[VIP] Realogy, Q1/2020: Excitement! And COVID!

Realogy was one of the first public companies in residential real estate to report Q1 earnings… and it was more or less what was expected: Q1 came in strong, even with the crash towards the end of the quarter with COVID. This was always going to be the case for Realogy and everybody else in residential real estate. Q1 of 2020 was heading towards being a record-breaking quarter, until the pandemic hit.

So like Ryan Schneider said on the call itself, we’re going to do this analysis differently than our usual approach. We’re going to spend more time on what is ahead than what was in Q1. Hey, actually, that’s kind of the same approach I’ve always taken!

As always, when it comes to Realogy, the big picture question is, “What do these results mean for the incumbent brokerage industry in North America?”

The Numbers

While not extremely relevant in the post-COVID world of real estate, here are the Q1/2020 numbers:

This was a great quarter by any measure not having to do with profitability. More revenues in the two core business units of franchising and brokerage, lower operating expenses driven by Schneider and Simonelli’s prior to COVID hitting, and strong performance in top line key metrics in Brokerage Group. The giant impairment charge of $442 million is from writing down goodwill due to COVID, and that’s a one-off thing and it’s non-cash:

During the first quarter of 2020, the Company determined that the impact on future earnings related to the COVID-19 pandemic qualified as a triggering event for all of our reporting units and accordingly, the Company performed an impairment assessment of goodwill and other indefinite-lived intangible assets as of March 31, 2020. This assessment resulted in the recognition of an impairment of Realogy Franchise Group trademarks of $30 million and a goodwill impairment of $413 million for Realogy Brokerage Group offset by an income tax benefit of $99 million resulting in a net reduction to Realogy Brokerage Group’s carrying value of $314 million. The primary drivers to the impairments were a significant increase in the weighted average cost of capital due to the volatility in the Capital and Debt markets due to COVID-19 and the related lower projected financial results for 2020. The impairment charges are recorded on a separate line in the accompanying Condensed Consolidated Statements of Operations and are non-cash in nature.

So except for that whole profitability thing, Realogy had a very good Q1 overall.

Realogy Brokerage Group in Q1

The violence in the P&L, to quote Schneider from a few earnings calls ago, is with the Realogy Brokerage Group. It had a very strong quarter in the top line, but the key concern for everybody is the issue of agent splits. That is a persistent — one might even think of it as a permanent — problem with Realogy. Q1 was no different.

More agents (about 4%), good. More transaction sides (up 3.5% YOY), good. Higher average home price (up 4.3%), good. Combine the two and you get Sales Volume that came in 8% higher YOY. That’s quite some growth! And commission rates were held constant at 2.41% per side, and total GCI was up 6.5%.

John Campbell at Stephens, a friend of Notorious ROB who has appeared multiple times on the Notorious Interview podcast, was excited about the results. From his Research Brief:

RLGY delivered an impressive quarter with the Company checking the box on several important items including: 1) a quality rev. beat aided by better transactions + price in both key segments, 2) a meaningful EBITDA beat/+300bps YOY margin expansion on the better top line, mix and benefits from the ongoing cost reduction efforts and 3) +4% YOY lift in Brokerage Group/NRT agents, which provides further evidence that the Company appears to have stabilized its base. A negative was splits jumping +210bps YOY, but given the large EBITDA beat it might not matter as much. Further, given the size of the lift, we think that there’s likely some explanation (ex. accounting shift).

So… what was the explanation about agent splits jumping 210bps YOY? From the transcript:

Jack Micenko — SIG — Analyst

Hi, good morning everybody. Thanks for if that means Wanted to come back to the splits question again and maybe in different way. The increase, it looks like it’s stabilizing our market share. That’s good. The split number was higher than we thought and higher than trend line. Certainly better agents do more deals in tough times, and they’re better agents for a reason, and so their splits are higher. How much, I guess, of what we saw this quarter in the uptick above trends is competition versus that agent mix, would you say?

Charlotte Simonelli — Executive Vice President and Chief Financial Officer

It’s not really driven by competition. There’s it’s truly driven by the agent mix. That is the single biggest driver. There’s always a piece of geography in there. There’s a little bit of the loss of USAA. So there’s some small little knits that will that are in the numbers that will plague us for the next couple of quarters as well, but the biggest single driver was actually the agent mix.

This is not good news, to put it mildly. Turns out the big jump wasn’t due to some accounting shift. The explanation is that Q1 saw better agents do more deals — that’s what “agent mix” means. Plus the geography piece (NRT is heavily concentrated in coastal markets that were locked down hard and early.)

The result is in the table above: despite more agents, more transactions, higher prices, higher GCI… Company Dollar was down 1.4% YOY. And this was a great quarter! Q1 of 2019 was not a great quarter. But Company Dollar is still down 1.4%. EBITDA was better, but that seems largely due to the serious and significant cost cutting measures both before COVID and afterwards. One shudders to think what it might have been if costs were held constant to Q1/2019 levels.

The issue is, as the issue has always been, this:

Oh yeah, lest we forget, this happened in a “more rational competitive environment” as Schneider said many times in the call. So competitive pressure is off… but splits are up and Company Dollar is down. Not good.

In the Q4 report, I talked about agent productivity issues with the NRT. Q1 was better YOY on all measures, except Per Agent Company Dollar. Nonetheless, what does this chart say to you?

I’m struggling to come up with a narrative here, a scenario under which Realogy Brokerage Group turns the corner and starts increasing Company Dollar, decreasing agent splits, and generates agent productivity at the same time.

Excitement and COVID

It was a weird earnings call, as can be expected in such a weird time that we are living through. But if I had to come up with two themes from the call, they’re Excitement and COVID.

On the one hand, Ryan Schneider is excited. He is very excited. I counted 11 mentions of “excited,” and “excitement” was mentioned twice, and “exciting” was used once. So let’s talk about some of the reasons for this excitement.

Tech Adoption

Schneider specifically calls out agent adoption of Realogy technology as a reason for excitement:

On the agents side, I’ve been excited by the agility agents in Realogy have demonstrated to continue to get deals done in a social-distancing world. Agents are using technology, both Realogy technology and third-party technology, more and in new ways to help customers buy and sell homes. We’re seeing an adoption acceleration of our technology products. We’re excited by rapid technology product enhancements we’ve deployed, including virtual home tours, expanding virtual staging, new online marketing capabilities and increasing digital payment options. We also like the creativity we’re seeing from agents and employees to complete the last mile of real estate transactions using our remote notarization product for title, our flash close product for mortgage and operational changes like our title company doing drive-through title and mortgage closings. And people are getting creative to take care of our most vulnerable customers.

I’m not really sure what Realogy technology he’s talking about. Virtual home tours is not a Realogy product, as far as I know. Virtual staging is not a Realogy product. What new online marketing capabilities Realogy launched post-COVID is unknown to me; it’s not to say they didn’t, but it is to say I don’t know about it… which means it could not possibly have been that significant.

Later in the Q&A, in response to a direct question about whether agents are using Realogy’s offerings or third-party offerings, Schneider says:

So as I said in the script, the adoption of our tech products by our agent base has absolutely accelerated. And we’re really excited about that. And there’s a lot of different pieces, obviously, to that.

But I would actually say but I don’t think they’re just using I know for sure, they’re not just using our products out there, and I’m fine with that because I’m an open architecture guy. I want to enable them to use whatever. And so for virtual tours, I mean, people are using Matterport and stream, and people have just have agents doing stuff with Facetime and stuff. I mean it’s and so I’m good with all of that, but we are getting more of our adoption, which we think will help us in the longer term, and then we want to be here to support them with other good products if that’s what they want to use and make it easy to integrate those in our ecosystem with APIs.

So we are seeing adoption of our stuff, but I love the creativity our agents are using of whatever is working for them and their customer. And we’re going to continue to try to support an open architecture more than require our technology. But we like the increased adoption of our technology during this time, which we absolutely have seen.

There’s a bit of a mixed message there, no? What Realogy products are specifically geared towards the virtual experience? None that I can name. And if agents are using third party technology that does enable the virtual transaction, and Realogy is all about open architecture and APIs and ecosystems and such… is that really agents “adopting our technology”?

It’s not a semantic argument. It’s really about what actual technology Realogy has that enables the virtual future, and whether agents are really adopting Realogy’s proprietary technology stack in their day to day business.

Optimization: The Virtual Workplace

During the Q&A, we get another peek into the thinking of Realogy management. And it is, you guessed it, exciting.

One of the things that we’re also doing that is prospective as many companies are is how do you use this time of crisis, frankly, to reimagine work, right? We’re finding a bunch of stuff we’re able to do either with more productive or lower cost or even higher employee satisfaction in a virtual environment, and kind of the forced adoption is helping us accelerate some of that stuff. And so Charlotte, I think, did it well, right, which is we had the cost stuff earlier that is separate. We’ve got this additional, a lot of which will depend how the prices evolve, but then there’s going to be whatever happens on our reimagining work, and I’m excited about that. And we don’t have any numbers to share with you on that yet, but knowing that we’re one of many companies taking on that challenge and can see some different things already, I find exciting and one to share with you.

It’s not real clear what he means here, but he’s talking about Realogy itself becoming more virtual. Simonelli spells it out:

Big cost. Big cost bucket, yes. Yes. So it’s predominantly two things, which is workforce optimization and office footprint optimization. So those it’s basically people costs and the costs associated with our facilities. So that was last year’s program.

Last year’s program has now been supercharged and accelerated with COVID and related cost cutting. We’ve already seen the press releases: huge pay cuts for senior management on down, layoffs and furloughs, hiring freezes, etc. etc. But again, this is merely Realogy doing what it has been wanting to do, but at a larger scale.

For example, back when I wrote about Realogy shutting down Climb, I wondered out loud why Realogy did that. Now, I think I know. It was part of the overall cost-cutting strategy. And that strategy can now be implemented across all brands, all divisions, all business units at Realogy without the kind of negative publicity that (for example) shutting down Climb generated.

I do kind of dislike the corporate-speak, such as “workforce optimization” instead of “layoffs” but it is what it is in our politically correct, linguistically neutered world. But we’re talking about reducing headcount, paying less in salary & benefits, and getting rid of office space. Every company in the world is thinking about the same thing, of course, so that’s hardly surprising.

Prediction: Realogy will go virtual as quickly as possible and reduce headcount as quickly as possible. This is a trend that’s been going on since 2019 when Simonelli came on board with the mandate to find cost savings, but COVID both accelerates the trend and provides the perfect cover story.

COVID: The Perfect Cover Story

Which brings us to the second theme of the earnings call: COVID as the perfect cover story for Realogy to do what it wants to do anyhow. We saw Opendoor do the same earlier, announcing Home Reserve under cover of COVID. We saw Google do the same. COVID provides the perfect PR spin on companies taking action. No different for Realogy.

I’m not going to get into every detail, but let’s point out the biggest: Realogy is canceling or suspending a number of its experiments, because COVID. From the call:

Let me just kind of give you a laundry list here and try to hit a bunch of them. So we’ve actually, on some of the things you talked about, been pushing faster. So social ad engine with Facebook, for example, we did an earlier release than we planned because of COVID to introduce some new capabilities to help agents even more with some of their online marketing. We’re really excited about that. We went ahead and actually did do a soft launch of the AARP program. We didn’t spend the big some of the big marketing dollars we were planning because of COVID, but we went ahead into the soft launch, and we’ve actually already closed some transactions from that less than about six weeks later. So we’re really excited about that. And Realogy Military Rewards continues to push forward with a lot of traction, and that’s doing really well.

A couple of things that have changed. One is, you mentioned RealSure, which is kind of an iBuying partnership we had with a slightly different model. We used HomePartners of America for the capital and the source of that. We have paused that because it just didn’t seem like the right thing for either of us when we kind of went into COVID here.

And then the TurnKey program, the value proposition of the TurnKey program, which we piloted with Amazon in 15 cities, the value proposition of that is all built around in-home services and in-home installation. And so we together kind of made the joint decision that we were going to suspend that because we think health of the smart home products and their own services that require people being in someone’s home just doesn’t work in a COVID kind of social-distancing world. So we really like the TurnKey pilot program, but we ran into this thing that really just cut the core proposition kind of off at the pass. And we and Amazon, we had a decision point on the next phase of what we’re going to do that was in April. And in a COVID world, bluntly, it didn’t make much sense to continue that pilot.

So in summary, the affiliate marketing stuff is moving forward: AARP, Military Rewards. Everything else is gone.

Since TurnKey launched to much fanfare, has anyone anywhere heard about its booming success? I know I haven’t. And I speak to Realogy brokers and agents all the time; not one has ever said, “Boy, that Amazon TurnKey program is showering me with leads!”

RealSure… I think you all know my thoughts on that program already. The fact that Realogy hasn’t really made much fanfare about it tells me a lot. The fact that they canceled it says a lot to me. Why?

Because if COVID has any psychological impact, it is this: vacant houses are more valuable now. And Realogy and HomePartners of America decide to cancel a program that creates vacant houses? Because of COVID? Yeah, okay.

Bottomline is that COVID provides Realogy (as it does to all other companies across all sectors) the perfect cover story to do all kinds of things they wanted to do anyhow. For example, I speculated in this post that Redfin, for example, used COVID as an excuse to layoff a bunch of people they wanted to get rid of anyhow. So COVID provides cover for Realogy to do “workforce optimization” and “office footprint optimization” without all of the negative blowback that would accompany such a thing otherwise. There will be no wild-eyed speculation that Realogy is going bankrupt because it laid off 30% of the workforce, or eliminated half of its offices, because COVID. There won’t be dire predictions of doom because Realogy canceled non-functioning, non-productive marketing programs.

No, if there are dire predictions of doom, at least coming from me, they will be because of the fundamental and seemingly permanent problem of profitability, extraordinary conservatism when aggression is what is called for (we’ll talk about this when we talk about Zillow’s Q1 results), and running out of options for capital when capital is the biggest factor in success or failure.

Wrapping Up

In my Q4 writeup, I said that 2019 was the darkness before the dawn. I think I was sort of right about that, because Q1 came in very, very strong. It’s entirely possible that without COVID, Realogy would have stabilized, buoyed by a record-breaking housing market, and had time to figure out the productivity-profitability conundrum. The sun was on its way… and then the world collapsed.

That’s not Realogy’s fault. That’s not anybody’s fault, unless you are one of those who hold the Chinese Communist Party responsible for the pandemic. But we play the hand we’re dealt, and Realogy is choosing to play the hand that it has been dealt with conservatism, cost cutting, retrenchment, and a “batten down the hatches” mentality, no matter how often Schneider says he’s excited about what’s going on.

Excitement is warranted, yes, if one is being aggressive and opportunistic. It makes little sense if one is hunkering down to weather a storm.

-rsh