Here in Q1 of 2021, I’m beginning to detect a certain pattern when it comes to trying to analyze earnings calls to see where the industry is. There’s a lot of repetition, as if the things I’ve noted years ago haven’t changed at all. And yet, Q1 was a sizzling hot market, with unprecedented activity and price gains and craziness across the board.
So it is with Realogy, the flagbearer for traditional brokerages. They just posted monster numbers, had a great quarter by just about every measure, and yet… strategically, it’s a lot less filling than I might have hoped for.
If this update seems similar to my Q4/2020 update, which was similar to every single update for the past couple of years… well… I suppose it’s because nothing much has changed. Rising tide, all boats, all that. But let’s discuss what was Q1 for the flagship of the industry.
Tastes Great…
In the Q4 and Full Year 2020 analysis, I wrote that Realogy posted much, much healthier numbers than it did in 2019. With that head of steam built up, Q1 numbers were awesome. From the press release:
- Generated revenue of $1.5 billion, an increase of 32% or $379 million year-over-year.
- Reported Net income of $33 million and basic earnings per share of $0.28, an increase of $495 million vs. prior year or $4.31 per share.
- Generated Operating EBITDA of $162 million, an increase of $130 million year-over-year.
- Title and mortgage continued to contribute meaningfully to our business results, generating approximately $61 million in first quarter Operating EBITDA (See Table 5).
- Combined closed transaction volume increased 44% year-over-year in the first quarter driving market share gains for the third consecutive quarter. Transaction volume growth was significantly above the National Association of Realtors’ reported 28% year-over-year market volume growth.
- Strong cost management with $80 million in permanent cost savings expected in 2021.
- Reported Free Cash Flow of negative $67 million, an improvement of $88 million from the corresponding quarter last year, with the first quarter being a seasonal use quarter for the business (See Table 7).
- Grew Brokerage agents 3% year-over-year and continued to maintain strong retention levels.
This is, as the kids used to say, all good. Revenues up, profit up, transactions up, volume up, agent count up, strong cash flows, reduced expenses… I mean… it’s all good man! Tastes Great! It was a bangin’ quarter, and Ryan Schneider is fully justified in stating in his prepared remarks:
I am incredibly excited to share our very powerful Q1 results. We delivered outsized top-line and bottom-line growth, gained substantial market share and made great balance sheet progress. Our strategic actions, our focused execution, and a strong housing market together are building momentum for our future.
Let’s get straight to the highlights of an outstanding quarter. Realogy generated $162 million of operating EBITDA, $130 million above Q1 of 2020. Our brokerage and franchise businesses achieved truly outsized growth. We grew closed transaction volume 44% year-over-year, significantly above NARs recorded 28% year-over-year market volume growth. This is now our third consecutive quarter of market share gain. We have gained almost 100 basis points of market share since Q2 of 2020 and continue to lead the industry with 15.7% share. Our share gains are a combination of our strategic initiatives getting traction and our luxury market success. And more granularly, we outperformed the market in both our brokerage and franchise businesses as well as in both unit sales and price appreciation.
Good for them! Realogy deserves a win. Speaking of wins….
Wins in Integrated Economics
In Q4, Realogy more or less admitted that they weren’t going to bother trying to go after splits anymore. Instead, they were going to make money on title and mortgage:
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.
Well, Realogy Title Group more or less killed it in Q1: revenues up $64 million YOY and Operating EBITDA up $49 million — which is more than the earnings from both Franchise and Brokerage. Further, the new mortgage JV revenue doubled in Q1, contributing $21 million of that $49 million in EBITDA growth. That’s very, very strong. As Ryan Schneider put it:
Our title and mortgage businesses produced major bottom line growth, earning $61 million of operating EBITDA in the quarter. We strategically expanded both businesses, and we are increasingly digitizing the homesale transaction.
There’s no arguing with results, and Realogy had fantastic results in ancillary revenues and profits. Kudos to the team for that. Within real estate, only HomeServices of America and possibly Howard Hanna have the full panoply of capabilities that Realogy has in integrated economics. But we’ll examine this a bit below.
Less Filling
The trouble is, as trouble always is with Realogy, in the Key Metrics of its Brokerage division:
The story these numbers tell is massive improvements across the board — even the ABCR (Average Broker Commission Rate) which is what consumers pay Realogy agents. And yet… Company Dollar margin is down 10% YOY, from 25.9% to 23.3%. Now, I grant you that this number is one I calculate, using Realogy’s numbers. Maybe their internal numbers are different. But we work with what we have.
And to be fair, in absolute dollar terms, Company Dollar was up almost $50 million YOY, a 22% increase. So that’s very good.
Yet… agent split is up 258 bps YOY to 76.7%. That’s not great. That’s decidedly not good. I don’t know if the fact that Q1 splits were 10bps better than Q4 splits is good news or bad news. Is it good news because it declined slightly? Or is it bad news because it didn’t decline enough given the massive gains everywhere else?
Loss Leader of the Pack
What is clear from Q1, however, is that the brokerage division really is just a loss leader. It loses money… but it makes money for the company. Charlotte Simonelli, CFO, pointed that out in the earnings call:
Realogy Brokerage Group revenue was $1.2 billion, up $302 million versus prior year, driven by exceptional volume growth of 37% versus prior year. RBG operating EBITDA was negative $5 million, an increase of $46 million versus prior year. RBG continues to generate substantial operating EBITDA for the enterprise when you consider the $76 million of intercompany royalties paid to our franchise segment.
So if RBG (formerly NRT) were not a franchisee, it would have actual operating EBITDA of $71 million? But because it had to pay its sister division a whopping $76 million, it lost $5 million?
RFG by contrast, then, should have Operating EBITDA of $65 million from $141 million since $76 million of that came from the captive RBG franchisee? That’s just… odd.
Word is that RBG pays the full 6% royalty rate to RFG as well, despite being the single largest franchisee of RFG. Every other large franchisee is able to negotiate all kinds of discounts, kickbacks, and other arrangements to make the franchisee fee bearable… but the largest franchisee cannot.
If I’m Ryan Gorman, CEO of RBG, shouldn’t I be a wee bit upset? I mean, if he were able to negotiate a better royalty rate — or not pay royalties at all — his company would be riding high, high, high.
Productivity-Profitability Dilemma, Part 51
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. I’ve published these charts before, so let’s give you the updated ones, given the awesome quarter Realogy just had:
So since 2017, Q1 was consistently the lowest agent splits (except in 2018, when Q4 dropped bigly) for the year. If we’re starting out 2021 with splits that are basically even with the record setting Q4/2020 splits… that doesn’t feel like the trend is going to reverse anytime soon, does it? And the same time, per-agent productivity keeps marching downward. Realogy executives tout adding 3% more agents to RBG as a big win but… is it?
Furthermore, look at this chart:
Company Dollar margin ticked up 10bps sequentially from Q4 but… I can’t say that’s great when transactions were up 14% YOY to over 608,000 transaction sides, and volume was up a whopping 35% YOY. I don’t know how anyone can.
Lat quarter, Simonelli acknowledged the issue and said:
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.
I’m not entirely sure just how much Realogy was able to offset split increases by adding 3% more agents, but it doesn’t feel like all that much. And Ryan Schneider was asked this question by an analyst:
Stephen Kim
Analyst, Evercore Group LLCAnd sort of following up on that just a little bit though, is there – there’s always been a pretty significant difference between your highest performing agents and those that are maybe newer in the business or not as focused on it as seriously. And we’ve always – you’ve always talked about that upper slice as being such a – an important part of your business, the real engine.
I was curious as to whether, during this unusual past year, that you’ve seen any shifts in the relative productivity of the higher or versus the lower, as we’re thinking about the hierarchy of your agents, whether that the higher end has or the more productive and more experienced agents have actually gained share or have actually lost share to the less productive agents?
Ryan M. Schneider
Director, Chief Executive Officer & President, Realogy Holdings Corp.No, great question. Look, the higher growth agents have gained share over the last kind of 12 months. And it shows up in our financials, both in terms of we like the volume that those folks are getting because they’re often gaining share at the expense of others out in the world. But it also has been one of the things that Charlotte’s talked about that’s been a bit of why our production costs have gone up and it’s been – there’s been – some of it’s been the mix change to the higher producing, higher split agents.
And you saw the strongest, Stephen, actually during the last summer when with some of the health and safety challenges and some of all the economic uncertainty, it was the best highest productive agent who powered through better than the average agent. And you saw some there and then it has continued not as much as it did last summer but it has continued though – and again, in Q1 of 2020, it didn’t look much different than Q4 of 2020 – excuse me – Q1 of 2021 we’re just talking about here, your phenomenon wasn’t very different than Q4 of 2020 but the acceleration in those folks did happen but it was more of a Q2, Q3 last year kind of thing. And then, it’s just kind of stayed there and that’s why we think it happened by the way.
If I’m understanding this correctly, I think Schneider is admitting that the top producers gained enormous market share throughout 2020, and that Q1 was the same as Q4, and then it just “kind of stayed there.”
So he didn’t answer the question directly, but the inference I can make is that no, the more experienced agents did not lose share to less productive agents. There’s no scenario where that happens, especially in the kind of insane crazed market we have in 2021. We saw that in the Redfin earnings release, where newer agents just couldn’t make any money because they couldn’t win enough deals for their clients. We saw that in the Compass earnings release where they attribute their revenue and market share growth to having the best agents.
So long and short of it is that none of that has changed.
Incentives of Integrated Economics
What’s missing in the narrative is the incentives for agents to go along with all this integrated economics. I mean, the incentives for Realogy are as clear as could be: that’s where they plan to make all the money. They’re expanding title and mortgage businesses, demonstrating dramatic growth, and investing like crazy in those.
What’s less clear is what the incentives are for the agents to do integrated economics. We may have to do a separate post about this, but for now, note this exchange from the earnings call. An analyst asks “What portion of agents actually have access to all of the integrated transaction offerings?” I rather think that’s a very polite between-the-lines way of asking the question on everybody’s mind: “Why would the agent send title and mortgage business to you?”
Schneider answers:
I don’t have enough proof yet, I think bluntly to pound the drum too much on that. But we’ve got, I think, a really good job with our own brokerage agents, Matt, giving them access to this. And some of that’s just through the core title and mortgage relationships and technology that we’ve got. We have a big undiscovered country still with franchises like we do some title joint ventures with franchisees.
But we – our franchise agents are not in the title mortgage ecosystem the way our own brokerage agents are yet. Now, that’s an opportunity that we think is quite interesting and we’d like to do more of and we’re working to do more of it. It’s a little more complicated because you’re obviously going to do it with the franchisee. But we feel good about where our 50,000 owned brokerage agents are in the ability to really access our title and mortgage. And then, there’s franchisees and opportunity.
So Realogy Brokerage agents “have access” to title and mortgage. Franchise agents do not, probably because any franchisee of any size and any brains is looking to do its own title and mortgage to survive. But “having access” is not the same thing as “sending business to” and one thing I am relatively confident of is that top producing agents often have their own relationships with their own title and escrow and mortgage people who do everything short of outright breaking the law (RESPA is a thing) to keep such agents happy.
What exactly is the incentive for a Realogy agent, or a Realogy franchise agent, to refer title and mortgage business to Realogy Title Group? Without an incentive, why would this business continue its torrid growth rate?
As of yet, there are no answers. I think we need to discuss this at some length in a separate post or two.
Technology, MoxiWorks: Still Just Noise
See my writeup last quarter about why I think Realogy’s “technology strategy” is just noise. But suffice to say that nothing changed in Q1. The MoxiWorks deal is just a deal; Realogy did a site license, essentially, probably at some kind of discount.
I do want to point out one thing from this statement, in which answered a question from an analyst: “Is there actually some value at some point to actually simplifying and streamlining what seems to be a just a wide and growing tech offering to agents?” Schneider responds:
We are going to be, as I said in my script, curators. We’re not just opening up our open ecosystem to any product. We got – it’s got to be good. We got to be excited about it. There’s going to be demand for it. But the power of us developing great products and our agents having some choice and franchisees in the technology they use, we think that’s a differentiator because, again, I think these closed garden ecosystems are not the right – are unlikely to meet the needs of agents or franchisees in the best way as this industry evolves.
I mean… I guess compared to a monolithic system like the one Redfin or Compass has, that’s an open system… but if a developer requires permission from Realogy, and Realogy curates the products, and Realogy has to get excited about the product… I don’t know that I’d call that an “open system.”
Feels a whole lot more like a closed system to me. Maybe not fully closed, but not fully open either.
Keep On Keeping On
Given the strength of Q1 and its outlook for Q2, I think it’s safe to say that Realogy will not be doing anything major, anything dramatic, or anything disruptive. I mean, why fix something that ain’t broke? Even if something is broken at a deep fundamental level, as long as revenue, agent count, transaction count, even EBITDA is growing, why not keep it going for as long as possible?
There’s no need for a pivot, no need for revolutionary change, when things are going this well. It doesn’t much matter that it’s less filling, as long as it tastes great. I thought Realogy might consider a pivot because of its competitive advantages; I no longer think that. I think Realogy keeps on keeping on as long as the inertia lasts.
Question is, will its competitors let the inertia keep going? We’ll see in Q2.
-rsh
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