At long last, Compass has reported on its first full quarter of operating as a public company. This is a moment I have been waiting for for quite some time, as there has not been a traditional brokerage to compare Realogy to since I started keeping track way back in the day when Realogy was first public. And Compass did not disappoint. Well, it didn’t disappoint me as an industry analyst; it might have disappointed its shareholders, but I don’t know much about that and don’t really care.
I think the picture that emerged after Q1 is that of a company that is trying to build the new Realogy, complete with Zap Platform from circa 2014. I know that isn’t the narrative that Compass wants to tell, because it wants technology company revenue multiples, not real estate brokerage multiples… unless that brokerage is EXPI with its 113 PE ratio… but that’s the inescapable conclusion.
Furthermore, I maintain that until we learn more directly from Compass on how it treats agent incentives, it is difficult to get a true picture of the core brokerage operations at Compass. The gross profit numbers don’t make any sense, as we’ll get into below.
With all that out of the way, fact is that Compass had a great Q1. Its agent count is up, transactions are up, sales volume is up, revenues are up, profits are up — I mean, it was a really, really nice quarter all things considered. Nonetheless, Robert Reffkin and Co. over there in NYC are building the next Realogy, not the next Zillow, which means that the impact on the industry itself is minimal at best.
Let’s get into it.
As is normal, I assume that anyone interested can go download the numbers directly from Compass itself. Instead, I’ll present my own calculations, dig in a bit, and try to give you numbers that you won’t find in an SEC filing.
The headline numbers directly from Compass’s press release are about revenues and operational key metrics:
- Revenue of $1.1 billion, up 80% YOY
- Net loss of $212 million, but that includes IPO-related expenses of $149 million, so it was way better than Q1/2020
- Principal agent count of 9,812, up 20% YOY
- Transactions of 40,268 up 67% YOY
- Sales Volume (“Gross Transaction Value”) of $43.8 billion, up 75% YOY
- National market share of 5.2%, up from 3.8% in 1Q20
Like I said, excellent results for Q1. Here, then, is my worksheet for thinking about Compass:
First of all, I think we have to calculate gross profit (or Company Dollar, in real estate brokerage parlance) because Compass is a traditional split-based brokerage, like Realogy and like 90% of the real estate industry.
On the numbers that Compass provides, Gross Profit was $172 million, up 55% YOY. Gross Margin eroded to 15.4% from 17.9% YOY, implying basically a 85/15 split. Even that number is bad compared to Realogy Brokerage Group’s 76.7% from 1Q21, but I rather think the truth is a bit worse.
Recall that in my post on Compass’s S1 filing, I wrote that the S-1 contained clear language about sales and marketing expense including “agent acquisition incentives” and Compass said then that they “plan to continue to invest in sales and marketing to attract and retain agents.” Well, we all know that Compass offers very generous incentives to agent, particularly the top producers, including cash bonuses and incredible splits — 90/10 or higher splits.
So in my analysis, I assumed that half of the Sales & Marketing expense line is actually agent incentive splits. Maybe that’s too much, maybe that’s too little; I don’t know. And until Compass tells us what their actual agent splits are (maybe the next earnings call?), it’ll be guesswork for everybody.
But on that analysis, the “True Gross Profit” for Compass was $116 million at 10.4% gross margins, which is on the money to the 90/10 splits that I have most often heard tossed around for Compass agents. Note that that is still an improvement of 12% YOY, but still, the gross margin picture is rrrrrough.
So when Compass claims improvements in Non-GAAP Operating Expenses, I have to wonder:
COMMISSIONS AND OTHER RELATED EXPENSE (“C&O”)
C&O in 1Q21 was $942 million, or 84.6% of revenue. Non-GAAP C&O was $898 million, or 80.6% of revenue, an improvement of 80 basis points compared to the prior year period. The 80 basis point improvement was due to the change in mix of the commission arrangements we have with our agents and changes in geographic mix. C&O incorporates the tech and resource fee paid by agents to utilize the platform, a contra-expense, which increased during the quarter.
The “Non-GAAP” here seems to mean excluding stock-based compensation… but I’m not entirely sure why you would do that for Commissions & Other Related. If Compass incentivizes agents via stock option grants (as it is said to do, especially in the age of eXp) then that’s a real non-cash expense. Those agents are going to consider those stock grants as part of their splits, or at least overall compensation.
Kristen Ankerbrandt, CFO, actually gets asked about these margins and that 80bps improvement specifically. Her answer:
That improvement of 80 basis points is really good to see. And we have started to see a nice trend in the fourth quarter of 2020, but this was a really nice step up. And really, it was the result of a few different things that you mentioned. First, we see improving margins as our agent cohorts mature and we are able to deliver more value for our agents. We expect for that to continue going forward. We really focused our expansion on higher margin markets. We started doing that in earnest. Last year in 2020, we will continue to integrate that into our expansion strategy. As I mentioned in my remarks, we are seeing a nascent recovery in New York City already and New York is one of our oldest markets. That’s a nice lift in New York should be good for margins over the foreseeable future. And of course, our move into adjacent services, expansion adjacent services will be helpful there too.
I have no idea what she means by that highlighted section. As agent cohorts mature, they’re willing to pay more because of “value”? Really?
Do tell us more about that, because I’m sure Realogy and KW and HomeServices and Howard Hanna and a thousand other brokerages would like to hear a lot more about aging cohorts willing to pay higher splits.
I dwell on this because as I have so long said in all of my Realogy analyses, THE key number for traditional brokerage is Company Dollar (or Gross Profit). If Compass is not playing games with this absolutely key number, then it is certainly presenting it in a rather confusing way. A bit more straightforward and transparent presentation would be welcome, certainly by me and I suspect by investors as well.
On Those Key Metrics…
Second, I find it a bit puzzling that Compass keeps talking about Principal Agents. I mean, I understand why they do; I just don’t quite get why Wall Street doesn’t ask them to clarify. Because Compass says flat out that they have 21,000 agents (Shareholder Letter) but only count 9,812 as Principal Agents.
Compass itself defines principal agent as team leaders and independent individual agents. So the implication is that there are some 11,000 Compass agents who are on somebody else’s team. That’s fine and all, but that leads to having to calculate different numbers for key metrics, which I have done above.
Using Principal Agents, we get these numbers:
- Transactions per Principal Agent: 4.1
- Sales Volume per Principal Agent: $4.5 million
Those are astonishing numbers! Per agent productivity through the roof!
But, using Total Agents, we get these numbers:
- Transaction per Agent: 1.9
- Sales Volume per Agent: $2.1 million
In comparison, Realogy posted these numbers per agent in Q1:
- Transactions per Agent: 1.4
- Sales Volume per Agent: $850K
Compass still comes out ahead of Realogy, yes, but it’s not quite as dramatic, especially when you consider the fact that Compass’s average sales price was $1.1 million vs $609K for Realogy which more or less accounts for the higher Sales Volume per agent number. One does wonder what would happen if Realogy started using the Principal Agent concept in its reporting.
FYI, EXPI posted 1.5 transactions per agent in Q1 as well. Meaning, Compass agents are more productive yes, but… we’re not talking leaps and bounds here.
One note: In 2020, Swanepoel’s Mega 1000 claimed that Compass had 19,385 agents. If Compass had that many agents in 1Q20, then we’re looking at 1.4 team members per Principal Agent. In 1Q21, Compass is down to 1.1 team members per Principal Agent. I think that means Compass recruited more solo agents, especially in its newer markets, who are likely to be less expensive than big team leaders with their big-time production numbers. That might explain this statement from Kristen Ankerbrandt, CFO:
As we also look to bring on more up and coming mid-tier agents on to our platform, we tend to have more attractive economics that will also support good performance in that line.
Yeah, I’ll agree with that. Of course, everybody else in the industry wants those up and coming mid-tier agents, and that competition will surely erode margins… but whatever! That’s a problem for the future.
The Technology Platform
By my count, the earnings call featured the word “platform” 35 times. It was the theme of the show, and indeed, it is kind of the theme of Compass as a company. Reffkin talked about their “850 plus person product engineering team” that is “constantly introducing new and updated products and features that drive agent productivity and efficiency.”
As an example, he brought up Business Tracker, “which allows agents to visualize their entire pipeline, leads buyers, sellers, renters, landlords all from one place.” He goes on to say, “Prior to Business Tracker, most agents manage their pipeline on a piece of paper or on a whiteboard, but now can do it within the platform.”
I mean… maybe most agents do manage their pipeline on a piece of paper… but a casual search turned up 30 different real estate CRM packages, a few of which appear to include a visual pipeline report:
That one in particular appears to work from within Gmail, which is kind of the default cloud email service for most people, no? It seems to me that agents who are using pieces of paper are possibly not the kind of producers that Compass (and everybody else) wants to go after… so there’s a touch of the straw man argument here.
“We recruit the best of the best agents, who have the most market share, but they’re all using pieces of paper for pipeline analysis, and don’t know how to do sphere marketing until we get them on our technology platform” seems like a bit of a stretch.
Then there was this:
Another great example is our AI-powered likely to sell recommendation engine, which predicts which properties are most likely to sell. It incorporates data like property details, pricing history and mortgage data to rate how likely a property is to sell in the next 12 months. Agents are then alerted to reach out to these contacts, helping them to win the listing before competing agents, even though the property is in play, likely to sell recommendations results in a 61% higher win rate for our agents.
That sounds like an amazing piece of technology… from 2011, when Inman wrote this article:
RealAgile.com and SmartZip Analytics, as examples, have created tools that allow agents and brokers to identify high-probability buyers and sellers. By targeting those homeowners who are likely to transact, both companies claim that they can improve your success rate from your geotargeted marketing campaigns.
Or there’s this story from 2017 about “3 AI startups using predictive analytics to transform real estate.” Or there’s Revaluate, whose CEO Chris Drayer is a good friend of mine, which was founded in 2014:
If an 850-plus engineering team has gotten Compass to cutting edge 2011 technology… hoo boy. To be fair, maybe Compass’s system is orders of magnitude better and more accurate than Revaluate, House Canary, SmartZip Analytics, and whoever else that claims AI-powered machine learning blockchain enabled whatever gizmo lingo thingamajig. Maybe.
But a proprietary platform that helps agents grow their business? Where have I heard that before… oh, I know, RE/MAX from Q3 of 2018 after it acquired booj, a proprietary platform that helps agents grow their business:
This was the first time many of our brokers got a look at the booj plans for developing a comprehensive ecosystem of RE/MAX technology on one platform. All of the booj sessions were filled to capacity and brokers like what they saw. After previewing the ecosystem plan, which is a data-driven platform where agents will create marketing campaigns, nurture customer relationships, evaluate leads and more, one broker called the platform “totally game changing for RE/MAX.” Others shared his excitement. Another broker said there’s no question his agents will be excited when they see the platform.
Before RE/MAX and booj, of course, there was Realogy and Zap Platform.
Maybe I’m missing something, but the latest and greatest from the most technology-focused traditional brokerage ever with 850 plus engineers, a huge tech hub 2 blocks from Amazon’s HQ, and almost $100 million spent in Q1 on research and development turns out to be stuff from 2011 and technology that vendors have been offering real estate agents for years. Compass is following the same strategy from RE/MAX in 2018 and Realogy from 2014.
But it’ll be different this time. Right?
Could be. We’ll see. Color me skeptical, but I’m willing to be proven wrong.
The All-Important Ancillary Revenues
A big part of the strategy discussion was around, what else, ancillary revenues. In the prepared remarks we get this from Robert Reffkin:
We also made progress in expanding our adjacent services business. Our extensive network or top performing agents and their transactions creates an opportunity to capture more spend in the real estate ecosystem adjacent to the transaction. Today, we offer services in title and escrow and digital marketing and we plan to provide mortgage and other adjacent services in the future. In February, we acquired KVS Title, a leading title company serving the Washington DC area. Compass’ closing services portfolio now operates in California, Florida, Washington State, Maryland, Virginia and Washington DC. We plan to continue to scale our title and escrow business in existing geographies and new markets going forward.
Of course you plan to continue to scale those businesses. Everybody else does too, so why not you? And what gives you the confidence that you will succeed better than everybody else? Again, Reffkin:
Yes. I think we have two advantages to get above the average attach rates: one, agents and two, integration. On the agent side, real estate agents are the number one source of recommendations for adjacent services, whether its title and escrow and even mortgage. The typical client doesn’t have a title or escrow first and that they tend to go back to. And the agent is the trusted advisor there. On integration, we are building an integrated platform where the recommendation can go through the workflow, through the platform, an actual title experience and work experience can go through that. That’s a real advantage. Other brokerage firms have title, escrow and mortgage, but it’s just united by a common legal entity. It’s not united in a single pane of glass. It’s not united through a one login experience. And that’s really the advantage that we have over the market. [Emphasis added]
I’m convinced that I need to write something separate on the agent side of things, because I’m not seeing what incentivizes the agent to refer Compass’s title, escrow and even mortgage. I already touched on this when talking about Realogy, and I’m still in the dark as to why Compass agents would send that business to the in-house title, escrow and mortgage when most of them will already have existing relationships with title, escrow and mortgage brokers whose job is to kiss their ass constantly.
The second piece is just… honestly puzzling. Unless I’m completely daft, I think Reffkin is saying that because title, escrow and mortgage are in a piece of software with a single login, that is going to lead to agents sending valuable ancillary business leads to in-house title, escrow and mortgage…. Really?
I’ve never sold real estate, but my recovering broker wife has. And I know a metric ton of agents. Neither of us have ever spoken to a single agent who said, “I know Joe at XYZ Title provides awesome service, sponsors my client events, and makes me feel warm and fuzzy inside, but I have to send him an email to refer business… so I’ll just click this button on the company intranet to route my client to the corporate call center.”
I also don’t know what “actual title experience and work experience” means here, but if Compass thinks that companies like First American and Fidelity National and various banks for whom Compass’s $100 million a quarter in technology budget is about what they spend on executive meals are going to sit back and not produce a software workflow platform… I have some news. It’s not good.
Here’s the crazy thing. Compass is just now growing its title and escrow businesses, including via M&A. It does not yet have a mortgage business, though they did say that they are just about to close a JV arrangement. Despite talking about how great their adjacent businesses are growing, the revenues were not big enough for Compass to split them out in the financials.
Just about everybody else in the industry who isn’t EXPI already has title, escrow and mortgage. The leaders, like Realogy, HomeServices of America, and Howard Hanna have very large, very experienced, very established operations run by people who really know what they’re doing. But Compass is going to beat them with the “one login experience?”
Could happen. Might happen. Let’s just… um… moderate expectations in the short term.
Compass is Building a Better Realogy
More I think about it, more my suspicions about Compass are confirmed. I have long held that Compass is just a traditional brokerage who happens to have a lot of cash and uses it to recruit the best of the best agents. But at its core, it was a traditional split-based brokerage. Nothing I heard during the Q1 earnings call changed my mind on that. In fact, it solidified my take on Compass.
The Q1 results were, as I said, fantastic. Everything grew. But then, everything grew for everybody else in real estate not named RE/MAX in Q1 as well.
Perhaps as a new public company, now valued at $5.5 billion as of this writing, Compass will use its access to the capital markets to grow smartly, build out its title, escrow, insurance, mortgage and whatever other adjacent businesses. Maybe Compass will introduce some new technology in its much-ballyhooed platform that hasn’t been around for a decade in real estate. Maybe Compass will make brilliant acquisitions to surpass other companies following the same “technology to grow agent business” strategy.
But at the end of it all, if Compass is indeed successful on all of its strategies, what exactly do we have?
A brokerage with high average sales price, concentrated in high-end markets like New York City, San Francisco, and other major urban metros, with tens of thousands of agents — many of whom will be top-notch team leaders — doing enormous volume, with a strong title, escrow and mortgage business to generate the path to profitability.
That sounds just like Realogy, whose market cap is less than half that of Compass, but already has everything that Compass wants to build other than the single sign-on platform with technology from 2014. Realogy dominates Compass on agent count, on number of markets, on national market share, on transactions, on sales volume, on revenue, on cash flow, on experience, in title, escrow, mortgage, on relationships within the industry… on everything other than splits/incentives and “technology platform.”
It’s not a terrible strategy, since Realogy at one time dominated residential real estate, and still is a power to be reckoned with. But unless something changes in the near future, let’s be clear about what Compass is building: a newer, better, shinier, Realogy.
The implications for investors are, I think, fairly straightforward. The implications for the industry however are that other traditional brokerages who are trying to do the same thing — recruit and retain top agents and give them technology to improve their businesses — are facing an extraordinarily strong competitor in Compass. Because they’re willing and able to lose money for a good while, have access to capital as a public company, have an actual technology team that likely does have some capability to produce as-yet-unseen tech (even if it hasn’t yet done so), and some real innovations that huge amounts of cash allow Compass to create. If you’re not willing to be innovative, then Compass has got your number. Because they are very, very good at recruiting as their numbers show.