Brief: Inflation and Brokerage Profits

I’m super busy with a couple of important projects, and I’ve been up in the mountains celebrating the Sunny Freedom Tour ’21, so time is a bit short. But I did want to share something that I thought was interesting.

As you know, I’m of the opinion that real inflation is way higher than the official CPI measurement and that had led institutional money managers to get into housing as a hedge against inflation. But there’s an angle to this that I had not considered until I listened to this interview of Michael Saylor, the CEO of MicroStrategies and one of the biggest Bitcoin bulls around:

It’s over two hours long and I do not expect anyone to be listening to all of it. But starting at around the 1:08 mark, Saylor talks about why his company put some $475 million in cash into Bitcoin. He lays out the logic of why he did that, and it’s compelling.

Basically, the logic is this:

  • The Fed (and all central banks around the world) is printing money like crazy. ~15% per year. He thinks the central banks will be forced to keep printing money for the next 4-5 years at minimum.
  • Accordingly, the cost of capital has tripled for his company from 5% to 15%, and in Saylor’s view, the real measure of inflation (aka, money devaluation) is cost of capital.
  • With risk premiums, cost of capital is close to 20%.
  • In order to preserve shareholder value, with cash being worth 15% a year less than the year before, he put his company’s cash into Bitcoin.

Then he says this, and the sentence has stayed with me:

The road to serfdom consists of working exponentially harder in order to earn a currency growing exponentially weaker.

The point is that people and companies work their asses off to make more money, but the things they want to buy with that money keep getting more expensive and at a rate where the additional cost outstrips the gains in income. He talks about having a company that makes $50 million a year; you then have to grow that company faster than the rate at which the dollar depreciates — about 15% a year.

How are you going to do that? he asks.

It really made me stop and think. Take a look at this chart:

These are the public companies in real estate that report their numbers. They haven’t been adjusted to use the same numbers (some report in thousands, some in millions, etc.) but the YOY change is what’s important. The concept of the 15% hurdle rate coming from inflation puts a whole new spin on these numbers.

Turns out, maybe Zillow and Redfin actually lost revenue YOY despite being up 8.2% and 9.7% respectively, because the dollars they made in Q1 of 2021 are worth 15% less than the dollars they made in Q1 of 2020. That’s… sobering.

Then I think about what Saylor said. How hard you have to work, how much you gotta hustle, and how much risk you have to take, to grow a business by more than 15% a year… for the next 4-5 years. That’s… insane, if you think about it. As Saylor puts it, no matter how hard you work, you can’t grow faster than the rate at which the banks print money.

The Real Estate Industry

Then I think about the various nonpublic companies I happen to have numbers on through my consulting work. Even in this crazy hot housing market, brokerages are growing at single digit percentages, because huge revenue growth means huge cost of revenue growth (agent commission splits, often with caps). I don’t know how many brokerages in 2021 are breaking through the 15% hurdle rate that Saylor sets.

MLSs are operated like nonprofits, so they see no to very little growth. Which means they’re actually losing 15% a year.

But let’s say that the unusually hot housing market has helped industry companies in 2021. How are they keeping up 15% growth in 2022? In 2023? Can brokerages and MLSs and Associations and tech companies just keep adding 15% to agents and revenues and profits a year for the next 4-5 years?

At least individual agents can count on home prices going up above the inflation rate for a while, which means their commissions will go up by the same percentage… unless the commission rate goes down… or they do fewer deals because of competition… but I’m going to say that brokerages, MLSs, Associations, and tech companies that make their money off of real estate agents are not likely to grow at at that kind of rate every year for the next 4-5 years.

Which means consolidation is inevitable simply because companies and organizations have to hit that 15% a year hurdle rate, or see their finances slide backwards. It is inevitable, because it is necessary. You have to do it, or completely restructure your business model, or face going out of business.

That’s… food for thought. Urgent, serious thought. If your business is making $200K today, it needs to be making $350K by 2025 to have the same purchasing power as today, to tread water as it were. That’s a 75% increase… in 4 years.

How many strategies do you have to increase your revenues and profits by 75% over the next 4 years?