A year ago, I wrote these words while analyzing Realogy’s 2019 results:
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.
A year later, and after the disruption of COVID, Realogy reported a banner 2020. From the press release:
“Realogy had an outstanding 2020, delivering $726 million in Operating EBITDA, $555 million in free cash flow, 13% homesale transaction volume growth, and substantial capital structure improvements,” said Ryan Schneider, Realogy’s chief executive officer and president. “In an extraordinary year, we were able to capitalize on the dynamic housing market, accelerate our strategic progress, and capture significant incremental transaction economics. With our strategic success and strong momentum, we believe Realogy is well-positioned to lead into the future. 2021 is off to a very strong start, and we are excited as we look ahead.”
And the numbers Realogy posted are much, much healthier than 2019:
- Generated revenue of $1.9 billion, an increase of 36% or $497 million year-over-year.
- Reported Net income of $18 million and basic earnings per share of $0.16, an increase of $63 million vs. prior year or $0.55 per share.
- Generated Operating EBITDA of $206 million, an increase of $80 million year-over-year, driven by higher transaction volume, strong performance at our mortgage JV, and ongoing cost management (See Table 5a).
- Title and mortgage continued to contribute meaningfully to our business results, generating approximately
$58 million in fourth quarter Operating EBITDA (See Table 5a).
- Combined closed transaction volume increased 45% year-over-year in the fourth quarter driving market share gains for the second consecutive quarter.
- Generated Free Cash Flow of $268 million vs. $77 million for the corresponding quarter last year (See Table 7).
For the year 2020:
- Generated revenue of $6.2 billion, an increase of 6% or $351 million year-over-year.
- Reported Net loss of $360 million and net loss per share of $3.13 includes non-cash impairment charges of $682 million largely attributable to the COVID-19 crisis.
- Generated Operating EBITDA of $726 million, an increase of $136 million year-over-year, driven by higher transaction volume, strong performance at our mortgage JV, and strong cost management both temporary and permanent (See Table 5b).
- Title and mortgage continued to contribute meaningfully to our business results, generating approximately $226 million in Operating EBITDA (See Table 5b).
- Increased combined closed transaction volume 13% year-over-year with improvement across both Brokerage and Franchise businesses and held market share steady in 2020 vs. 2019.
- Generated Free Cash Flow of $555 million, up $329 million vs. last year (See Table 7).
- Strengthened the balance sheet reducing net debt by $493 million from December 31, 2019 with the Net Debt Leverage Ratio declining to 3.4x (See Table 8b) and senior secured leverage ratio of 1.70x (See Table 8a).
- Grew Brokerage agents 2% year-over-year and had continued improving retention.
I am left conflicted. On the one hand, the financial results are positive and can’t really be argued. 2020 was a great year for Realogy, as it was for most of real estate, and a rising tide lifted all boats. Realogy’s title business in particular did very well, and you can’t argue with $555 million in free cash flow, paying down another half-billion in debt, and substantially better earnings.
On the other hand… the trends I’ve been talking about for years now (go back and re-read just about every post I’ve ever written on Realogy) have not been reversed in the all-important brokerage business.
The Core Issue: Productivity-Profitability Dilemma
In every post I’ve written about Realogy, because it is the sole publicly reporting traditional brokerage today, I wrote that the key issue is the dilemma of productivity and profitability:
I’ve written this elsewhere, but the fundamental problem of brokerage is a simple one: it is the only business in the entire world where more productive a worker is, less profitable that worker is. Productivity is inversely correlated to profitability.
They key challenge for Realogy — as it has been for all traditional brokerages — is how to keep agent splits under control, in good times and in bad. Well, here’s from Q1 of 2017 to Q4 of 2020:
This is a striking chart as well, illustrating basically the same problem: closed transactions are slowly (very slowly) increasing, while margins are eroding rather faster than that:
Commission splits increased 265 basis points year-over-year in a very high volume year. The lion’s share of that approximately 200 basis points was driven by two things. We saw upward pressure as a greater share of our transactions were closed by higher split agents and as other agents produced more and progressed up the commission rate schedule. We also saw upward pressure from our investments to grow agents and improve retention. Our owned brokerage agent base grew 2% and retention improved each quarter, and we like the net economics of our agent investments. The remaining 60 basis points was driven primarily by the loss of the lower split USAA business in the previous year, the sale of our property frameworks business and geographic mix. We expect continued pressure on splits in 2021, which in part will depend on the strength of the housing market and we will work to offset split increases by growing our agent base, leveraging our ongoing cost reduction programs and by capturing more economics from the consumer transaction.
This part is pretty much the same as every earnings call from Realogy since… like, ever.
What’s different is this: it appears that Realogy has decided not to fix that problem. Instead, the strategy is to tackle the problem via “integrated economics” which is a fancy way of saying what traditional brokerages have been doing for the last couple of decades: make money on title, mortgage, escrow. Here’s Ryan Schneider from the earnings call:
Charlotte talked about this which is in a world where not just Realogy, but our industry has some increase in upward pressure on agent commissions being strong on our cost approach year-over-year on operating costs is a way to offset some of that margin pressure. And then the more we can capture the integrated transaction economics, obviously that’s another way, not just to offset the pressure, but if you look at 2020, go beyond offsetting the pressure with our mortgage and title results. And so that’s how the business works. And one thing is, as we report mortgage and title separately, but those businesses wouldn’t exist without brokerage right. And when you go talk to our franchisees, who are running brokerages, they don’t report this out separately. It’s brokerage mortgage title is an integrated business, that’s how we are trying to deal run it also.
And so when you think about the power of our brokerage business, which makes hundreds of millions of dollars on the owned brokerage side, the title and mortgage economics are an integral part of that and you can think of them all as a whole that we’re trying to maximize and creating more integration for the customer is a big part of our future on that we believe and we’ve got some early success on, but it’s also with mortgage and title in these integrated economics, a way to deal with some of the margin pressure that’s been in this industry and for our company on commission splits.
Two questions naturally arise from this.
“Big Part of Our Future”
If there is no way to fight the commission pressure, then why fight it at all? If I’m reading the sentiments correctly, the strategy is basically the same one that all brokerages who aren’t W-2 (Redfin, REX, Homie, etc.) are employing: run brokerage as a lead funnel for the profitable businesses in title, mortgage and escrow. “Integrated economics” is the way forward, or as Schneider put it, “a big part of our future.”
The trend lines make it clear that this is not just a big part of Realogy’s future, but the only future that is logical.
So why not embrace it and get there proactively?
eXp hasn’t reported yet, but I’m fairly confident that eXp will post more than 2% YOY agent gains. Why? Because eXp is cheap, cheap, cheap; it is effectively a 90/10 split brokerage, with a cap on commissions. And there are dozens of large brokerages (one of them publicly traded, Fathom Realty) who are 100% commission shops.
They all look to “integrated economics” to make it work.
So why not get there?
Realogy wouldn’t actually be giving up all that much. Here’s the full year 2020 Operating EBITDA by segment:
- Franchise: $594 million
- Brokerage: $48 million
- Title: $226 million
Remember that this is in the “best real estate market in a generation” year that was 2020. $48 million in EBITDA is a fart in a windstorm, even when compared to how much Realogy made on Franchise and Title. Why not sacrifice that so that Brokerage can become even more competitive, then up the profits from Title and Franchise?
In Q3 of 2019, Ryan Schneider said:
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.
Okay… make your default splits 90/10. Reward top performers with a cap on commissions. Give the agents a stock compensation plan, like eXp is doing. Who cares if you go from earning $48 million to losing $10 million on Brokerage, if your Title and “integrated economics” goes from $226 million to $400 million?
Technology and So On: All Noise
The second question that naturally arises is, “Why is Realogy bothering with distractions like technology?”
During his prepared remarks, Schneider says:
The future is using data technology to support the agents who remain central to the transaction today and into the future. The digital marketing products, technology products and data insights we are developing, ranging from when a consumer starts looking for a home all the way through closing on a home, created advantages with the acceleration of digital adoption in 2020. These differentiated products and insights helped our agents and franchisees drive substantial volume throughout 2020 including market share gains in Q3 and Q4 when volumes were the highest in the industry.
I mean… I guess it’s possible that “differentiated products and insights” helped drive volume. It’s more likely, I think, that the particular markets where Realogy is strongest combined with the craziest of crazy housing markets did that… but whatever.
Yes, Realogy like any other company needs to have bells and whistles so that agents would consider them. You can’t recruit and retain agents these days if you offer nothing at all, so you have to offer something. And then hype it up so you can recruit agents.
Thing is, it’s really difficult to see how those bells and whistles and window dressing really impact recruiting when we have examples like RE/MAX, which has gone all-in on bells and whistles, and eXp, which has (basically) no bells and whistles, and their divergent results over the past couple of years.
Could Realogy Pivot? Would Realogy Pivot?
I have no idea what internal issues would make it difficult or impossible for Realogy to pivot, but given what we saw in Q4 and in 2020 as a whole, it does seem to me that there might be a pivot coming.
When Ryan Schneider first came in as CEO, I remember writing that he’s bringing a world of experience and expertise in technology and in economics and might look to change the fundamental model of Realogy:
What that means basically is that Realogy (at least the NRT) will no longer be in the running for the elite top producers who demand the world to deign to grace your company with their presence. What it means is that Schneider deeply understands what I just wrote about with respect to the two key numbers for brokerage.
Schneider doesn’t care as much (if at all) about Headcount, Volume, or Transaction Sides as he does about Company Dollar and Profit Margin. That’s a philosophical sea change. If what I’m reading is correct, he’s saying that the NRT would rather have three agents who do 60 deals between the three of them, at a lower split so the company has better margins, than a single super-agent team that does 60 deals and demands 95/5 splits.
Since that beginning, however, it feels as if Realogy has done a complete 180 and has gone back to its roots of recruiting, retention, top producers, and giving away the farm. Maybe there was a huge revolt internally from Brokerage managers who basically said “We’re not competitive for top agents.” Who knows.
The enormous emphasis that Schneider put on “integrated economics” suggests that perhaps Realogy is ready to pivot in the other direction. Forget the “Strong Pareto Optimal point” on the production-commission curve; go with forsaking the piddly $48 million in earnings from Brokerage, and maximize the earnings from mortgage, title and escrow.
That would be a pivot. And I could see a world where a Realogy that decided to compete on price and stock options — basically playing eXp’s game — could pose a real threat to everybody else. Because Realogy still has enormous brand goodwill in the industry. It still has top agents and top brokers and top managers. It has a ton of free cash flow. It has integrated economics in a way that upstarts like eXp and Fathom do not.
I could see that happening.
I didn’t actually think there was 2,500 words to write about Realogy. It had a great year, but then, so did everyone else. Its margins got worse, but then, I figure so did everyone else’s margins (in brokerage). It hasn’t solved the productivity-profitability conundrum, but then, no one else did either.
Yet, there is something interesting buried in there: $48 million in EBITDA vs. $226 million in EBITDA. Integrated economics as a big part of Realogy’s future.
The threat that an inexpensive low-cost Realogy poses to everybody else is not to be overlooked. Don’t you forget about them.
We’ll see if Schneider and team take advantage of that, or simply allow eXp and others to grow and grow and grow to a point where they can’t compete.