the key to setting compensation plans that maximize brokerage income. So, whatever mix of art and science you use to set your plans, make sure you have a clear picture of how much your associates cost you.





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