Building a sustainable and profitable commission plan is crucial for any brokerage, as it ensures that your business can weather both market fluctuations and changes in your make-up of agents. A well-designed plan aligns the interests of both broker and agents, safeguarding the brokerage’s bottom line while creating incentives for success.
But how do you ensure that your commission structure holds up under different scenarios? Stress testing your commission plan is an essential practice that can help you anticipate potential financial pitfalls before they arise. You’ll want to brush up on your spreadsheet skills for this.
By the end, you’ll know how to test your commission plan under a variety of market conditions and recruitment scenarios to ensure long-term profitability.
Why Stress Test Your Commission Plan?
Stress testing is the practice of simulating different extreme conditions to understand how your commission plan will behave. Here are two primary areas to consider when stress testing:
- Market Conditions: These include changes in the real estate market, such as price increases (inflation), price decreases (recession), or flatlining market growth. Does your commission plan still result in profitability for the brokerage under these varying scenarios?
- Recruitment Conditions: This involves examining different agent scenarios, such as having a few agents versus many agents, or having a mix of high and low producers. Does your commission structure ensure profit for the brokerage regardless of agent performance levels? Finally, does it push top-producers out the door because at their production your commission plan no longer benefits them?
Fixed and Variable Costs to Consider
To get a complete picture of profitability, your stress test should factor in both fixed costs (e.g., rent, utilities, licenses) and variable costs (e.g., software subscriptions that increase with the number of agents, marketing expenses). Pulling a prior 12-month report from your bookkeeping/accounting software will be a great way to be sure you’re capturing all those recurring costs.
Market Conditions Stress Test
1. Inflation Scenario: Rising Costs, Flat Revenue
A big risks in flat fee commission plans is in keeping up with inflation. Rent, utility bills, vehicle and software expenses tend to increase over time. If your commission structure doesn’t adjust, you may find your brokerage becoming less profitable as expenses rise.
Test Scenario: Suppose your brokerage charges a flat $700 per transaction an agent closes. Just three years of 3% annual inflation, makes that $700 worth roughly $640. Your brokerage will have to increase sales volume by at least 3% every year just for your company profit to remain flat over time.
Key Consideration: Ensure that commission fees either rise with inflation by adjusting annually, or that you have enough profit built-in to absorb increasing costs for a period time before having to make adjustments.
2. Recession Scenario: Price Drops, Reduced Transactions
In a recession, housing prices typically fall, the volume of transactions may also drop, and agents may even leave the market. Can your brokerage still turn a profit if fewer agents are selling fewer, lower-priced properties?
Test Scenario: Knowing that your fixed costs remain the same, you’ll want to calculate roughly how many transactions or how much sales volume you’ll need to keep the lights on and the doors open. You can see how sensitive your profits are to a downturn in the market.
Key Consideration: By testing worst-case scenarios, you can decide if you need to adjust commission plans during a down market to maintain profitability. Or know what contingency plans to have in place, should a market start heading towards your bottom-line.
Recruitment Conditions Stress Test
1. Agent Count & Production
It’s important to test how your commission plan holds up with a small number of low producing agents by calculating brokerage profitability, as compared to profitability with a small number of high-producing agents.
Likewise, profitability with a high number of agents (20x your current size) as low producers as well as high producers. These four profitability numbers will show you if your commission plan begins to break-down when shifting in a certain direction.
Test Scenario: What if a high-number of low-producing agents stresses your profitability the most? This can be an issue created by variable costs that increase with headcount, which you’re not charging your agents for. For example, an e-signing or CRM system that charges you per seat.
Key Consideration: Control excess headcount by having a production requirement. If an agents doesn’t do X deals per month or year, they’re removed from brokerage. This reduces having to deal with agents that just want to hang their license for the infrequent personal deal. Another option is to add a modest flat, monthly fee due any month an agent doesn’t close a transaction.
2. Successful Agent Retention
It’s equally important to consider what happens as your brokerage matures, and you have long-time agents that have become your top producers. Does you commission plan just keep charging agents more-and-more, the more they produce? Or does it taper-down so that high-producing agents would be less incentivized to commission-shop other brokerages. A simple solution to this is following a cap-split commission plan, which introduces a new wrinkle. What if your top producer blows your expectations of the water, they hit their cap within weeks and now you’re left processing their transactions for the rest of the year for free. The resolution there is a hybrid cap-split plan with a small fixed administration fee per closing, on all closings, regardless of their cap.
Conclusion: Make Stress Testing a Regular Practice
Stress testing your commission plans for different market and recruitment scenarios is an essential practice that ensures long-term profitability. By simulating these conditions and running simple tests, you’ll gain valuable insights into how your brokerage can maintain its financial health through changing times. Whether it’s adjusting for inflation, preparing for a recession, or scaling your agent base, proactive stress testing will help safeguard your business. If you had 5 agents the last time your ran such scenarios, and now you’re at 50 agents… time to re-run all the scenarios, such as calculating if the brokerage grows 10x again and you end up with low-producers in a descending market.
By routinely analyzing your commission plans, you can adjust and optimize them for sustained growth, no matter the market conditions or size of your firm.