[VIP] Realogy Q1/2019: Things Done Changed

In my final Red Dot, where I looked at the full year 2018 earnings results for the public companies in real estate, I titled the section on Realogy as “The Deathwatch Gets Serious.” My concerns then were centered on not just the numbers, which were historically bad, but on the strategy. I wrote then that “all of the announced plans from Realogy were still around the old agentcentric model of recruiting and retention.”

Well, the Q1 results are out for Realogy and they just had their quarterly chat with Wall St. analysts. It did not go well. As Inman reported, Realogy’s shares are down 22% to a new historical low. Realogy’s market cap is now $1.15 billion as of this writing. Just as a point of comparison, Compass is valued somewhere north of $4.4 billion after its last fundraising round, and Opendoor is valued at $3.8 billion after its March funding round. Redfin, with its sub-1% market share, is $1.78 billion (at least as I’m writing this, before Redfin reports).

I have a deep love for Realogy, because I started my career in real estate at Realogy. I think that bias makes me look for the silver lining, and look on the bright side. I’m gonna have to work extra hard to find that silver lining in these Q1 results. I fear that I won’t find much, but will perhaps talk about one positive angle from analyst John Campbell of Stephens, Inc.

The Numbers

Let’s start, as I usually do, with a quick look at the numbers. Just like the 10Q, I’ll limit this to Q1 of 2019 and 2018 and look at YOY changes.

As you can see by the sea of red, this was not a great quarter numbers-wise. Revenues are down, profits are down (that is, losses have widened), and well, things don’t look great. (I should note that Realogy has changed the way it reports revenues, but it all seems to line up with historical data I’ve been keeping for them, so it’s all good.)

Of some interest to me was the fact that interest expenses were up $30 million YOY, which more or less accounts for the greater net loss number, but that turned out to be because of being on the losing end of an interest rate swap. It happens. Says very little about core operations. So let’s move on to core operations.

There, the bloodbath continues. 8.6% lower closed transactions to go with the 2.5% lower average home price equals double whammy. Much of it can be explained by Realogy’s exposure to high-cost markets like California that are softening. Ryan Schneider said as much during the earnings call:

Our volume is lower than NAR’s, which was down 4% year-over-year and our variance was driven primarily by two factors; first, geographic mix. Industry volume in California was down significantly more than the national average and we have a very high concentration in California. It makes up over 25% of NRT’s volume.

Okay, that makes sense. Crappy market in California means bad things for the NRT. Big shrug… but then he continued:

Second, an even greater increase in the competitive environment that began in late 2018 especially in a few specific markets.

Oh? Let’s talk more about this competitive environment, shall we? Because the NRT’s total GCI was down over $104 million YOY; a lot of that could be California. In fact, 25% of it could be California by Ryan’s own stats. But that means 75% of it was not California. What else is going on?

Competitive Pressure

[All quotes come from the earnings call transcript from The Motley Fool.]

In his prepared statement, Ryan Schneider said:

Shifting to execution. We’ve actually — we’ve demonstrated substantial progress. We’re excited about many of the things we’re doing and we get good feedback on our pace of change. However, while we’re working to change our financial trajectory, it has not had happened yet. The housing market being down the past few quarters hasn’t helped and equally important, the competitive environment has gotten even tougher recently especially from a few companies who seem fine losing money.

That then leads to a fascinating exchange between an analyst and Ryan Schneider:

Anthony Paolone — JPMorgan — Analyst

You mentioned the competitive landscape and some of the competitors willing to operate at losses. Can you talk a bit more about what you’re seeing out there that doesn’t either feel rational or what you’re fighting against these days outside of say over the last year or two, it seemed to be very split-driven. Is there any competitors that competitors are doing that you’re seeing that you have to match or that’s on your mind?

Ryan Schneider — CEO and President

Yes. It’s — when we talk about some of the competitive challenges and people willing to operate at a loss and basically operate at a loss, it effectively shows up in one place which is the agent commission area in terms of having real impact. A lot of people talk about attacking the average broker commission rate that customers pay, but there’s been very little traction on that when you look at the numbers either regionally or nationally; whereas, there are people out there who will make offers that are literally underwater and we’ve seen that. And we actually — part of the reason we saw what happened was the ramp-up in Q4, is in a few cities when the market’s got really tough, we saw people making even more aggressive offers to agents. And so who knows if people have a path to make money in the future? Some have said they don’t have a path even to that point, but that’s a little bit of what we’re dealing with. It is a geographic thing and I called out there were four cities Chicago, San Francisco, San Diego, and L.A. where the real violence was on that in the fourth quarter but there’s other geographies where that’s not anywhere near as big of an issue and those are some of the geographies to the first question I got where we see a lot more growth and we’re a lot more excited. But we’ve got a — we compete in all these places and we’ve got to deal with all of them. So that’s a little bit more color. [Emphasis added]

Chicago, San Francisco, San Diego and L.A…. hmm…. who could Schneider be talking about? Competitors fine with losing money… that isn’t Redfin, since Glenn Kelman is absolutely not fine about losing money (although he does and has because, you know, technology and marketing). It might be eXp, except they’re not all that strong in Chicago, SF, San Diego and LA.

That’s right. We’re talking about Compass, one of the many companies I simply cannot wait to go public, so I can finally see what they’ve been up to. I imagine it’ll be the same ah-ha and holy %*#$@ experience as I had reading Redfin’s S-1.

So reading between the lines, we can surmise that the NRT got hammered by Compass and its admittedly aggressive recruiting tactics, including signing bonuses, sweetheart commission splits (at least initially), amazing support (“Your very own graphic designer!”), and programs that no one else has. Maybe 25% of the $100 million decline was from market conditions, maybe more. But it does feel like a big chunk of that $100 million in lost GCI might have gone to Compass, which has been on a tear in major cities like Chicago, SF, San Diego, and LA. In fact, a friend just told me that Compass is up to 38% of the San Francisco market, which is all high-end luxury because… well… San Francisco where a parking spot would be the same cost as a condo in some U.S. markets. That 38% had to come from somewhere. And now we know where a lot of that came from.

Thing is, Realogy isn’t facing competition from just Compass. That might be the most serious competition at the high-end, where admittedly, NRT is heavily invested. But even in San Francisco and San Diego, not every agent in a Coldwell Banker Residential office is a $50 million a year producer. Many are more like 3-5 transactions a year tier-2 and tier-3 agents. Many more are part-timers who sort of fall into a deal once in a while.

Even if companies like eXp and NextGen Brokers like HomeSmart, Realty One Group, and others are not aiming for the superstar agent team leaders like Compass is, they’re for sure aiming for the 95% of the other agents and recruiting them with extremely low commission splits (it’s hard to get lower than 0%) and impossible-to-distinguish set of technology and training and whatever.

Finally, it isn’t as if Keller Williams, Re/Max, Berkshire Hathaway HomeServices, and other major regionals like Howard Hanna have gone away.

How is Realogy to compete? That’s a rhetorical question, because we have been hearing the same answer more or less from Ryan Schneider since he took office. And we heard it again in this earnings call:

First, we must stay incredibly focused on executing what we’re doing strategically in the market could; improving our value proposition, driving more transactions, lowering our cost, and moving faster are all needed to compete today given the dynamics in the market.

Value proposition, value proposition, value proposition. A quick search of the transcript reveals twelve appearances of the phrase “value proposition.” So let’s talk about value proposition.

The Value Proposition of Realogy

If we’re going to be reductive, what is the value proposition of the various companies out there competing against Realogy?

• NextGen Brokers: 100% Commissions
• eXp: Really low commissions with a cap, work in your underwear, plus stock!
• KW: Commission with a cap, plus profit sharing, plus culture!
• Re/Max: Low commissions and booj!
• Compass: In the Ferrari or Jaguar, switchin’ four lanes / With the top down screamin’ out, money ain’t a thang!
• Redfin: A regular paycheck and benefits
• BHHS/HomeServices: Warren Buffett is a genius!

And then of course you have a bewildering array of independents and boutiques who have all kinds of value propositions as well. So what’s Realogy’s value proposition?

I think it used to be, “We’re the 800lb silverback gorilla.” Today, that’s not playing like it used to. Which is why Ryan Schneider says:

There have been in these few that have been pretty tough in the last kind of three to six months that showed up in some of the results here, but that’s exactly what we’re focused on working on and driving toward and continuing to enhance our value proposition, provide more things to recruit people with, Listing Concierge, cataLIST, us and our franchisees is just an important thing. This is — the value proposition that we offer is at the end of the day is what everyone is going to compete on out there in the industry and we have a lot of things that we can really enhance on a relative basis we think it can pay off in a lot more of recruiting success over time and we’ve got to stay focused on it no matter what others are doing.

I wrote about Listing Concierge and cataLIST in the April Red Dot, and we’ll know much more about them in the months ahead. But let me quote from the Red Dot for those of you who were not Red Dot subscribers. (Because value.)

On Listing Concierge, I wrote:

It turns out that Listing Concierge is a web-based storefront for branded marketing materials that agents pay a subscription fee to access. The materials are not free; agents still pay for those, but they can order them from one place.

To say this is underwhelming is… quite an understatement. The Inman News article on Listing Concierge literally says, “The idea of a web portal to craft and order branded creative is by no means new.” In fact, it is so not-new that Realogy’s own Coldwell Banker has had the exact same web-based storefront for years, which allowed agents to go on and order branded marketing materials from a single website.

On cataLIST, I wrote:

And cataLIST itself is fundamentally an agent-centric program rather than a consumer-centric program. The name alone should betray the true intent behind Realogy’s so-called iBuyer program: it is really meant to be a listing tool, not a consumer-convenience tool. And as Schneider makes clear, Realogy’s iBuyer program is about making the agents more money, not making the consumer’s life easier.

As a variation of the old “purchase guarantee” program that brokers and agents have been running for decades, Realogy’s iBuyer program is more or less a bait-and-switch on consumers. Those programs have not changed the fortunes of traditional brokerages. There is no reason to believe that Realogy’s cataLIST would have different results.

The most important takeaway here, however, is the same takeaway from across the board from Realogy’s strategic initiatives. Not one has anything to do with the consumer experience, with real consumer convenience, and with consumer benefit. They are all about agent experience, agent convenience and with agent benefit.

It should be noted here that a 100% regional company, JP & Associates REALTORS (JPAR) recently announced that it too was launching an “iBuyer” program. Except… that it’s not an iBuyer program of any kind, as Giuseppe “JP” Piccinini, CEO of JPAR, told Inman:

“We’re nothing more than a facilitator connecting the seller with the potential buyer, the investor,” Piccinini said. “We have buyers across the United States.”

That might be why Ryan Schneider at one point tries to distinguish cataLIST, the listing acquisition program disguised as an iBuyer, from “iBuyers” by saying:

We’re in this for the learning more than when you’ve got $6 billion of revenue, starting something like this isn’t going to change our company in the near term. And then, our conversion rates have been a little bit higher than our competitors. Part of that is, by the way, is because our partner, Home Partners of America — we’re not in the business — they’re not in the business of buying houses just to flip them like iBuyers are.

At some point, people in real estate will understand that iBuyers are not investors, and are not house flippers. They are market makers. All of you Notorious VIP members already have a leg up on the rest of the industry.

Here’s the thing about these new value propositions. We heard about them last year. I wrote about new initiatives after Q3. If Listing Concierge and cataLIST had a major impact on recruiting — remember, the way that Realogy defines “value proposition” is by its impact on recruiting — wouldn’t we have heard something about that in this Q1 earnings call?

Instead, we hear that net agent growth is “basically flat” because of major markets like Chicago, SF, San Diego, and LA where Realogy got plundered by Compass (and others). And the best that Schneider can say in May of 2019 is: “I think our agents are liking the new products that we’re putting out there in the market having cataLIST in some cities, Listing Concierge, and our commission roll out is pretty much national now.”

I’m sorry, but “I think” isn’t going to cut it if we’re talking about value proposition to drive recruiting and lower agent splits, especially not after six months of having some of those things in the marketplace. If agents aren’t lining up at the local Coldwell Banker Residential office to get their hands on Listing Concierge and cataLIST… I don’t think they’ll be lining up anytime soon.

The Bull Case for Realogy: John Campbell, Stephens

Now, one of my favorite real estate industry analysts, John Campbell of Stephens, Inc., published a rather favorable research brief for Realogy. I can’t share it, since that’s kind of his bread and butter, but I do encourage you to contact him and see if he’d share that report with you. I hope he won’t mind that I share some quotes and conclusions from the report.

John’s overall take on Realogy’s Q1 results is very positive:

The big takeaway for us is the EBITDA beat driven by better cost controls/cost savings and better-than-expected splits – two very important items for our long thesis. Splits of 72.0% fared better than us (73.5%) for the second consecutive quarter. Splits pressure continues to moderate, growing just +45bps YOY in the quarter after a quarterly avg. in 2018 of +190bps YOY.

…

In our view, the Company’s initiatives around the $70 mil. cost reduction plan (likely more to come) and splits pressure + a much improved housing outlook set the stage for better operating leverage, which could lead to some nice EBITDA beats in the coming quarters.

All the bad news, he thinks, is because of the macro housing market environment particularly in California, and that Realogy’s new programs, its new initiatives, cost-saving measures, and “data-driven efforts” will lead to sustainable control over agent split pressure.

That’s a reasonable take on Realogy. It is a pretty sunshiny view but entirely reasonable.

But… I need to cast a bit of gloom on this upbeat forecast.

First, it is true that agent splits were not up as much as they were in 2018. But they’re still up YOY. I mean, on the data I have, Realogy’s splits went from 68.5% in Q1/2017 to 71.4% in Q1/2018, or 290 bps. For Q1/2019, it’s 72.0% by my calculation, which is still a 60bps increase in agent splits. (On the data John has, using the new “Gross Commission Income” way of reporting that Realogy adopted, it’s 71.5% to 72.0% or 50bps.)

Second, the cost-cutting measures are important for EBITDA… but I’m trying to understand how that fits in with the whole value proposition to recruit more agents to grow like kudzu strategy. Even John does admit that Realogy can’t cut costs to greatness; he just thinks that cutting costs would let Realogy bide its time until market conditions improve. I wonder how Realogy is going to invest in new products and services while tightening the belt even further; at some point, you have gone past cutting the fat and have to start cutting tendons and sinew.

And third, there was a line in John’s report that I had missed in the earnings call. Here it is:

We believe that RLGY’s commentary was intended to simply isolate how much of the splits pressure was offset by the new efforts, which are fully sustainable going forward (though the impact is likely less felt in higher volume quarters across 2Q and 3Q). On the sustainability of this and the why, RLGY is now charging some agents new fees for technology, annual events, etc. This acts as a contra offset to the expense line. [Emphasis added]

Uh… yes… true… charging agents new fees for technology, annual events, coffee in the office, and paper for the copy machine would act as a contra offset to the expense line… but… how would that impact that whole value proposition for recruiting thing?

“Hey, so you know how we used to not charge you for tickets to events because you were paying us 28 cents of every dollar of commission you made? Well, we’re going to charge you now, but you can pay us 27.8 cents of every dollar you make instead!”

That agent is going to walk out of the managing broker’s office and immediately have either (a) someone from Compass offering a chauffeured limo to take her around her listing appointments, or (b) someone from a NextGen Brokerage saying, “We charge you for everything, but you keep 100% of your money!” How’s that going to play out, really?

The Outs for Realogy, or A Lesson for All

As I see things, on the current path, on the current strategic thinking, on the current definition of “value proposition” as stuff you can dangle in front of agents to recruit and retain them, there are no outs for Realogy. It will continue the slow decline because of slow but steady erosion of margins from the slow and steady upward pressure on commissions. And Realogy’s aura of invincibility, its size and scale and reach, its access to capital, its status as a public company… all of those things don’t matter as much.

The industry has taken notice. I speak to a lot of brokers and agents and industry executives in my travels. Not one is even remotely scared of Realogy. Not one. Plenty of people are terrified of Compass, of eXp, of 100% shops, real iBuyers like Opendoor and Zillow, and even of Redfin. No one is even thinking about Realogy. Listing Concierge and cataLIST generated precisely zero buzz in the industry. Gary Keller talking about KW becoming a technology company has generated far more buzz, and sent a little shiver of concern down the spines of various brokers (soon dismissed, to be fair, but still… there was something there for a while). But Realogy? Nothing. Nada.

Realogy still has outs. It still has cards it can play. But nothing it can do on the basis of “recruit and retain agents while trying to hold on to our margins” is going to work.

What it can do, what it must do, if Realogy is going to change its path is to redefine its “value proposition” into something that the consumer would give a damn about. Something like… Fast Track.

Here’s Ryan Schneider talking about that program:

So for example at our March conference, we shared with our agents a bold new effort we call Fast Track to reinvent the transaction process. Fast Track will leverage our industry-leading agent scale, national title business, mortgage expertise, and our partner, Home Partners of America’s home buying capabilities to see if we can shorten the transaction process from months to something like a week.

By doing the mortgage and title work, specific to the house in advance, the Home Partners of America’s home buying as a backstop, we believe we can substantially shorten the closing time frame and increase the certainty of close. Many competitors talk about making money from ancillary services like title and mortgage. We actually do that today. Many competitors talk about reinventing the transaction process. We actually have the business components to do it.

And so while it’s early, if we can make Fast Track work, it would be really impactful for consumers, for agents, and for us. It would create a much better customer experience. It would help us capture more transactions and generate more ancillary services revenue and that is also the kind of unique product Realogy could provide its agents creating beneficial differentiation helping us recruit and retain. It’s an opportunity to leverage Realogy’s strengths to think bigger and drive more results. [Emphasis and line breaks added]

This is the out for Realogy, and by extension every traditional brokerage in North America.

Now, maybe it isn’t Fast Track itself; I don’t know the details of that program, and even if I did, I’d want to see how it actually works in the marketplace. But the philosophy behind Fast Track, the mindset behind it, is the out for Realogy: much better customer experience.

As longtime readers know, especially the Red Dot people, I have long been bullish on Redfin through some tough quarters, because I think what underlies Redfin’s overall philosophy is “much better customer experience.” Zillow has had its ups and downs, but I fundamentally believe in Zillow because of its obsession with “much better customer experience.”

If Realogy can somehow change its mindset from “throw goodies at agents to get them here” to “much better customer experience,” then it can change course and win out in the end. The months and years from now to then will be dramatically painful for Realogy and its investors, true. But at least there’s a chance.

And so we are perfectly clear, by “much better customer experience,” I do not mean the hoary adages of real estate industry about client service and fiduciary duty and local expertise and we treat you like family and so on. I mean the totality of the experience for the home seller and the home buyer. It’s Zillow’s “Push Button, Magic Happens” internalized by a real estate brokerage.

In the earnings call, Schneider said “I am on the hunt for new and bigger ideas that can change our company and even the industry. I know we have to keep thinking bigger given the industry dynamics and our need to create more shareholder value.” Here’s your new and bigger idea, Ryan, which I share with the industry as well. Put the consumer first, make “much better customer experience” the new mantra of all of your strategies, plans, products, and projects. Try not to care about losing money or making money or margins or commission splits. Focus like crazy on “much better customer experience” and see where that gets you.

It might not work… but then again it might. And we know that every agent-first idea you and all the other traditional brokers have tried for years and years has not worked, does not work, and will not work.

The old ways are dead and dying. The rules have changed. This ain’t back in the day.

-rsh

https://www.youtube.com/watch?v=rdciOXroU9o