In the aftermath of a disappointing Q3, I wrote:
One of my biggest takeaways from this earnings call is how much of the positive spin was put on October. For example, Karri Callahan mentions seeing some “positive traction” on agent count in October, contrasting with last October when RE/MAX lost hundreds of agents. Or there’s Ward Morrison from Motto Mortgage, talking about how October was one of the strongest months for Motto franchise sales. And Nick Bailey, the new Chief Customer Officer, talks about growth initiatives launched in October that has led to some of the best gains they had seen in a month.
I think we are all supposed to sort of gloss over the horror film that was Q3 and look forward to Q4 where we will see all manner of improvement. It’s almost as if RE/MAX would desperately want to put the terrible three months behind them and look ahead into the future.
Well, Adam Contos and team turned things around and rather dramatically. So they cashed the checks they wrote back in October. Good for them, I say, and a job well done. They closed 2019 strong, even though the year as a whole was a bit of a downer, and it appears that they might have turned a corner.
Or maybe not. We’ll have to get a bit into things to find out what we think about the future.
I also wanted to wait to write this until I had a chance to sit down with Adam Contos and Nick Bailey. I took advantage of the fact that the annual RE/MAX convention was in Las Vegas, and got to meet up with both of them last week for a far-ranging conversation. I think it helped me to understand the RE/MAX story of Q4 and into 2020.
Let’s get into it.
We begin with the actual numbers from RE/MAX.
On a YOY basis, Q4 did not compare well. Operating income was down a whopping 53.4% from $21 million to just under $10 million. The components of that were slight declines across the board in revenue categories (except broker fees) and some big increases in selling, operating and administrative expenses. In fact, from a strictly financial standpoint, Q4 was a bit of a disaster, wasn’t it? Net income down 54%, Adjusted EBITDA down 3.3%, and even Free cash flow down 20.2%.
The fact that broker fees was up is interesting, for RE/MAX, because as I wrote in Q3, this is the one revenue category that has very little to do with agent count, office count, or whatever but with actual production of RE/MAX agents. Judging by the reports from the other three public real estate companies (Redfin, Realogy, and eXp), it looks as if Q4 was a great quarter for everybody, not just RE/MAX.
So why are we calling it a turnaround and a strong end to 2019?
Agent count reversed the trend of losses that have been going on for six straight quarters, and finally went up in the all-important United States market in Q4: from 62,548 in Q3 to 63,121. Canada and the other international markets continued their growth, which has been consistent, but it was the turnaround in the U.S. that is the reason for all of the optimism.
Since the entire business model of RE/MAX is based on monthly fees paid by agents, it is agent count that drives everything. Hence, the turnaround.
How did RE/MAX achieve this?
Back to Basics
One thing from the earnings call I found important and interesting was when Nick Bailey talked about a new culture he put in place at RE/MAX:
Without a doubt, this is a long-term permanent play for us that will make adjustments and investments in along the way. Q4 we did broadly to US and Canada to all markets. So it was not just within specific MSAs, because we have growth potential with our footprint in all of our markets. What we’ll continue to do though is really frame our entire culture around recruiting.
I found it interesting, not to mention odd, because RE/MAX has always had a business model that is based on headcount. It seems odd to think that a company whose revenues depend almost entirely on recruiting and retention needed to frame its culture around recruiting.
So I asked Nick about that. What he said, essentially, is that while yes, recruiting has always been important to RE/MAX and its corporate culture, he tightened things up and brought everything back to basics.
For example, talking about the big initiative they launched in Q3 (called Plus+One), Nick revealed that RE/MAX brokerages were simply not making phone calls to agents in their markets and inviting them to join. Rather, they were waiting for agents to contact them, and then try to recruit them… if they were the “right” sort of agent.
That is revealing. If RE/MAX brokers were not even making phone calls, then yeah, it’s safe to say that recruiting was not a big part of the culture.
Extend that across the board, as Nick suggested, to all RE/MAX products, marketing, services, offerings, etc. and it is entirely possible that RE/MAX will rediscover its mojo.
Thing is, there is a real risk here for RE/MAX as a brand (to the industry, at least, since it isn’t at all clear that consumers care in the least bit about real estate brands). For most of its history, RE/MAX’s brand was that it was a place for the experienced agent. Even today, consider the importance that RE/MAX places on average agent productivity, with Adam Contos bragging that the RE/MAX agent outsells the other large company agent by a 2 to 1 margin, and that RE/MAX has more of the top agents in the industry.
Some of RE/MAX’s business decisions — such as the very high price it charges the agent for a desk fee — is rooted in the brand identity of RE/MAX as the home for the top producer.
But in Q4, we got word that RE/MAX temporarily waived some of the fees in order to drive recruiting. Price competition is natural, of course, but it is the first time I’ve heard of such an incentive being offered by RE/MAX. The actual amount is not very large — $2-3 million through Q3 — so I wouldn’t overreact to this. It’s the principle that’s more interesting, especially as it pertains to the “culture of recruiting” that Bailey mentioned.
What I’ll be interested to watch over 2020 and beyond is whether RE/MAX can keep up its culture of recruiting, going back to the basics of blocking and tackling, while maintaining its high per-agent productivity numbers that is central to its identity as a brand and as a company.
The most disappointing part of the earnings call for me, because I genuinely like the RE/MAX team, is that they kept at it with the tech-centered narrative about increasing agent productivity, referrals and repeat business, and made an announcement:
RE/MAX is widely known as being the home of the top producer. Our per agent productivity levels are the envy of the industry. RE/MAX agents consistently outsell other agents at large brokerages by more than 2 to 1. Several fundamentals tend to drive agent success within our industry. For example, many successful RE/MAX agents derive the bulk of their business through repeats and referrals. We see this especially among established top producers who have built large databases through their relationships, community presence and past clients. Even so every agent has felt the pain of seeing a competitors sign pop up in the yard of a friend or past client. In the industry, almost all clients say they use their agent again, but only a very small fraction actually does. That’s because agents aren’t staying as connected to their sphere as they should.
To help solve this problem RE/MAX acquired First, a North Carolina firm recognized for its industry innovations. The First app uses data, machine learning and predictive analytics to analyze an agent’s contacts and identify those most likely to move soon. The app, serving as an intelligent coaching platform then prescribes a strategic action plan for the agent to reach out, fortify the connection and be top of mind before any potential move. With a proven product already on the market, First has had a strong track record since its 2016 launch. Its signature app is a great complement to our current tech offerings and could help make our highly productive agents even more productive.
Why is this disappointing? On two levels.
In the Q3 report, I wrote:
Since real estate is a zero-sum game, where each transaction an agent does takes away from another agent, making RE/MAX agents more productive means all of those transactions have to come from somewhere, from someone else.
I suppose the thinking is that RE/MAX agents can take those from Realogy agents and KW agents and so on, but the reality is that each and every agent at RE/MAX is his or her small independent business. They all compete against one another, even in (especially in) the same office.
It’s one thing for Realogy, whose business model is all about agent splits from GCI, to talk about productivity. It’s a whole other thing for RE/MAX with its agent count dependent model to talk about productivity.
Adam and team simply did not address this strategic problem, nor did any of the analysts on the call ask any questions about it. Buying First to enhance the productivity of RE/MAX’s already productive agents is nice, but it doesn’t solve this fundamental problem.
But let’s assume, arguendo, that 100% of RE/MAX’s agents embrace the hell out of booj and First. The technology lets them increase their productivity to unheard of levels: say they all double their production. What does that do for RE/MAX’s profitability? For the franchise broker’s profitability? Precious little, that’s what, because of RE/MAX’s business model. This is Slide 22 from RE/MAX’s own presentation:
I would have loved to have heard something, anything, about that.
Second, in my conversation with Adam Contos and Nick Bailey, both admitted that RE/MAX is no different than every other brokerage or franchise company in North America in terms of the distribution of agent productivity. That is, the average or median per-agent productivity at RE/MAX might be 2 to 1 compared to other large companies in the industry, but RE/MAX too has the pareto principle in full effect. That is, 20% of the agents do 80% of the business, if not more like 10% of the agents doing 90% of the business. Neither Contos nor Bailey offered any statistics on the actual distribution of productivity, of course, but both men are smart, seasoned operators who can’t deny what everyone in real estate knows to be true.
The disappointment, then, is the fact that the First acquisition as well as the original booj-based strategy of “increase agent productivity” remain mired in the old way thinking of the brokerage (and/or the franchise) serving up value to the individual agent. The reality is that the new modus operandi of real estate is the domination of large, well-operated agent teams. I can’t see how either First or booj will do a whole lot for RE/MAX in terms of appealing to these teams, who often have more money to spend on technology than their brokerages do, and have very little desire to be locked into the brokerage’s system (or the franchise’s system for that matter). That has nothing to do with the quality of the software, but with the business realities of that team and its owner.
It’s one thing for RE/MAX to continue to pursue the old way of thinking if the top executives were firm believers in that old way. It’s another thing entirely when the top executives know that the 80/20 rule exists, and that the future is teams, but continue to pursue strategies based in the world of the 1970s and 80s.
The Old Rules Dominate RE/MAX
Let me give you an example of what I mean.
At one point, Nick Bailey says:
I think that there is within the industry, agents are losing patience on just buying leads in general. And to Karri’s point, we know [from] top producers that the repeat referral business is where the vast majority of their income comes from, and that’s why we’re solving for that. If you look at according to Realtor.com, the number of leads in the US in 2011 were around 4.5 million, seven years later, it’s 90 million, but the number of home sales has not changed in that same respective fashion. And so there are more leads flying around our industry that can be purchased.
This is straight up old way of thinking. It ignores the evolution of Zillow over the past couple of years, and it ignores the plain roadmap that Rich Barton laid out about the direction of online leads ever since he returned to the helm a year ago. It ignores what’s been going on with Flex, with Opcity, and with Redfin Partner Agents. It ignores the entire rise of the market maker movement.
Agents can lose patience with buying leads all they want; fact is, Zillow has lost patience with them, and it’s just a matter of time before everyone who has leads will lose patience with the agents.
The value proposition has flipped. The agent is not the customer; the agent is the vendor, whether we’re talking about the new breed of agent super teams or Zillow or Realtor.com. That’s what the new world order is, and by the time the trend is obvious, it will be too late.
It is, if you will, a back to the basics play… but unlike the culture of recruiting play, this one is simply out of date.
Finally, Technology as the Value Play? Really?
I can’t leave this off without pointing out the obvious, especially in light of the Realogy earnings call.
The general narrative of Q4 is something along the lines of, RE/MAX is investing in technology to make its already-productive agents even more productive, because 70% of the business comes from repeat business and referrals. By increasing the value of RE/MAX to agents who want to build their businesses, RE/MAX will be able to recruit more and better agents, which will drive topline growth and then somehow magically drive bottomline profitability.
That would be a compelling narrative if RE/MAX were alone in making productivity-enhancing technology the central theme in why it will be successful. Sadly, literally every single brokerage of any size in real estate is doing and saying the exact same thing.
It’s somewhat like hotels advertising Free Wi-Fi to attract customers. That was something compelling in 2002. In 2020, it’s table stakes. It’s a given. In fact, as a frequent traveler, I rule out hotels that want to charge me for wifi.
The fundamentals of competition are either (a) price, (b) differentiation, and (c) focus. The current strategic path does none of those three things. And yet, RE/MAX persists. It’s strange.
The turnaround in agent count in the U.S. is just that: a turnaround. Things were bad for a few quarters there, and it was reasonable to wonder if RE/MAX is still relevant in the industry landscape. With some of the back to basics blocking and tackling, and a shift to a culture of recruiting, it appears that RE/MAX might actually be back.
However, that culture of recruiting poses a challenge for the existing culture of exclusiveness, of being the home of top producers. We’ll see how RE/MAX resolves that dichotomy in the months ahead.
The financials are not great compared to a year ago, but with the change in agent count, 2020 could end up being a decent year at least for growth and topline revenues. We’ll see what it does for profitability, of course, since that’s the strategic conundrum.
In addition, the tech-centered main strategy of value creation is both old school thinking that seems to ignore the new reality of the industry, and worse, it’s simply not a differentiator at a time when every Tom, Dick and Harry is offering the exact same thing to agents. That smart, capable and knowledgeable industry experts like Adam Contos and Nick Bailey and the rest of the team at RE/MAX seem unable to break out of that old way of thinking is a bit bizarre to me. It’s as if they can’t actually implement the strategies they know they need to, because of legacy concerns.
Perhaps the issue isn’t with the team at RE/MAX. Perhaps the issue is in the boardroom at RE/MAX. Because these executives are just far too talented and far too knowledgeable to be doing the old school thing in a new world order.