Trying to Make Sense of RE/MAX

Q3 earnings are starting to come out, with Realogy, Zillow and RE/MAX reporting and Redfin and EXPI coming soon. I’m likely going to do a Red Dot on the important takeaways from Q3 (and there are a few, from what I can tell right now) but I typically don’t do RE/MAX in any sort of depth. The main reason is that my interest in doing those in-depth analyses is to look at issues confronting brokerages and technology and the blend of the two. Franchises are a step removed from both, so I’ve never found RE/MAX all that illuminating for trying to figure out what’s going on beneath the surface of the industry. I look hard at Realogy because it owns the NRT, the largest brokerage in the country.

But RE/MAX remains an important company in the space, and they are a public company who does earnings calls, so there are things to learn by looking at them.

The problem for me right now is, I can’t make much sense of what’s coming out of RE/MAX. They’re doing well, at least by the numbers, but things aren’t adding up for me. So I figured I would learn what I think by reading what I wrote…. Let’s do this together, shall we?

The Numbers Look Good

RE/MAX posted very respectable numbers for Q3/2018:

• Total agent count increased 5.4% to 123,905 agents
• U.S. and Canada combined agent count increased 1.2% to 85,698 agents
• Over 100 Motto franchises sold and almost 70 Motto franchises opened since inception
• Revenue increased 11.8% to $54.9 million
• Net income attributable to RE/MAX Holdings, Inc. of $8.1 million and earnings per diluted share (GAAP EPS) of $0.46
• Adjusted EBITDA of $29.5 million, Adjusted EBITDA margin of 53.7% and Adjusted earnings per diluted share (Adjusted EPS) of $0.65

Those all seem pretty solid. 11.8% increase YOY in Revenues, and in particular, the 119.0% increase in Net Income strike me as good performances. If what I’m seeing on Yahoo Finance is correct, RE/MAX beat consensus earnings by $0.03 in Q3.

$57 million in net cash from operations seem fine, and a nice increase YOY of 6.7%. And after spending what appears to be about $25.9 million for acquisitions (booj, in all likelihood), RE/MAX is sitting on $51.3 million in cash.

So, What’s the Problem?

Given that performance, it should be a case for celebration and calling stockbrokers to buy RE/MAX shares, no? But it’s not. Since announcing Q3 results, RMAX is down from $38/share to $33.60/share, a drop of 11.6% (as of this writing). What gives?

Who can say how Wall Street thinks for certain, but there are a few obvious things going on.

Market is Slowing

The first and most obvious factor is that the real estate market is slowing. We heard this from everybody connected to residential real estate who have reported so far, including Realogy and Zillow. I imagine we’ll hear it from Redfin and EXPI as well.

From the earnings call transcript (SeekingAlpha):

However, from our perspective the September drop was bigger than anticipated. The decline in home sales year-over-year was largest since May 2011. And September became the 7th month of 2018 to record lower sales than the comparable month of 2017. Results vary by geography but many of the larger western cities including Seattle, Denver, Portland, and the major California metros experienced the largest sales declines.

Despite the change in market conditions, we don’t believe it’s cause for concern. Even if sales have tapered, September posted a median sales price of $241,000, marking the 30th consecutive month of year-over-year price increases based on MLS data for the 54 metro surveyed. That is the highest September price in the 10-year history of our report.

I’m gonna go out on a limb and say that despite Adam Contos’s reassurances, Wall Street did think it was a cause for concern. Especially since many of them heard more or less the same thing from all the other real estate public company CEOs.

Recruiting is Down

The second, and RE/MAX-specific, factor could have had to do with their lack of success in recruiting. Here’s Adam from the call:

No matter what else may be happening in the real estate space, RE/MAX continues to attract and develop the industry’s top producing professionals and those aspiring to be. That consistency remains a defining characteristic of our brand and value proposition.

…

However, our agent growth in the U.S. has come down. Initially we were anticipating agent growth approaching 2% this year but now we are on a lower growth environment and now expect flat to slightly positive agent growth in the U.S. for the full year 2018.

Given that RE/MAX’s business model is entirely dependent on agent count, that’s not good news. And the rationale for the decrease is… well.. weird:

Looking at the U.S. market we think our current agent growth rate is largely attributable to 2 factors, the rebalancing market and the unprecedented competitive environment, a factor we have mentioned frequently. The drop in September closings coincided with a small decline in our U.S. agent count.

Agent count results often vary in the final 4 months of the year, sometimes resulting in a net loss during the off-season. Like any good entrepreneur, our brokers more carefully assess their businesses at the first sign of choppiness in the market. We know some of our brokers are being more mindful in their current recruiting and retention efforts. Further, the competition for the best agents is as fierce as it’s ever been. As we’ve stated before, the number of new well-financed, well-marketed competitors with varying business models is unlike anything the industry has ever seen. We are often asked if any one competitor in particular is having a greater effect on our business. In general the answer to that question is no. No one specific competitor is making a material difference.

However, the increased amount of competition overall has had an impact. [Emphasis added]

Why is that a weird rationale?

Fundamentals of Competition in Real Estate

Longtime readers know we’ve covered these topics at length in this blog, but let me do a quick refresher about some fundamentals of competition in residential real estate.

Agents Pay Brokers

First, with rare exceptions (think Redfin), brokerages do not pay agents. Agents pay brokers, by way of a split. “Recruiting” is just another way to say “Sales” when it comes to brokerages, and to franchises whose business model depends in one way or another on agent headcount.

So when Adam Contos says that some of the RE/MAX brokers are being “more mindful” in their recruiting and retention efforts, that just doesn’t sound right unless “more mindful” is a different way of saying “obsessively focused on”. If the market is slowing, there are fewer transactions, leading to less revenue for the brokers, their response would/should be to recruit as many damn bodies as they possibly could. Those agents are not a labor workforce whom the broker has to pay; they are customers who pay the broker all kinds of fees plus potentially a split on commissions if they close a deal.

Is RE/MAX suggesting that its brokers have slowed down their sales efforts, because the market is softer? That makes no sense at all.

RE/MAX Controls Recruiting?

Furthermore, it’s weird when Adam leads off the whole bad news on recruiting section with “RE/MAX continues to attract and develop the industry’s top producing professionals and those aspiring to be. That consistency remains a defining characteristic of our brand and value proposition.”

I admit that I haven’t read RE/MAX’s franchise agreements. Maybe there’s a clause in there that says that franchisees agree to get permission from RE/MAX corporate before bringing on a new agent to make sure that said agent is a “top producing professional” or someone “aspiring to be”. (As an aside, is there anybody coming into real estate thinking, “You know, I really want to be a mid-level mediocre professional”?) But I don’t think so. I’ve never seen such a clause, because that would mean very few brokerages would buy a RE/MAX franchise in the first place, and under various laws and legal precedent, that could make RE/MAX itself a vicarious employer of all of those independent contractors working for independently owned and operated franchisees.

Zero Sum Game

Second, real estate is a zero-sum game. Here’s something I wrote back in 2015 on this issue:

Ever since Netscape introduced the general public to the Internet, and AOL made “email” somewhat mainstream, the business practices of real estate have completely changed. Remember, Zillow and Trulia weren’t even founded until 2006 or so; right in the middle of the Bubble inflating.

And yet, home sale numbers have remained right around 5M units; higher during the Bubble years, lower during the Crash years, but hovering right around that mark.

The point is this: There is absolutely nothing that the real estate industry does that affects the housing market.

Even if some brokerage somewhere were to come up with a novel new business model charging $5 flat fee to buy and sell homes, that doesn’t transform a guy on unemployment into a potential buyer. That kind of screwup requires the federal government working hand-in-hand with Wall Street.

Since only macroeconomic factors affect the housing market, anything within the industry itself means someone has to lose in order for someone else to win:

If an agent leverages technology, smart lead management, and topnotch service to increase production from selling 20 homes to 50 homes, then other agents in her market will be doing 30 fewer transactions. A broker making $100M more in revenues has to get that from somewhere — other brokers, from higher agent splits, somewhere. They don’t affect supply and demand; only macroeconomics does.

Similarly, if a vendor in the real estate industry becomes successful, that success must come from somewhere. It has to get a larger share of the Commission Pool, which necessarily means that someone else has to get a smaller share.

This fact of life — the zero sum game — makes the rest of RE/MAX’s earnings call all kinds of interesting… and problematic.

All In on booj

At a high level, the RE/MAX earnings call tells a story that goes something like this (all my interpretation of what I heard and read):

Our recruiting was bad, but that’s not a problem. RE/MAX brokers only hire the best agents in the business, and those who aspire to be the best. So as the market is turning soft, our brokers are slowing down the recruiting to be extra-careful. Plus, competition is really, really fierce. But we have the best value proposition in the business, and we’re doing something to add to that, since the best value proposition is no longer enough to hit our recruiting goals. Let’s talk about booj, this marvelous game-changing technology.

Yes, I’m leaving out Motto Mortgage for now. I have nothing interesting to think or say about that program.

So let’s talk about booj. Or rather, what booj represents, since I’ve never used booj and don’t care to. And yet, I’m still going to opine on booj. How can I do such a thing? Because if booj truly were something unique and novel that the industry had never seen before, instead of yet another “platform” that cobbles together marketing, CRM, lead routing, blah blah blah… I’d have heard about it long before RE/MAX came along to acquire it. Inman News would have been all over that for years if booj were something truly unique, like iBuyers.

So here’s what I think booj likely is: a very nice, likely well-designed piece of software that does what dozens of other very nice, well-designed piece of software out there does. If I am wrong about that, I invite real estate CRM and web development companies to write in declaring their surrender to booj due to its inherent superiority that they cannot hope to match. For example, Boomtown, Contactually, Moxiworks, etc. should announce they are closing their doors forever since booj exists.

Nonetheless, here’s Adam on the amazingness that is booj:

This was the first time many of our brokers got a look at the booj plans for developing a comprehensive ecosystem of RE/MAX technology on one platform. All of the booj sessions were filled to capacity and brokers like what they saw. After previewing the ecosystem plan, which is a data-driven platform where agents will create marketing campaigns, nurture customer relationships, evaluate leads and more, one broker called the platform “totally game changing for RE/MAX.” Others shared his excitement. Another broker said there’s no question his agents will be excited when they see the platform.

And finally, a third broker remarked it’s going to be a powerful system, superior to what our competitors have. Alpha testing on the initial CRM product will begin soon with beta testing following in the spring of next year and a staggered rollout slated to begin in the summer of 2019. As product development progresses, our franchisees and many agents are excited to be highly involved in the process.

That sounds pretty amazing, doesn’t it? I mean, yes, one does wonder why that one broker who called the platform “totally game changing” did not bother to purchase and implement booj before RE/MAX acquired it, since booj has been around for quite a while and not been keeping its product a secret… but I digress. One also wonders how that third broker knows booj is superior to what competitors have, but maybe said third broker is a technophile whose hobby is to review real estate marketing platforms and have joined every other franchise system out there to suss out what tech is and is not superior to another piece of tech. But I digress.

But I don’t really digress, because that’s sort of the point, isn’t it? RE/MAX says booj is a total game changer that’s going to make recruiting a matter of selecting the very best top producing agents who will kneel at the feet of the RE/MAX broker who has access to booj praying desperately, “Pick me! Oooh, pick me!” But Realogy says Zap is the same thing. Keller Williams says its upcoming suite of amazingness is that. Compass says its in-house platform is the shiznit and how top producers are lining up to throw money at Compass to get access to that gamechanger-ness. (Well, maybe money is being thrown the other way, but what difference does that really make, right?)

In fact, the only brokerages that don’t say something like “our technology is a total game changer” are some of the 100% guys (who say instead, “You keep all your money, so you go buy yourself whatever game changer tech you want”) and W-2 brokerages like Redfin (who say instead, “We’re gonna hand you a paycheck, and you’ll use our technology whether you like it or not”). Other than those guys, every single broker, every franchise, and every software company claims to have the game changing awesomeness that will have agents desperate to join to get their hands on this Holy Grail of real estate technology.

Turns out that Wall Street analysts are extraordinarily polite on earnings calls, but they’re not stupid. Here’s one question from Jason Deleeuw of Piper Jaffray:

Jason Deleeuw

Good, that’s good to hear. And then, I was just wondering if we could get kind of a higher level just strategic update. I mean, there’s a lot of volatility going on in the real estate industry from a volume standpoint and with all the capital that’s come in. But your business model is steady and you’re continuing to grow. So there’s always opportunity in that volatility. I know you have the booj effort and — but is there anything else strategically that you’re thinking about that you could be opportunistic on?

Adam Contos

Good morning, Jason, it’s Adam. You’re right. There is a lot of opportunity in the marketplace. And I just spent the past 6 weeks traveling around North America speaking with a lot of our brokers about that. The marketplace is busy. There’s a lot of noise. There are a lot of people that have entered the marketplace because it is opportunistic. That’s evidence that we’re in the right place. So we look at it as — we’re doing the right thing.

We’ve been continuing to heavily reinvest in the company, particularly with booj, which we’re really excited about, as well as with Motto. We’ve made a lot of strides, as I talked about in the earlier part of the call. And we’re super excited about Motto, we’re super excited about booj, and I think our network is as well.

So right now what we do with all the volatility is we flex the strength of our network. And the top-producing agents continue to see that this is the place to be and in fact I’ve been communicating with one that just joined us for all of these same reasons recently. So it’s a time for those to focus and to really hone in on the things that matter in this space. And that’s when you see the separation in the marketplace between the high-producing and professional organizations and those that dabble in the business. [Emphasis added, and line breaks added for legibility]

So, the answer to the question of “higher level strategy” turns out to be “really hone in on the things that matter in this space” which is odd since RE/MAX just failed to hit its recruiting goals, which is presumably one of those things that matter since RE/MAX calls it a key performance indicator.

And the answer to “What else you got besides booj?” turns out to be, “We got booj!”

I’m actually not kidding when I say that from the earnings call, it almost seemed as if the answer to every question was “booj”. One analyst asked about company lead generation efforts from remax.com and asked for an update. Adam’s answer was that they’re proud of their web presence, and then:

So we continue to work in the laboratory to maximize those opportunities, which is one of the things that we’re really excited about with booj is the lead processing, the CRM and lead management that occurs that we’re — we’ve been working with our agents and brokers on further development for. So it’s going in a good direction. We’re happy with it. But we’re really, really excited about what we have to offer with the booj platform when it comes to that.

If booj is the answer to all questions, including “high level strategy” in a volatile market, then we have problems, Denver.

Problems with Betting on Tech

Start with the premise that RE/MAX has gone all-in on booj, on a “unique” technology platform as its key value proposition and key strategic initiative. There are, as I count, three problems with this. And it’s not limited to RE/MAX, but to every brokerage and franchise who think the same way.

Are You Fast Enough?

RE/MAX says that they plan to rollout booj by summer of 2019:

Alpha testing on the initial CRM product will begin soon with beta testing following in the spring of next year and a staggered rollout slated to begin in the summer of 2019. As product development progresses, our franchisees and many agents are excited to be highly involved in the process.

Staggered rollout is “slated to begin” in the summer of 2019. Just as a point of comparison, let me give you a quote from the Zillow earnings call:

Sure. So, yeah, last time we spoke, we were about a quarter of the way rolled out with PA 4.0. Today, we’re about 70% of the way rolled out with PA 4.0. And then there are two changes in PA 4.1. One is reducing the screening questions. That is already complete, so all 70% of the country that is on PA 4.0 in that regard is on that aspect of PA 4.1. The second aspect of PA 4.1 is giving agents back those up-funnel leads. These are consumers that say they’re not ready to connect with an agent, but they will be soon. We’re doing that in the next month – sorry, the next week or two. And so within the next two-ish weeks, 70% of the country will be on PA 4.1, and then we’ll move the last 30% of the country before the end of the year from PA 3.0 to 4.1. [Emphasis added]

Yes, that really says “next week or two”. Not next quarter, not next summer, but next week or two.

Also note that the “last time we spoke” was three months ago. So Zillow rolled out PA 4.0, which is a massive business model change, from 25% of its agents to 70% in three months.

Yes, granted, Zillow is not a franchise, not a brokerage, but a technology company. So maybe it is comparing apples and oranges. But look, if you’re going to place technology at the center of your strategy, at the center of your value proposition, then aren’t you going to have to adopt some of what the real tech companies do when that’s the case? Otherwise, are you actually implementing fast enough for your agents — who all have access to products from actual tech companies, who execute in weeks rather than months — to adopt it at all?

Agent Adoption

Speaking of adoption… I look forward to hearing from Adam on every earnings call from here on out how the booj rollout is going, in exactly the same way that Richard Smith had to address the question of the Zap Platform rollout on every single earnings call after aquiring ZipRealty. Or not.

Adam says:

The agents have been so heavily inundated with technology options and overwhelmed with just the noise in the marketplace that it’s nice to provide clarity to them and single-point directional tactics that they can utilize, and that’s ultimately what the booj platform is about, is to keep people from having to log into so many different technology platforms and help them be more efficient in their business.

Except that he has the cause and effect reversed. Agents are not heavily inundated with technology options and overwhelmed with noise because so many vendors are out there hawking their wares at them non-stop. Rather, so many vendors exist to inundate agents with options because agents want anything other than what their broker provides, because agents (a) don’t trust their broker, and (b) want to pack up and leave for another broker at a moment’s notice.

Zero Sum Game, Remember?

More fundamentally, though, it’s difficult to wrap my mind around how companies see the interaction between technology and the fact that real estate is a zero-sum game. Technology that “lets agents do more deals in less time”, using Adam’s words, means that other agents have to do fewer deals. Remember, nothing that the industry does affects the housing market; only macroeconomic factors do.

But technology fundamentally reduces the need for labor; that’s literally what “efficiency” means — more output for same or less input. So if booj is in fact this amazing technology that lets RE/MAX agents do more deals in less time, short of RE/MAX putting in a cap on how many transactions an agent or an agent team can do (which would result in instant Going Out of Business sale at RE/MAX), those top producing RE/MAX agents are going to take deals away from everybody else — including those “aspiring to be top producer” agents that fill RE/MAX’s ranks.

Which then reduces the number of people wishing to remain in the real estate business, as they can’t compete with the top producers who get more and more efficient using booj, which then results in fewer agents, which then results in missing recruiting and retention targets even more, which then depresses RE/MAX revenues… see the problem?

What makes this even more puzzling is the fact that Adam Contos knows real estate is a relationship business:

But ultimately it’s fascinating because when I talk to a lot of our million dollar GCI producers, we call them the Diamond Club, and these are folks that are over $1 million a year in gross commission, you hear a lot of them say, I don’t buy electronic leads, I go out and I make my leads through community involvement. Because ultimately this is a boots on the ground business where everything is a micro market and everything has to do with the relationships you build in the communities. So lot of mixture there. The ebb and flow of the industry isn’t necessarily going to be based on that, it’s going to be based on what are the big agents doing to make business.

What the big agents are doing to make business is leveraging technology to become more efficient so that they can build more relationships with more people and muscle out the newer agents, the smaller agents, the less-great agents, so that they can capture more of the zero-sum game pie that is the pool of real estate commissions.

Betting on technology makes sense if you are not dependent on agent count. (See, e.g., Zillow after its new announcements.) It makes very little sense if your entire business model is about headcount and dues and fees.

Whither RE/MAX?

Well, this got long. I didn’t really expect that, but here we are.

So where do we stand after all this? What do we think?

RE/MAX still posted very nice numbers. It is still growing, not shrinking. It’s trying big things, like the booj acquisition, whether that is the proper thing or not, at least it’s doing something. It’s still one of the largest brands in real estate, with decades of brand loyalty and brand equity, at least among real estate brokers and agents. (Not so clear such things exist with consumers.) And many of those brokers and agents are some of the best in the business. So it isn’t as if we need to be planning a funeral for RE/MAX.

Plus, I like Adam Contos. He always struck me as a real genuine guy with real genuine concern for his people and for his brokers and agents. And he’s probably the best pistol and rifle shot among major real estate company CEOs.

I guess for their sake, I hope RE/MAX comes up with a different answer the next time some Wall St. analyst asks about high level strategy. They face the same kind of problems that Realogy faces, in that legacy answers of legacy structures may not be adequate for what’s coming, but they can’t do like Zillow and upend core parts of their businesses overnight. It’s not a simple problem, but it is one that has to be solved.

If you think about it that way, isn’t RE/MAX’s problem the same one that just about every brokerage and brand faces today? How to innovate and change without going bankrupt from too much change too fast?

-rsh