I’ve decided to change up how I go about analyzing the quarterly earnings reports from the five public companies in residential real estate. Part of it is that I’ve started a new investor-focused set of products and services (contact me if you want more information) but the other part is that the old way of doing this took an enormous amount of work, and I didn’t think added tremendous value to most VIP Subscribers.
If you’re an active investor, you’re already on top of all the numbers. You’ve already looked through the data and have come to your own conclusions. What you’re curious about is what you might have missed, and what the impact is on the rest of the industry. If you’re not an active investor, but in the industry, then you likely don’t care all that much about the numbers anyhow. You want to know how the results affect the rest of the industry.
So… I’ve decided to focus more on the implications and less on the numbers part. Obviously, the numbers are important to drawing some conclusions, so I’ll use them where necessary, but I don’t really see the value in tons of hard-to-read tables that take hours and hours to put together.
Instead, we’ll focus on the big picture takeaways for the VIP audience.
We start with the two companies that have already reported: Redfin and Realogy.
Redfin, In Brief
The shortest version of the Redfin Q2 results is that Redfin absolutely killed it in Q2.
As the press release says:
“Redfin blew away our second-quarter financial targets,” said Redfin CEO Glenn Kelman. “Within the span of a single quarter, year-over-year changes in demand went from -41% to +40%, a level of volatility that I have never seen in nearly 30 years of business. Over the past two months, Redfin’s online visits and customer inquiries have been growing at a faster rate than at any point in the last three years. We’re inside a tornado, hiring agents, lenders and closing specialists at breakneck speed to keep up with demand, but also mindful that the bottom of the economy could fall out a second time.”
- Revenue: Up 8% YOY to $214 million.
- Gross Profit from real estate was down 6% YOY, but that’s far less of a decline than most people expected.
- Importantly, real estate gross margin was 34%, up 2% YOY, because expenses were down to 24% of revenue vs 31% a year ago.
More revenue at better margins — it just doesn’t get better than that.
In contrast, Realogy had a disastrous Q2. From the press release:
- Generated Revenue of $1.2 billion, a decrease of 27% or $457 million year-over-year.
- Operating EBITDA down $63 million YOY “driven by lower transaction volume primarily due to COVID-19.”
- Combined closed transaction volume declined 24% in the second quarter. (But, as Realogy points out, “Closed transaction volume improved meaningfully in June to negative 8% year-over-year after reaching a bottom in May 2020.”)
- Splits (i.e., margins) worsened by 174bps YOY and 53bps compared to Q1 to 74.6%
Granted, Realogy says they “strengthened the balance sheet” but that was through refinancing their debt, not from raising more money via equity sales or from better cash flows. In fact, their free cash flow was down quite a bit: $106 million vs. $178 million last year… and if you include discontinued operations (Cartus, which is the subject of a lawsuit that isn’t going well for Realogy), we’re talking $47 million vs $147 million.
So it was a bad quarter for Realogy, which is still the largest brokerage and largest real estate conglomerate in the industry.
So what accounts for the huge difference between the two?
The real answer is, “Lots and lots of things.” Redfin controls its lead generation, while Realogy does not, etc. Redfin is really a giant agent team with a super-duper lead agent who happens to be a website. And fundamentally, it is the gains that agent teams have made during COVID that explain the different results for the two companies.
The Agent Team
Longtime readers know that I have been talking about the disruptive impact of the super agent team for years now. So there’s little that’s new there. What is new is some data I have analyzed from some production data out of Houston. I’ve presented this now to two webinars, so I figured it’s worth sharing with you all:
First, the industry is not yet real good at keeping track of agent team data. The MLSs have just begun (and only a few) to implement teams as a thing. That means the way to try to track team performance is by looking at the very top agents. The second way, which I used above, is to arbitrarily say that anyone doing more than X number of transactions a year is likely a team.
By both methods, what we see is that the top 1% and the top 10% — which I think is fair to characterize as agent teams — are gaining major market share. 2019 is particularly eye-opening. The top 1% of agents in Houston grew their market share by nearly 25%, while the “middle 40%” (those from the 40th to the 80th percentile) only grew market share by 18%. Then for the first six months of 2020, which includes the massive hit from COVID, the middle 40% lost market share while the top 1% gained market share.
Interestingly, the top 10% also lost market share, implying that at least some of them are likely (a) individual agents, or (b) small teams that are not well setup.
If we look at the agents who did 40+ units in 2019 (I spoke with my ex-broker wife to arrive at that number, but it is somewhat arbitrary), they increased market share every single year, including the COVID-devastated 2020. Everybody else gained share during the hot hot markets of 2018 and 2019, but dropped significantly in 2020.
What this tells me is that during bad times, the agent teams at the top of the industry gain even more market share. They are better operated, better funded, have more control over their employees (because that’s what they are, no matter the tax status), have better systems, better technology, better lead generation, etc. etc. They’re simply better at doing real estate than those who are not in well-managed and well-operated teams.
Redfin is such a team. That explains its booming Q2 results.
Realogy is not such a team. That explains its terrible Q2 results. And Ryan Schneider knows it. From the earnings call:
Yeah. I draw less – look, the competitive environment bluntly has not really been correlated with the housing market strength. 2018 and parts of 2019 were kind of flat and in some cases even down housing markets and the competitive environment at times was just incredible.
We’re happy that Q2 like Q1 felt like a much more rational competitive environment the year before, still tough out there and we’re part of that tough competition out there in the market. The bigger thing probably for splits is, remember the stronger the volume is out there, the more people can kind of work their way up to the tables. And so I think there may have been a hypothesis going into COVID that, weak housing years, maybe you won’t have to pay as much in splits because people don’t do as much volume. But the stronger volume comes back then the more volume business people do and especially the higher-end agents like Charlotte talked about, you get kind of higher splits kind of coming from that as people move up the tables. But, look, we’d rather have the stronger volume and pay people to move up the tables than the reverse. So, we’re okay with that. But the market strength in this -and the competitive environment have not been really correlated, and I don’t think that is what’s ever really driven the competitive environment. But there is the relationship which is pure volume and splits that we have talked about before. [Emphasis added]
Tough markets = tough get going = he that hath, gets = teams outperform. Those teams eviscerate brokerage margins, because they’re on higher splits.
So not only did Realogy lose revenue (because its lower-tier agents just got crushed in the market disruption), what revenue it did generate came disproportionately from the top agents (who are almost all teams), which then compressed margins due to higher splits.
Realogy’s 25.4% Company Dollar margin (a number I compute myself using what data Realogy publishes) in Q2 is the lowest it has ever been since Q1/2017, which is when I started keeping track of it. There is no sign that trend reverses.
Even the positive signs coming from the end of June and July that Schneider mentioned in his call are unlikely to reverse this trend, since chances are very good that it is the agent team that is going out and getting those listings, getting those transactions, all at higher splits. For myself only, I wouldn’t be surprised if Realogy’s Company Dollar margin dips below 25% for the first time ever.
And since Realogy is the flagbearer for all traditional brokerages, where Realogy goes is where they all go. They don’t report publicly, but they don’t have to, because Realogy tells us what’s happening with them.
A Note about Redfin and Technology
Having said all that, it is worth noting something rather interesting about Redfin.
Wall Street thinks Redfin is winning and winning big because of its technology. After all, when COVID hit, Redfin had all of the tools to do real estate virtually. And compared to other brokerages, there is no doubt that Redfin had a giant lead over all of them in terms of remote transactions, virtual tours, virtual showings, and so on and so forth.
This came up during the earnings call, when an analyst asked Glenn Kelman about Redfin’s technology advantage. Glenn’s answer is worth quoting in full:
So, we have seen competitors start to embrace three-dimensional scans of listings, which make it easier to see a house without actually getting out of your car and walking into the property. But nowhere near the universal or near universal level that Redfin has.
So, we do see individual agents trying to cobble together a special camera for taking those scans or trying to offer FaceTime video to their customers, just telling each customer that I’ll do that for you. But our platform lets us offer that to every single person who’s looking at a listing online. And just being able to tell everyone that we can take you through the whole transaction without having to meet you is a comfort to many customers.
I would say it’s just as important or maybe perhaps more important to home sellers that we know how to sell a house without having to host open house after open house, because we can show you how much traffic that listing is getting online, we can run digital campaigns, and you can see the results in real time from your computer. And just talking to people about the premium amount of traffic we can deliver because of our platform, because of our digital capabilities, has been more important.
It used to be that when you told somebody, “Hey, we’re going to run these custom campaigns, it’s going be email, it’s going to be redfin.com, it’s going to be Facebook, there’s plenty of work we have to do here.” They’d say, “But what about the post card? Are you going to send a postcard?” Nobody is really saying that anymore. People really want to hear about how you’re driving virtual showings.
So, I do think it favors us. I do think the industry is going to try to close the gap and only get halfway there.
There’s a lot of truth here, but it’s missing one big element that affects everything. You guessed it: the agent team.
For my upcoming Q2 investor report, my team and I interviewed 18 of the top team leaders and brokerage owners across the country. One of the most surprising-but-not-surprising things we heard was that many of the best operated teams were equally ready for the COVID crisis as Redfin was. These teams already owned and have been using Matterport on every listing they had. Many had in-house drones and pilots for aerial videos. They had staff who could do virtual showings. They had the “platform” that let them offer 3D virtual tours to every single person looking at one of their listings online. These teams knew how to sell a house without having to host open house after open house, because they can show sellers how much traffic that listing is getting online (from Zillow, for example), and they can run digital campaigns and do run them.
In other words, the top agent teams all had similar technology capabilities that Redfin had, and they all grew their businesses in much the same way that Redfin did throughout Q2. In many cases, the teams I spoke to often outperformed Redfin, with some having the best quarter they had ever had.
At least one Wall Street analyst, John Campbell of Stephens, a friend of NROB and one of the sharpest guys on Wall Street on real estate noticed the same, when he wrote:
Virtual Tours are a New Concept That Could Be Helping Share Gains Share Now; But It’s Not That Unique.
Matterport is the 3rd party vendor that runs RDFN’s 3D tours. Given its vendor status, others can (and have) add this feature. Traditional players like Coldwell Banker have added the virtual tour feature and are experiencing some of the same virtual trends as RDFN (60%-70% of Coldwell Banker buyers were viewing properties and willing to make offers on homes sight unseen in May). Of course, there’s also the elephant in the room with Zillow. While RDFN is building industry-leading technology for itself, Zillow is building as good, if not better, technology to supply to the industry as an “arms dealer” of sorts
And who is Zillow’s top targeted customer? That’s right — the top producing agent teams.
I talked about this on Bill Risser’s excellent podcast, The Real Estate Sessions, back in March:
The section on bionic super teams begins around 45 minute mark. But now I have some data and more research to feel confident about the call. These super teams + Zillow = bionic super teams that can match, or exceed, what Redfin brings to the table.
Which might explain the biggest news to drop during the earnings call that I haven’t seen picked up yet by industry media. Early on in prepared remarks, Kelman says:
We’re extending our software and potentially our call centers to give our partner agents more of the support now reserved for our own agents. These efforts should improve our partners’ agent service and increase the average gross profit Redfin generates per website visitor.
Whoa. How are we not talking about this?
Every former Redfin agent or manager I have ever spoken to, who went on to another brokerage in pursuit of “unlimited earning potential” all tell me the same thing: they wish they had Redfin’s technology tools.
Numerous brokerage owners and CEO’s of major companies have long speculated that Redfin might never make money as a brokerage, but it might make millions if it started selling its technology platform to other brokerages.
Well, that’s essentially what Redfin is going to do going forward, no? It’s just that it will “sell” the technology platform by way of 30% referral fees from the partner agents.
Now, ask yourself this: do you really think Zillow is going to sit back and watch all that unfold and do nothing about it? This is the same Zillow whose CEO said during past earnings calls that he sees major opportunity in working on thorny lead-to-closed-transaction conversion funnel problem.
Not. A. Chance.
Watch for Zillow to ramp up its technology platform offerings to its customers: the super teams that make up most of its elite Premier Agents. I know I will be.
Big Picture Takeaways
So what I took away from the two earnings reports is simple: Redfin is ascendant, but Realogy is fading away. By extension, the agent team is ascendant, and traditional recruit-and-retain brokerage is fading away. I expect that eXp as the New Hotness of the moment will post great results in Q2, but there are only so many top teams to recruit… and they will eventually push margins lower at eXp as well, because eXp remains a split-based brokerage. I suspect that Keller Williams will do fine, because it is home to so many top teams in the industry, as that is the model the company is built around.
But fundamentally, you can analyze the fortunes of various entities in real estate quite simply: how well do they mesh with the rising of the bionic super team?
That is the disruption that keeps on giving. Most everything else is a sideshow.
I hope this was useful to you, because it was so much shorter and skipped over the extraneous charts and numbers and such. If you miss having those charts and numbers are such, let me know and I’ll see what I can do for my VIP readers. And as I mentioned, if you are in the investment industry, and want to get even more in-depth, with content and analysis geared for your particular needs, let me know and I’ll send you more information on that.
Thanks everybody! See you soon after ZG, EXPI, and RMAX report.