Update: This was an April Fool’s Prank!

In what can only be classified as bad timing, a handful of real estate agents at Dewey Cheetham and Howe Realty have announced plans to adopt the now infamous “two and twenty” fee structure popularized by hedge fund managers on both sides of the border. (It should be noted that two former hedge fund managers recently took an ownership position with the firm).

The Two and Twenty Fee Structure

Hedge fund managers have long used a two and twenty fee structure (or other variants, like one and twenty, for example) which means that they would collect an annual 2% management fee based on assets managed in the fund, and they could potentially take another 20% performance fee of the fund’s return over and above a certain hurdle. For example, if you had a Canadian Equity hedge fund whose benchmark was the TSX and the fund returned 20% when the TSX returned 10% for the year the fee to the investor for that year would be 2% as a base, and then an additional 20% of the 10% excess return of the fund over the TSX index’s return. In this case the performance fee would be 2%, which when added to the 2% base fee equals a total annual fee of 4%.

Initially Cheaper, But Over The Long Term

Well, now this model is being applied to real estate commissions. The firm has not posted any example calcuations, so let me throw one up. Let’s assume you buy a house today worth $300,000. Let’s further assume that you sell that house in 5 years for $400,000. The initial commission for a traditional real estate agent would be 5% of the sale price, or $15,000. With a two and twenty structure, the agent is only getting 2% of $300,000 (or $6,000) up front. BUT 5 years later, when you sell your house for a gain, that original agent is also entitled to 20% of your gain – or 20% of $100,000 – for another $20,000 pay day (but they waive their 2% on the second transaction). So what initially sounded like a healthy savings in commissions ($6,000 upfront versus $15,000 upfront) turned into a raw deal ($26,000 over 5 years versus $15,000 once). Also note that not only would you pay $20,000 in commission to the original agent upon the sale of the house, you would also potentially pay 2% upon the sale to a new agent if you didn’t retain the services of the agent who had helped you purchase that house in the first place.

This is not a step in the right direction.

…Happy April Fool’s!