[VIP] REMAX Q1,2019 Earnings: Refusing Greatness

I don’t often talk about RE/MAX, because it’s not a brokerage. It’s a franchisor, with a business model that doesn’t tell us a whole lot about what’s going on with fundamentals of brokerage. But it is a public company, which reports numbers, and discusses what management thinks about things. From time to time, I do get some really interesting insights into the state of real estate listening to RE/MAX earnings calls. This is one of those times.

What strikes me about RE/MAX after Q1 is how it is poised on the brink of greatness… but is refusing to make the jump. Whether that’s out of conservatism or not knowing what else to try is unclear today but this is a company that has enormous strengths and competitive advantages… and is watching them slowly drip away.

Let’s get into it.

The Numbers

As we always do, let’s start with a quick glance at the numbers.

I should note that I modified RE/MAX’s actually released financials by removing Marketing Funds from both revenue and from operating expenses. I’m not sure why RE/MAX included that, unless they were required to by law or accounting standards, since Karri Callahan, CFO, states that Marketing Fund is just a pass-through entity. By removing Marketing Funds, we can better compare YOY performance.

And what we see is basically a slight decline. It isn’t enough to warrant alarm, but it isn’t growth either. I mean, over a full year, RE/MAX revenues declined by 40bps. The sky isn’t falling, but… it’s not inspiring either. Net Income dropped by 11.5% YOY, but it’s really no big deal.

Here’s the thing, though: RE/MAX is making money, has fantastic gross margins, and has fantastic cash flow. Realogy would kill for 8.4% Net Income margin, as an example. And as Callahan mentioned during the earnings call, RE/MAX has a very strong balance sheet and generous cash flow. Unlike most companies in real estate, RE/MAX can really make some noise, invest in game-changing initiatives.

So she says:

Generous cash flow means more capital available for those initiatives, which are likely to deliver the best returns. Our capital allocation priorities remain unchanged. We plan to continue to allocate capital to acquiring independent region, reinvestment to drive future organic growth, exploring other strategic acquisitions and partnerships, and returning capital to shareholders.

Wow! That’s really… unexciting. In the midst of a massive transformation of the industry, RE/MAX is returning capital to shareholders and acquiring independent regions, along with some vague words about future organic growth. I can’t stop yawning.

Zero Excitement…

This is the core problem of Re/Max. It’s just boring. Solid revenues, solid profitability, slow and steady decline, with nothing exciting going on. It doesn’t matter how many times Adam Contos says “exciting” in the earnings call; it isn’t exciting. It isn’t even mildly interesting. It is straight up nod-inducing.

Literally, the biggest talking point of Q1 for RE/MAX is the “strategic relationship” with Redfin… which was terminated mere days after the earnings call. The second biggest discussion item is the rollout of booj, which RE/MAX bought back in February of last year. After a full year, RE/MAX is still talking about “exciting details about booj platform” and alpha tests and beta tests.

I’m likely reading into things, but even the Wall St. analysts on the earnings call sounded bored.

Slow Drip of Decline

If RE/MAX were imploding spectacularly, like Realogy is, then it would suck for RE/MAX but at least there would be some excitement. Instead, we just get a slow drip, drip, drip of constant decline.

RE/MAX does trumpet that there are 125,000 agents in its network. But the truth is that most of the growth since 2017 is coming from international markets outside of North America. In fact, if we look only at U.S., agent count is actually down 1.5% YOY; over two years, RE/MAX gained 223 agents, or 0.4%. During that same period, eXp went from 3,100 agents to 17,900 agents, or 475%. NextGen Brokerages (100% transaction-only shops) absolutely exploded. RE/MAX’s total agent count in the core North American markets is half that of Keller Williams, which hasn’t been explosively growing either.

It’s a slow drip of decline. Operating income from Q1 of 2019 is lower than from Q1 of 2018, which is in turn lower than from Q1 of 2017. In fact, since cumulative inflation since 2017 is 4.3%, the picture is actually a bit worse.

Uninspiring Initiatives

That RE/MAX’s strategy appears to be rooted in rolling out the booj platform as a way to jolt the company back to growth is deeply problematic. It is also emblematic of the approach throughout the industry, and it is extremely difficult to understand.

Companies like Zillow and Opendoor and Flyhomes and Knock are literally changing the way we buy and sell houses. Redfin is rolling out efficiency tools seemingly every quarter. Compass is… well… spending a lot of money to get market share, but along the way, they’re rolling out initiatives like a COO for agents, offers to front the seller money for renovations, and so on. Realogy is launching new franchise brands, trying new things like cataLIST and Fast Track.

RE/MAX is… talking about technology training?

In the first quarter, we took steps that will give education and professional development an even bigger role in the future success of our franchises and agents. In concert with the recently announced changes in our broker service model, we increased our investment in training resources. We now have a full technology engagement team to help affiliates understand and adopt the new tools connected to the RE/MAX and booj type platform, as well as other products in our technology ecosystem.

It doesn’t even make much sense to talk about how training and professional development will play a bigger role given how Contos just spent a bunch of time talking about how great RE/MAX agents are and how much more productive they are than the industry average.

And Yet… Poised for Greatness

What is truly fascinating is that despite all of the above, RE/MAX is actually poised for greatness. I know, it’s counterintuitive, but hear me out here. RE/MAX has all of the ingredients to create a truly novel approach to the business… if it would take some risks and start being more creative. The risks involved are minimal, but the rewards could be truly significant. This is not the place to lay out the details of a strategy, but maybe I’ll try to pitch RE/MAX on the idea.

This is the place, however, to point out those ingredients. Longtime readers may be able to discern the general shape of a strategy to make RE/MAX exciting again.

RE/MAX Has Great Agents

First, fact is that there is a lot of truth to RE/MAX’s main brand claim: it has some of the best agents in the industry. Yes, it’s a press release talking point, rehashed in the earnings call, but RE/MAX is not lying when it points out that its agents in the Real Trends 500 list do outsell the competition 16.3 to 7.1 in the latest Real Trends 500 survey.

And while plenty of exceptions exist, RE/MAX does have at least the stated goal of only trying to recruit the best of the best agents who are full-time and productive. On the whole, it is generally acknowledged that while Keller Williams has an advantage in super-teams and super producers, RE/MAX is not far behind in the number of top agents and the conventional wisdom is that RE/MAX tends to have greater breadth of quality than other brands.

Plus, RE/MAX does have some 62,00 agents in the U.S. and another 21,000 in Canada. Those are boots on the ground that very few others can match.

In a recent podcast with Greg Robertson, Redfin’s CEO Glenn Kelman also pointed out that RE/MAX has the best retention statistics for any company or franchise not named Redfin (which pays its people a salary), and that RE/MAX is dominant in Canada. Both remain true today, even after the end of the affair between Redfin and RE/MAX.

Access to Capital

The other interesting thing about RE/MAX is that it has a very strong balance sheet, as I touched on above. With a net leverage ration of just 1.6 times EBITDA, RE/MAX can borrow quite a bit more money if it wanted to. RE/MAX has fairly strong free cash flow as well: $13.8 million in Q1.

Of course, RE/MAX is a publicly traded company whose stock has some real liquidity, unlike say eXp which is trying to get there.

That means RE/MAX has capital and access to capital, which I have written in a Red Dot report is the key to competition going forward:

The old basis of competition was based on headcount, which meant that recruiting and retention was the key to success. Everything that brokerages, MLS and Associations, and technology companies in real estate have done for the past 45 years was based on and around creating advantages for recruiting and retention.

The new basis of competition is based on deploying huge amounts of capital, which means that access to capital is the key to success. Everything that the companies that will dominate the future of real estate will do will be based on and around acquiring and deploying large amounts of capital.

Interestingly enough, RE/MAX is the company that gave birth to the old basis of competition: recruiting and retention. It is poised to be one of the companies that can keep up with the new breed of institutional real estate companies on the new basis of competition.

Business Model: The Original NextGen Brokerage

Finally, we can’t forget that RE/MAX is the original NextGen Brokerage, which I wrote about in the October 2018 Red Dot. Here’s what I wrote there:

Dave Liniger invented agentcentric brokerage in the late 70s when he founded Re/Max. He wasn’t the originator of the model; that honor goes to Realty Executives out of Phoenix. But Liniger was the man who took the concept national and transformed the industry.

The incumbents at the time denigrated Re/Max as a low-cost bargain basement bottom feeder. Steve Murray of Real Trends, who has forgotten more about the history of real estate than most people ever knew, says that at one time, Dave Liniger might have been the most hated man in real estate for his low-cost, agentcentric model.

But his idea and his business model caught on. As the Re/Max official history puts it, Liniger’s “controversial idea [was] to build a real estate powerhouse where experienced, productive agents would keep more of their commissions and enjoy the freedom to run their business as they saw fit.” It was the birth of the agentcentric model.

The rest of the industry had to follow his lead, or face extinction as agents fled brokercentric 50/50 companies in droves. They too converted to an agentcentric model.

The main difference between RE/MAX and the contemporary NextGen Brokerage models is that RE/MAX relies on desk fees, while the latter relies on transaction fees, as the core business model. That makes all kinds of sense, given the era in which both came into being.

In the 70s, 80s and even into the 90s, location and physical space were critically important. The main value proposition of brokerage in the pre-Internet era was in providing space and office technology and office support. In the 00s and 10s, it is no longer about office space and copy machines, but about leads and productivity tools; the NextGen Brokerages are built accordingly, while RE/MAX stuck to its roots.

That transition, however, is not exactly impossible to make. I’m not suggesting it will be easy to do, but it isn’t as if RE/MAX needs to transition from a split-based model into a transaction-fee model.

Conclusion

I have been suggesting that the future of real estate will be dominated by institutions which have to have three key thing: Technology, Capital, and Control. With the booj acquisition, RE/MAX has signaled that it wants to provide Technology. My take is that the Technology RE/MAX & booj will be providing is inadequate to the challenges at hand, but there is a solid base of talent there that could be deployed to providing the proper technology institutional real estate demands.

RE/MAX has the capital and access to capital.

What it lacks is Control. That’s the tougher nut to crack, but it can be done.

So what you have is a company with one of the largest footprints in the industry, with some of the best agents in the business, capital and access to capital, a business model that is more resistant to things like market conditions and Black Swan disruptions (like commission compression) and a base of technology it can build upon. This is a company with all of the elements for greatness.

Yet, it has thus far steadily refused to reach for the brass ring. Perhaps some of that is because of the influence of Dave Liniger, the founder of RE/MAX, its longtime leader, and still a major shareholder. He invented agentcentric brokerage and has spent his career on it. He’s a first ballot Hall of Famer in real estate. But RE/MAX has a new CEO in Adam Contos, who is not a Baby Boomer but a Gen-X. The executive team at RE/MAX is also mostly Gen-X, and certainly the people at booj are younger technologists.

While most of them have spent their careers at RE/MAX and in the real estate industry of the past (undergoing a transition), I do think there’s a better chance of younger leaders being able to be more flexible in responding to new challenges rather than trying to hold on to what worked in the past.

RE/MAX is not a disruptor, but it might be best positioned to respond to the disruptors. That alone is saying something in today’s environment.

-rsh