Over 40% of agents are associated with a franchise brokerage according to NAR. A large limitation for traditional brokerages was moving from one geography to another. This is why many brokerages are locally focused. Franchises helped solve this problem. Brokerages could spread their existing business model and marketing through the franchise. But regulatory work, sales, and operations are placed into the hands of a local leader. Cloud brokerages modernize this approach. They use technology to remove offices traditional brokerages required.
For a quick summary, a franchise is simply a business system. It provides ongoing marketing, technology, and brand support. In exchange the local brokerage operator, or franchisee, pays fees. Usually those fees are a percentage of revenue, and some flat fee per agent, per office, or both.
A franchise makes attracting, retaining, and improving agent performance predictable for local owners. For a franchisor such as Keller Williams, there is little risk in adding a new franchisee. Franchisees typically pay a fee as a percentage of their revenue. Usually this is called a royalty fee. It can be up to 10% of gross revenue. This number is sometimes capped per agent. This means a franchisee will pay no more than a certain amount per agent they employ. Then there is also startup and ongoing flat fees. These can include technology fees, educational fees, and marketing fees. Ultimately, the franchisor gets paid whether the franchisee is successful or not. Of course, the franchisor gets paid more if the franchisee is successful.
Franchisees are often former broker owners or team leads. They love real estate and building teams. But they don’t want to create training materials, manage business documents, or develop branding assets. This is where most of the costs come in for franchisors. For example, RE/MAX collectively spends over $118M in selling, operating, and administrative expenses annually. And part of this spend is to personnel who then allocate $73M in annual franchise marketing fees. Other spend goes towards administrative work, marketing collateral, and centralized support. RE/MAX corporate handles national marketing on behalf of its franchisors. In exchange, local franchisors handle the operations of a regional team. They make payments to RE/MAX. They recruit and train agents on RE/MAX systems. And they manage offices.
Cloud brokerages lack offices. Franchises helped overcome the need to launch and operate hundreds of offices one-by-one. Cloud brokerages get around this by not having offices. It means their costs are substantially lower than a traditional brokerage. And their agents demand fewer resources. For example, an agent without an office will not require printers and office administrators.
Many of the top franchisors have standardized commission splits. This was popularized by Keller Williams. The standard split for a Keller Williams agent is 70%. RE/MAX recommends a 95% split to franchisees. There is also a commission cap. This cap means that after a brokerage generates a certain amount of gross commission income, their split moves up to 100%. This cap means an agent never pays above that amount in commissions. For example, let’s say an agent has a 70% split with a $30,000 cap. If they generate $100,000, they pay the brokerage $30,000 ($100,000 x 70%). But if they generate $150,000 in GCI, they still pay $30,000 because of the cap. This does two things:
Many cloud brokerages use this model. eXp Realty has an 80% commission split and a $16,000 cap. Real has an 85% commission split and $12,000 cap.
But there is a second payment outside of commission splits. These are flat-rate fees. This is also taken from the model of many franchises. RE/MAX has agents pay around $400 in annual fees. Virtually all cloud brokerages have monthly or transaction-based fees. This is especially important for brokerages with 100% splits for agents. For example, Fathom Realty charges $450 per sale on the first 12 and $99 on each sale after. Fathom Realty boasts a 100% commission plan. The $450 essentially takes the place of a percentage commission split. Real has a .05% processing fee on each sale. eXp charges $85 per month for month for technology and $65 per transaction up to $500. These monthly or per-transaction fees help cover legal, transaction, and technology costs for the brokerage. If an agent isn’t doing enough business to generate substantial commissions, they still pay fees to support the work they generate for the brokerage.
Cloud brokerages also borrowed profit sharing from popular franchises like Keller Williams. An agent receives some amount of company profit or shares based on agents they recruit. There is usually a lot of complexity in the structure. A quick summary is agents receive a portion of the profits or revenue that an agent they recruited generates for the brokerage. It incentivizes existing agents to recruit new ones. At a traditional brokerage, an agent does not have a financial incentive to do this. This structure means an agent can make money not just by selling homes. They can also focus on recruiting and training productive agents. This removes a key cost of acquiring agents. Traditional brokerages have inside sales agents and sales managers that help drive recruiting.
For a quick finance review there are fixed costs and variable costs. Fixed costs occur no matter what. Variable costs occur for each new unit you have. So if you have an office, it’s a fixed cost: you pay the lease each month. But a cell phone plan for each person in the office would be variable: you only pay when you have a new employee. The struggle of traditional brokerages is high fixed costs. You need an office and support staff regardless of the numbers of homes sold. This makes underperforming agents expensive. You still have to provide them with office space that a better performing agent could be using. And once agents perform better they will want more competitive splits. But franchises and cloud brokerages limit fixed costs. They don’t lease local office space or hire new teams to support untested agents. This means that a low-performing agent can still be profitable for the company. I’ll illustrate this with RE/MAX and Fathom Realty, as both have public financials.
RE/MAX generates around $2,600 per agent in fees for their core regions. $1,850 comes from annual dues and franchise fees from agents and the franchisees. Only $750 comes from agent performance, which RE/MAX calls broker fees.
Ultimately, this means that RE/MAX is generating over 75% of its revenue based purely on agents existing. Even if agents generate $0 in sales, RE/MAX would retain 75% of its revenue.
The important question is how much it costs to support an agent. To do this math, we need the number of agents and the total expenses for RE/MAX. According to their annual report, they had 130,889 agents at the end of 2019 versus 124,280 at the end of 2018. Let’s average those to estimate the number of agents RE/MAX supported throughout 2019 at 127,584. For expenses, we’ll take the selling, operating, and administrative expenses only. We will exclude their marketing fund (it is money passed from franchises to corporate to be spent on advertising). RE/MAX spent ~$119M in selling, operating, and administrative expenses in 2019. Dividing that by the average agent count gets you $932.70. That means each agent costs $932.70 to support.
Remember, RE/MAX generates $1,800 per agent before the agent even sells a home. At worst, agents are generating almost $900 in profit just by existing. While there is nuance to this calculation - some regions are less profitable than I present - it is illustrative of the model.
We’ll look at Fathom Realty’s S-1 for a sense of how the cloud brokerage model works. They are a 100% commission split, all-fee model, which makes the math easy to follow. They charge a $500 annual fee, a $450 per-transaction fee. Transactions cost $99 after the first 12 sales.
In 2018, Fathom employed 2,724 agents compared to 1,734 the year before. We’ll take the average of those to assume that Fathom supported 2,229 agents throughout the year. Fathom generated ~$77.3M in total commissions in 2018. But they paid back 73.4M to agents after commissions but taking out per-transaction fees. This means that Fathom took in ~$3.85M in fees from their agents in 2018. That would mean each agent on average paid ~$1,725 in fees (3-4 transactions per agent).
Collectively, Fathom spent ~$3.8M in operating expenses in 2018. But almost $1M of this was in salaries of the top three officers. As a result, we can reduce total operating expenses to something closer to $2.8M. This divided by the average number of agents means the average agent cost ~$1,250 to support. This low cost means each new agent is generating ~$500 in profit. Support costs are so low because there are no offices. Technology development is outsourced to other companies for a small fee. Of course, if an agent has only one transaction Fathom does lose some money. But this is a low hurdle to clear.
Most traditional brokerage owners are worried about underperforming agents. Underperforming agents generate low commissions. But they still cost a good amount to support. An agent that only does one deal in a year may only bring in $2,000 in commission splits to the brokerage. But they may cost $4,000 in office space alone. As we've discovered, franchise and cloud brokerages eliminate this business risk.
But traditional brokerage owners get more upside from successful agents. Franchises and cloud brokerages almost always have commission caps that limit upside. This is the core tradeoff these companies make. They limit the risk of low-performing agents. But they lose the upside of unlimited commissions of top performing agents. And this makes sense because top agents would want higher service levels if commissions were not capped. This means a cloud or franchise brokerage does not have much incentive to have a top producer increase their volume by $100,000. But picking up another 20 agents who contribute any fees is a large win. In summary:
While franchises refined this model, cloud players are certainly enhancing it. Keller Williams, the top franchise company in real estate gained ~4,000 agents from 2017 to 2019. eXp, added almost 20,000 agents in that time (6,000 agents at the end of 2007, 25,000 by the end of 2019). Pure franchise models will likely continue to account for a large number of agents. But cloud operators will become more prevalent in the next few years. And many franchises are already integrating this model into their business.