[VIP] Did Redfin Just Surrender?

Yesterday, Redfin announced that it was entering into a partnership with Opendoor to become a conduit for Opendoor’s direct purchase offers:

SAN FRANCISCO and SEATTLE, July 11, 2019 /PRNewswire/ — Opendoor and Redfin, two of the nation’s largest technology-powered real estate companies, today announced home sellers in Phoenix and Atlanta can now request an Opendoor offer through Redfin’s site and mobile apps. By coming together, Opendoor and Redfin are giving homeowners more options for selling their home in a simple and convenient way. Redfin will also continue to expand RedfinNow, its own instant offer service.

The response from at least one analyst, John Campbell of Stephens Inc., is that this is good for both Redfin and Opendoor and a slight short-term negative for Zillow. As he puts it in a Research Brief that went out over email, John says:

We believe that this development is notable for a few reasons including: 1) it offers up a higher margin partnership rev. stream for RDFN, 2) it could be signaling a waning Redfin Now national expansion appetite (which would likely be a positive thing for some investors), 3) it could be the starting point for a larger partnership and potentially even a merger/ acquisition (Opendoor buying RDFN/Opendoor has a private valuation >$4 bil. and well-funded by Softbank) and 4) it helps both companies better compete against Zillow’s quickly emerging iBuyer offering.

I guess that’s right… but I can’t help but read that press release and wonder if this is a tactical retreat or a strategic surrender by Redfin. One thing it is not is a step forward. Perhaps the Q2 earnings results will reveal more information, but I can’t see how this is good news for Redfin.

Memories of High Hopes

Longtime readers, particularly those who were Red Dot subscribers, remember the halcyon days of merely a year ago, when I wrote these words in the June 2018 edition:

And Redfin is not focused on the short-term. It looks where the puck is headed, not where it is today. That ability to adapt to changing consumer needs is shared only by Zillow in the real estate industry today.

Nowhere is this more evident than in Kelman’s discussion about Redfin Now, its iBuyer program.

Because in that discussion, Kelman made it clear that he saw the point of iBuyer, of Redfin Now, as one of providing liquidity to the market. From the June Red Dot, quoting Kelman:

So why don’t we talk about Redfin Now first. There are people who just want to be done with it. There are investors who live in another city. But part of this is a credit arbitrage opportunity that they can’t get the loan to buy the next house, because they still own the last house. And even though there are fairly strict lending guidelines for consumers, there are not for companies. So if you have this asymmetry in the market where companies can get easy access to capital but consumers can’t, we become the provider of liquidity and that is one of the services that we offer. 10 years ago when there was a hot market, people would just get a loan for their next house while they still own the last house but that’s just harder to do now. [Emphasis added]

In that understanding, Redfin launched its attempt to become a market maker long before Zillow did. In fact, Zillow in the beginning more or less copied Redfin in its approach to iBuying, by combining the instant offer with a CMA from a Premier Agent, which was not Opendoor’s approach. Which is why I wrote that it isn’t easy to out-innovate Zillow, but Redfin did that.

Furthermore, Kelman was quite confident that Redfin had an advantage over all other iBuyers, including Zillow:

One thing to note is that Zillow’s buyer traffic – and therefore the volume of buy-side signals – is many times larger than Redfin’s. On the other hand, Redfin has agents on the ground who are working with buyers and sellers every day, who are W-2 employees who use Redfin’s systems and processes and enter data into Redfin’s systems. As Kelman put it, “[Having agents] gives us a better eye for the properties that are going to be marketed quickly and sold reliably.” [Emphasis added]

And in the Q2 earnings call, Kelman said:

In committing to Redfin now long-term, we eyed our competitors wearily as many are well run, some are willing to take risks we aren’t and seeming all of them are well funded. But we decided we can win, because we believe nobody is better at selling homes than we are. We believe that nobody in real estate is better at combining local service and technology.

Newer entrants don’t have the online audience we do, and pure websites don’t have as much operational expertise. We believe few companies have our spending discipline. This audience field experience and penny-pinching should let us acquire and sell homes at a lower cost, which will let us offer homeowners more money. For the person selling her home to Redfin Now that money is almost all that matters, and a war on price is the one we feel best prepared to win.

So at least in the summer of 2018, Redfin looked poised to have the best of both worlds: a highly trafficked website, which reduces marketing costs and generates buy-side signals, and thousands of highly-trained, efficient W-2 based workforce of agents on the ground with local expertise. Nobody is better at selling homes than Redfin, right?

Signs of Trouble

But then the Q1/2019 earnings drop, and… things don’t look so hot. Redfin Now posts not only losses but widening gross margin slippage: -4.3% down from -2.4% in 2017. I made a quite a big deal about this in the April Red Dot:

If you have tied your success to your operational expertise, then you have to deliver operational expertise. If you claim that nobody is better at selling homes than you are, then you actually have to show that in the numbers.

In other calls, Kelman has said repeatedly that Redfin has a decade-plus experience of helping homeowners renovate homes, stage them, maintain them, and sell them for top dollar. He claimed that same experience, that same expertise, would let Redfin Now compete against the likes of Zillow who lacks such on-the-ground experience.

After all that, Redfin simply cannot lose money on Redfin Now (negative 4.3% margins) while Zillow made money on its iBuyer program. That just can’t happen. And Redfin lost money due to paying more for houses, and paying more to Redfin’s staff for buying and selling those houses. That can’t happen either. If Redfin is going to compete because of its operational expertise and local agents on the ground, then it can’t overpay for houses and then sell them for less, not while Zillow without that local experience apparently did just fine.

So yeah, I’m making a bigger deal of this failure than perhaps others will, and perhaps more than I should. But it’s a big flashing red light.

You can’t talk about how you’re the best in the industry at selling houses, talk about how you have 10+ years of working with local contractors, talk about combining technology with local expertise, and then post worse results than a portal with no agent workforce. That was a major red flag.

Now, just before Q2 earnings are to be released, we get this announcement about a partnership with Opendoor.

The Opendoor Partnership Sounds A Whole Lot Like Giving Up

Sure, Redfin claims that it will continue to expand Redfin Now. But partnering with Opendoor sure does seem like throwing in the towel in the most developed, most competitive markets like Phoenix and Atlanta.

And reading the Inman News story on the partnership which provides additional color from both Kelman and Eric Wu of Opendoor, I can’t help but feel that Redfin is maybe throwing in the towel on Redfin Now altogether, no matter what they announce. For example, we have this:

“Just as traditional agents are our partner for brokered sales our own agents can’t handle, Opendoor is our partner for giving customers reliable, competitive offers on homes we ourselves can’t buy,” said Redfin CEO Glenn Kelman in a statement.

Homes we ourselves can’t buy? What in the world does that mean for a publicly-traded company with 35 million monthly average uniques and a legion of agents on the ground who supposedly make Redfin the best at selling homes, the best at combining “local service and technology?” Does that mean Redfin can’t raise the capital to buy homes? That doesn’t seem right to me seeing as how even second-tier iBuyer companies appear able to get investors to cough up hundreds of millions of dollars. I can’t imagine there isn’t a legion of investment banks who would love to raise capital for Redfin.

So what gives? Kelman makes the deal sound like just a marriage of convenience, sort of a short-term fling:

But, Kelman added, “obviously Opendoor gets a channel to reach a large number of homeowners who may want an offer” and “they get a channel for liquidating their assets once they buy a house.”

Meanwhile, “Redfin can offer more consumers the [iBuyer] choice.”

While Redfin is expanding its own iBuyer, Redfin Now, as quickly as it can, the brokerage is “not about to have Redfin Now available in 80 markets,” he said.

After this partnership, how many markets is Redfin about to have Redfin Now available in, exactly? Not Phoenix or Atlanta, or any of the other 20 markets in which Opendoor is currently active, I imagine. Since a deal that allows Redfin to cut Opendoor out of the call to action on Redfin.com whenever Redfin gets around to launching Redfin Now is a sucker deal for Opendoor, and I imagine Eric Wu and team are not looking to become suckers, I can’t imagine that they signed that kind of a deal. So as far as I’m concerned, here’s a list of markets in which we won’t see Redfin Now anytime soon:

Atlanta, GA
Austin, TX
Charlotte, NC
Dallas-Fort Worth, TX
Denver, CO
Houston, TX
Jacksonville, FL
Las Vegas, NV
Los Angeles, CA
Minneapolis-St. Paul, MN
Nashville, TN
Orlando, FL
Phoenix, AZ
Portland, OR
Raleigh-Durham, NC
Riverside, CA
Sacramento, CA
San Antonio, TX
Tampa, FL
Tucson, AZ

What markets are left? Do we even need to point out that those are the markets that have the kinds of properties that are most suited to iBuying activity, with relative standardization across housing stock in master planned communities?

And since Opendoor has been raising money like crazy with the goal of being in 50 markets by 2020, after it launches in an additional 30 markets, what markets are left for Redfin Now? New England towns with 200 year old homes that are really, really difficult to price through an algorithm?

It is difficult for me to see this as anything other than conceding the entire iBuying market to Opendoor. Redfin will use the partnership to make a little bit of referral money and to generate seller leads for Redfin the brokerage.

But there is now reason for concern on that front as well.

If You Can’t Do It For Yourself….

The problem here is that Redfin appears to be suggesting that it can’t make money buying and selling houses on its own account despite having the giant website, having all manner of technology, and having agents with years of experience and local knowledge. It can’t price the homes accurately enough, work on renovating/repairing those homes cost effectively enough, or sell the homes for enough of a spread over the purchase price to make the program make financial sense.

If Redfin can’t do it for itself, why in the world should I believe that Redfin can do it for a seller? For that matter, why should I believe that Redfin can price the home better for me as a buyer if it has trouble pricing homes for itself?

Logically, there are only two explanations.

One, Redfin either can’t or doesn’t want to operate Redfin Now at a loss/breakeven. But since the market is the market, which limits the ultimate selling price to whatever the market will bear, the only way to make a spread is to buy low. So Redfin makes lowball offers that result in, as Glenn Kelman said in the Inman article, an average of 5% less net to the seller through Redfin Now than through the open market.

Or two, Redfin isn’t actually better than anybody else at buying and selling homes, and its results from Redfin Now is proof of that. All of the fancy technology, the 1% listing fee, the marketing, the giant website and mobile app — none of that makes a difference in the ground game of buying and selling houses. If that is the reality of the situation, then we have some major problems.

For Redfin’s sake, I hope it’s the former. Because then at least there is a story of some kind that Redfin can tell its buyers and sellers that they should continue to trust Redfin and Redfin agents. Otherwise, we might have another Purplebricks story on our hands.

Maybe a Merger Would Be Best

Inman and other sources, including John Campbell’s research brief, made quite a point of noting that both Kelman and Wu were making friendly noises about each other, making the prospect of a full-on acquisition of Redfin by Opendoor a real possibility.

Maybe that would be for the best. Maybe that’s the only real out here for Redfin and for Opendoor, if they plan to remain relevant in the rise of institutional real estate.

Because with this deal, Redfin signals that it will be exiting the iBuyer market and concede that to Opendoor. What is Redfin then without Redfin Now? It is a real estate brokerage with a large website that generates leads, W2 employee agents who are far more productive (but carry ongoing costs), and a suite of technology tools. Those tools are the best in the business, but still, they’re just tools. And apparently, those tools were not enough of an advantage for Redfin to do the buying and selling on its own account.

And Opendoor clearly signals that they need to figure out a way to overcome Zillow’s advantage in marketing. Getting access to Redfin’s traffic in the 20 (soon to be 50) markets in which they are active is a start, but Zillow has even more traffic in those 50 markets today. Obviously, having marketing expenses that Zillow does not makes the financials for Opendoor’s iBuying far less competitive… which will show up (if it hasn’t already) in the numbers.

These two might need to get married. Because the point of iBuying is not to make money from it; the point is to provide convenience to consumers, and then to make the money in mortgages. I’ve said that from the very beginning in 2014 when Opendoor first appeared on the scene: this is a mortgage play, not a real estate play.

And Opendoor is not going to give the mortgages to Redfin, nor will Redfin give the mortgages to Opendoor, no matter how much of a partner they are in this iBuying venture. That is where the real money is.

So yeah, if you’re an investment banker, it’s well past time to start calling on Opendoor and Redfin to try and arrange a marriage. These two kids had better fall in love for everyone involved not named Zillow. Because what this partnership reveals is real fundamental weaknesses for both Opendoor and for Redfin compared to the juggernaut that is Zillow.

Waiting for Q2 Earnings

This is just my initial reaction to the news, given the depth of my interest in Redfin, who I have called the most important brokerage in the industry for years now, and in my interest in iBuyers which is a fascinating new development in and of itself, but also a necessary element for a company that hopes to contend to become The Platform for real estate into the future.

I can’t wait for Q2 earnings releases now from Redfin, to see what the numbers say — especially on Redfin Now. And certainly, Kelman is going to have to address the Opendoor partnership during analyst calls, or have a refusal to discuss it be a statement in and of itself.

So fine, let me withhold final judgment until we see the Q2 numbers. But final judgment doesn’t mean I’m not seeing what I am seeing with this announcement. I’m not a financial analyst, and I don’t make stock price targets and all that. But if you’re overweight on Redfin today, you’d best be counting on an acquisition in the near future with a fat premium.

-rsh