[VIP] Realogy, Q4 and Full Year 2019: Darkest Before the Dawn?

I realize this is almost two weeks after Realogy reported, but… between international travel and my computer giving up the ghost, it’s been a bit of a challenge to write this.

It likely would have been a challenge anyhow, because of how much I like Realogy (I have written often about my biases). Q4 was not pretty, although maybe there are some reasons for hope. I promise to try hard to find the silver lining, since Realogy still remains one of the most important real estate conglomerates in the U.S.

But fact is, Q4 continued the downward trend from Q3. The numbers were mostly bad, as we’ll see. The presentation and conversation during the earnings call were mostly bad, although Ryan Schneider put as brave and optimistic a face on as possible.

The Numbers

Since this was Realogy’s full year 2019 annual report as well, we might as well start with those:

2019 was a rough year, and 2018 wasn’t that great either as we saw net income go from $431 million in 2017 to $137 million in 2018. That’s a big drop. So to underperform 2018 is saying something, but Realogy posted a loss of $188 million for 2019, a (237%) decline.

Driving the loss was the drop in gross commission income — the NRT Realogy Brokerage Group segment — by almost $200 million. The increases in Franchise Fees and Service Revenue (Cartus, title, etc.) did not offset these losses nearly enough, and besides, the Relocation unit has mostly been sold in 2019.

And while Charlotte Simonetti, new-ish CFO, and Ryan Schneider cut tens of millions in cost, the fact that interest expense went up by $60 million is both interesting and concerning. I couldn’t understand this one, since Realogy has been actively paying down its debt and any prepayment penalties and such would have been accounted for separately. Plus, interest is something that isn’t subject to cost-cutting measures like laying off staff or getting out of expensive leases.

To echo something I’ve written on Notorious before, I can’t help but wonder what Realogy could do with an additional $60 million a year in terms of investing in its products and services and recruiting…. Just so sad that the debt is not something that current management created, yet they have to deal with it.

Having said all that, let’s not brush under the carpet the two numbers that Schneider and Simonetti have a right to be proud of: $590 million in operating EBITDA, and $226 million in free cash flow. Paying down $78 million in net debt is also not nothing.

But let’s take a closer look at why I got interested in Realogy in the first place: the newly renamed NRT unit, the Realogy Brokerage Group.

The NRT (Realogy Brokerage Group) in 2019

The violence in the P&L, to quote Schneider from a few earnings calls ago, is of course with the NRT, renamed the Realogy Brokerage Group. I wanted to present the last 8 quarters, because Realogy changed the way it is reporting segment information in Q4. So here it is:

Some of the bright spots here is that Q4 revenues for Brokerage rose 2.4% on a YOY basis, and Franchise also went up 2.2%. Since Q4 is normally a slow season, and Realogy has been cutting costs aggressively, it is possible to see this as a real positive. Plus, continuing operations did post a net profit for Q4. All of that is good.

John Campbell at Stephens, a friend of Notorious ROB who has appeared multiple times on the Notorious Interview podcast, focused on these bright spots for his rather upbeat take on Realogy results. From his Research Brief:

Revenue. Total rev. grew +3.5% YOY driven by a +6.0% lift in overall transaction volumes (Franchise Group +7.0% YOY, Brokerage Group +3.9% YOY) that was aided by a better macro and improved agent recruiting/retention.

Profit. Overall EBITDA margins expanded triple digits (+210bps YOY) to 9.5% despite splits re-accelerating (+80bps YOY vs. prior 3-quarter avg. of +40bps YOY). The growth was largely due to better Franchise Group margins, which grew +70bps YOY to 67.9%. Given the Franchise Group’s favorable incremental margins (~175% in 2019) and impact on overall profitability (accounted for ~91% of total Company EBITDA in 2019), it is likely to remain a very important driver for RLGY’s underlying EBITDA growth.

About the Brokerage unit, John writes:

Realogy Brokerage Group (formerly NRT). NRT rev. grew +3% YOY on higher transaction volumes (+3.9% YOY sides x price). Brokerage Group’s EBITDA margins improved ~35bps YOY despite slightly higher splits pressure than anticipated.

I like his optimism, and if you listened to our last podcast, you know that John is rather bullish on the incumbents weathering the storm and coming back strong.

I’d love to adopt his sunny outlook on Realogy, but I’m struggling. Looking into the numbers (and admittedly, some of them are calculated by yours truly, rather than reported by Realogy), I find a few deeply concerning things about the Brokerage segment’s performance. (You might need to do some scrolling in the table above; or contact me and I’ll send you the link to Google Sheets.)

First of all, losses widened in Q4 YOY, despite higher transaction volumes and revenue, as per John.

Second, and more important for us, are the fundamentals driving the financial results. Look at the Key Metrics section above. Transactions are up, total Sales Volume is up, but GCI per side is down? And far more worrisome is the fact that while transactions and volume are up 2.4% and 2.2% respectively, Commission paid to agents is up 3.4%. Commission splits are up 158bps YOY (which John acknowledged).

So despite higher revenues and sales volume, the NRT’s Company Dollar (GCI less Commissions paid to agents) is down by 4.4%.

Third, even more concerning from a brokerage analysis standpoint (since I have long said that Realogy’s NRT is the standard bearer for the entire traditional brokerage industry as it is the only one that reports publicly) are the agent productivity stats. Per agent transactions, volume, GCI, and Company Dollar are all down despite the fact that the NRT added some 2,000 agents net. Take a look at this chart:

Every single quarter in 2019 is worse than the year before. Realogy added agents, but lost per agent productivity across the board.

That is all kinds of bad news for Realogy. Why?

Realogy’s Strategic Focus

If you read any of my writings on Realogy over the past two years or so, you know that I’ve been concerned about the strategic focus on recruiting and retention that centered around driving agent productivity.

That focus continued in Q4. Here’s Ryan Schneider during prepared remarks:

Throughout the course of 2019, we aggressively delivered to enhance our value proposition for our agents and our franchisees. We organically grew the number of agents in our owned brokerage business by 4%. We delivered differentiated marketing, technology and data products, while also launching multiple new high quality lead generation programs. Products like Listing Concierge and Social Ad Engine are now national. We have new technology products available to both agents and franchisees nationally and in pilots. Our new Realogy Military Rewards program is already driving good growth, and we are launching our AARP lead generation program this quarter.

We moved closer to the consumer by providing our agents and franchisees with unique solutions that improve the customer experience. Our RealVitalize program in partnership with HomeAdvisor has expanded to over half the country and our RealSure iBuying alternative with Home Partners of America is driving thousands of cash offer requests in its 10 markets after only a few months. Both consumer products help agents win more listings and make Realogy a more attractive destination for agents and franchisees.

So Realogy spent all of 2019 aggressively delivering value propositions and grew agent count. Realogy invested heavily into all of these programs Schneider mentions: Listing Concierge, Social Ad Engine, new technology products, RealVitalize, RealSure iBuying, and so on and so forth.

The result is lower agent productivity, higher splits, and more pressure on profitability. I mean, Realogy’s NRT unit delivered $44 million in operating EBITDA in 2018, and a mere $4 million in 2019. That’s with all of these products, the focus on recruiting and retention, and so on. And frankly, since Compass eased up all of the pressure on recruiting (something Schneider mentioned often both in the Q4 and Q3 earnings calls), the commission splits in Q4 don’t make a whole lot of sense.

Honestly, I went into some depth on this topic in the Q3 writeup, so I’ll just direct you there instead of boring all of you to tears. (If I haven’t done so already, that is.) But I do have to touch on one point.

In the Q3 call, Ryan Schneider stated Realogy’s strategic focus fairly concisely:

So we’re in the business of recruiting profitable agents and especially try to grow agents here, something we’ve done for a long time and will continue doing.

The Q4 and FY 2019 numbers don’t back this up. That’s the real problem here. Realogy recruited 2,000 net agents. Presumably, each and every one of them was the profitable kind. Realogy then spent the year trying to make them more productive through programs, training, technology, investment, partnerships, etc.

Realogy then cannot deliver lower per agent transactions, volume, GCI, and company dollar. None of those are signs of productivity or profitability.

Having said that, let me acknowledge that at the very least, profitability showed signs of perking up in Q4 as per agent losses narrowed by 1.2%. It’s not nothing. And maybe it’s that seed of hope that will grow into a mighty oak in 2020 and beyond.

The Darkest Hour, Before the Dawn

With all that darkness, let’s try to discuss some of the reasons for hope.

First, Schneider tried to put the agent commission pressure into perspective. I’m not going to quote the whole thing as it is rather long and involved, but basically, his point was that Realogy has had huge spikes in agent splits before — 200bps and such. Plus, 2018 was a terrible year because of Compass and other “irrational competitors” who were throwing money at productive agents. Plus, as he acknowledged, more productive agents get higher splits. So all in all, he thought that the increase in splits was better than expected.

On agent commission splits, we absolutely — we’re — had a higher Q4. I’m not just troubled by it in the sense that we got the — we got a lot more growth in the quarter, which is part of it. But also remember, the higher volume you get from people, the higher they move up the split table, so that’s a piece of it.

But the other thing, if you look compared to 2018, right, the Q4 of last year was our smallest increase year-over-year. So it’s a little bit of a lower comparison than some of the 200-ish basis point year-over-year comparisons earlier in the year, but this is — if we step back bluntly, we came into the year, and I think I told you, you should expect about 100 basis points of split increase for the year, right. And as it turned out, the number was, on a like-to-like basis turned out to be 70 bps. It was 49 bps on the face of the financials, which includes the fees that we’re now getting, which is a real thing. And so I actually think the 49 is a real number, we should all be excited about.

If the changes in the competitive environment lead to Realogy somehow reversing the so-far inexorable march towards 100% commission splits, that’s the game changer. If Schneider can say “we’re at a steady state” at a future earnings call, which he mentions, that would be a huge boon for Realogy’s fortunes — which translates directly into sign of things changing for traditional brokerages across the industry.

My skepticism on that front is well-documented, but hey, hope springs eternal, right?

Second, as both Schneider and Simonetti acknowledged, losing USAA last year is going to be a big hit. However, Realogy has worked very hard to try and replace that flood of leads with other programs, like the AARP partnership, the Realogy Military Rewards program, and others. If the AARP thing in particular works out, it is entirely possible that Realogy will stabilize.

Third, the overall market is showing signs of strength. Realogy, after all, isn’t the only company to report surprisingly strong Q4 and optimistic results from January. Zillow and Redfin and RE/MAX all did as well. So as a rising tide lifts all boats, Realogy could find far happier days in 2020. Maybe 2020 brings a reversal of the agent productivity trends that have been bad for two years now. Maybe all of its lead generation efforts, all of the technology investments, all of the reorganization all lead to Realogy agents being more productive, while holding commission pressure down.

Fourth, the fact that Compass has retreated from its super aggressive recruiting tactics is kind of a big deal not just for Realogy but for all traditional brokerages. I’ve been hearing that from the field since early fall of 2019. So there is more reason for hope.

But as I said in Q3, just because the hottest girl at the club just walked out the door doesn’t make Realogy the next in line. The real estate industry is hypercompetitive and all of the other companies, like Keller Williams, HomeServices of America, RE/MAX, eXp, and thousands of others are not just hanging out on the sidelines waiting for Realogy to be the destination for agents. So we’ll see.

Fifth, let’s not ignore the fact that Realogy is still generating a ton of free cash flow and operating EBITDA: $226 million and $590 million, respectively. This is still a great company that is making substantial amounts of money. It has been declining, yes, but relatively slowly. But to paraphrase Adam Smith, there is a great deal of ruin in a great company. Unless there are unexpected events, external shocks, or massive disruption (which I do think is happening, but not necessarily in 2020), Realogy will soldier on.

Finally, I’m going to take Ryan Schneider at his word when he said:

Let me close the call on a personal note. I’ve been very blessed to have held multiple senior operating roles over the years and by my count, I’ve been involved in preparing for around 60 earnings calls over that time. And once in a while, you realize something feels different, like there is a change in the air, and that’s how I feel today. For the past two years, it’s felt like the headwinds for Realogy have outnumbered the tailwinds. With our accomplishments throughout the year, especially in Q4, combined with the change of the competitive environment, we began to feel more positive energy.

The excitement for the future is higher, the optimism is higher, and I feel that from our employees, from industry insiders, and from many who watch our industry closely. I’m not saying the road ahead is easy, and I shared some of the headwinds with you during the call, but it does feel different to me. As I said in my opening remarks, I’ve never been more excited about Realogy than I am right now.

Great leaders are optimistic when everyone else is despondent. Look at Patrick Mahomes in last year’s playoffs as an example. If Schneider can inspire the entire company to the excitement he feels, the positive energy he’s projecting, and the team believes in him the way Kansas City Chiefs had no doubt that they would win while being down double digits in the Fourth Quarter of the Superbowl… that will make all the difference.

Conclusion

I am choosing to end this write-up on a hopeful note. The team at Realogy deserves better than the dumpster fire they were handed.

But I can’t ignore the fact that 2019 was not a good year, nor can I pretend that Q4 was particularly strong because of the optimism coming from Schneider. There are real problems at Realogy, and real reasons for concern.

At the top of my list remains the productivity-profitability conundrum, and after 2019, I have to add the questions about agent productivity to the mix. Perhaps all of those will turn around in 2020, but there is no real reason to believe that. Past performance is no guarantee of future performance, true, but it is the best indicator any of us have. So we are left with hoping for a surprise result, similar to what we saw out of Zillow in its Q3/2019 turnaround of its IMT business.

2019 was the darkest for as long as I have tracked Realogy as the standard bearer for the residential real estate brokerage industry. Perhaps the sun is on its way. For Realogy’s sake, I certainly hope so.

-rsh