Technology Deflation and Real Estate Business Models

Last week, I had what was probably my fifth conversation of the week with a proptech-brokerage-disruptor startup that went something like this:

  1. Save somebody (consumers, agents, brokers, MLS) a lot of money
  2. Build a large userbase
  3. Make money from referrals to service providers (appraisers, movers, mortgage, etc.)

As a general matter, I don’t really see a big problem with this kind of a business. It is, after all, sort of what Google and Facebook do. This is roughly the stated business model for most modern brokerages as well, and most clearly articulated by Compass. So this model works.

However, I spent some more time over the weekend with Jeff Booth’s book, The Price of Tomorrow. Its central thesis is that technology is deflationary and technology is growing exponentially. And I started wondering how that insight would end up affecting real estate. I have some thoughts.

Deflationary Technology + Inflationary Currency = Real Estate is Prime Target

The first thought I had was that if technology is deflationary (because it lets us humans get more for less), and the only reason why we haven’t seen prices plummet across the board is inflationary monetary policy pursued by every central bank in the world, then that naturally leads to asset price inflation. One of the most important assets being inflated this way is real estate.

In early 2022, real estate brokers and agents still get compensated largely via commissions, a percentage of the sale price. That sale price is being inflated via currency inflation, which means that broker and agent compensation is being inflated along with the price. Home prices rose almost 20% YOY in 2021; you cannot convince me (or anyone else) that real estate agents worked 20% harder or worked 20% more hours or delivered 20% more value or in 2021 over 2020. The windfall of real estate agent commission was straightforwardly tied to asset price inflation.

What that then suggests is that one of the fattest targets for tech disruptors anywhere and everywhere has to be that continuously inflating commission. This is in fact what we have seen over the past 20 years or so, and what I think we’ll continue to see over the next decade or so. The famous Jeff Bezos quote, “Your margin is my opportunity” applies more and more to real estate brokerage.

Which is why I think we’re seeing so many companies moving into this space. The growing margins in real estate have nothing whatsoever to do with productivity, with additional services, etc. It is purely from underlying asset price appreciation via inflationary monetary policy, which means that smart entrepreneurs figure there has to be a way to make money from saving somebody a lot of money.

Agentcentric = Loss Leader Business

As they move into the space, however, to try and figure out how to convert somebody else’s margins to their opportunity, they run smack into one of the key realities of the industry: it’s a complex web woven over decades to ensure that no one can make any money without a licensed real estate agent at the center of it all. Thanks to the genius of Dave Liniger and Gary Keller, combined with the lobbying power of NAR, the real estate industry today is all about making sure the agent stays central to everything … and makes more money doing it.

So entrepreneurs looking to convert that margin into opportunity have to figure out how to either (a) save consumers a lot of money, but ensure the agent keeps getting paid, or (b) save agents a lot of money, but figure out how to make money while doing so.

Prime examples of (a) are Redfin, Homie, and others who become, for all intents and purposes, discount brokerages with their own agents because they have to. Prime examples of (b) are low-cost brokerages like EXP and Fathom and HomeSmart.

Technology growth allows both models to work. Getting more for less, which is what technology does, means that discount brokerages could offer the same level of service to consumers at far lower cost. It also means that brokerages could offer the same level of service as full-priced competition at far lower splits to agents, or far better service for the same price.

Ancillary Business Depends on Control of Relationships

In either case, the entrepreneur is naturally forced to look elsewhere for profits. Ancillary businesses of title, escrow, mortgage and insurance are the first stop as they are so closely connected to the real estate transaction. But more and more companies are thinking about slightly more distant, yet related, businesses like home improvement, moving services, referrals for internet connectivity, etc.

This move to ancillary revenue streams depends on one key thing: control of the consumer relationship. Today, the real estate agent has that control, and the successful agent spends a huge chunk of time and effort getting and improving that control over the consumer relationship. As long as the agent controls that relationship, the agent will capture the lion’s share of the economic benefits from the transaction. They all know it, explicitly in many cases, and instinctively in other cases.

Deflationary Technology, Part Two

But that’s today, with today’s technology. If we take Booth seriously, and I see absolutely no reason why we would not, then we have to think that technology will continue to advance at an exponential rate. Whatever seems like complete nonsense and science fiction today likely will see the light of day far sooner than we imagine.

Within real estate, we already know that some of the biggest successes have come from companies that provide technology for greater acquisition and control over consumer relationships to agents: lead generation (Zillow) and CRM and automated marketing have seen some of the most activity. Company after company talks about an “end to end platform” or “all-in-one solution” for agent productivity. Do more with less, get more for less — this is the core promise of technology, and entrepreneurs are delivering it to agents.

Which means that concentration of market power is all but inevitable. The 80/20 Rule has been 90/10 for years now; we will move (or maybe we already have moved) into the 95/5 environment.

At the same time, technology is moving more and more into the hands of consumers, even in real estate.

Confession time. Over the weekend, Sunny and I spent a lot of hours watching Hulu (Dopesick is pretty awesome in a horrifying way). We get served ads on Hulu. And a couple of ads on constant rotation for us made me think of this post. Here’s the first one:

What got me about this commercial is the whole “anywhere you are with your phone, you are in a DriveTime dealership.” It’s pitching ease and convenience, and your phone replaces the often nasty dealership experience for most consumers.

Then there’s this commercial:

“Sell your home the new fashioned way” is a clever tagline. But again, it’s pitching ease and convenience, with your phone replacing the often dreary and unpleasant brokerage experience for most consumers. It is “inaccurate” since no one gets an offer from Opendoor within seconds while standing in the lawn, and we in the industry know that Opendoor is a brokerage with its own agents and partner agents and Opendoor pays full cooperating compensation and is a member of the MLS, etc. etc.

But as a commercial, it is effectively replacing the agent in the consumer relationship with Opendoor, the institution.

Opendoor’s “new fashioned way” is possible only because of technology advances. Now have that technology double in efficiency and effectiveness. Have new technology capabilities be introduced.

At the same time that technology is moving real estate agent economics from an 80/20 Rule to a 95/5 Rule, it is moving more and more functionality directly to the consumer. More and more of the economics will have to move to the consumer. This too is inevitable.

Ancillary Business With Deflationary Technology

The specific issue worth exploring is what happens to the reliance on ancillary businesses to fuel profits, when technology is deflationary and growing exponentially.

How much longer can brokerages and proptech companies rely on being able to make money from title, escrow, mortgage, etc. from delivering value to real estate agents, who in turn control the consumer relationship? Can technology eventually move that control over the consumer relationship closer to those service providers who are today paying for access to the consumer?

To use just one example, suppose that today a title company relies on the real estate agent to deliver a consumer’s order for title insurance. Most consumers have no idea what title insurance is, and they don’t much care. For this access, the title company is willing to pay half the profits over, plus provide various marketing concessions and the like. (RESPA rules are tricky, so just assume whatever they do is RESPA compliant.) As technology advances, how likely or unlikely is it for the title insurance company to offer 25% of profits back to the consumer in the form of savings in order to get the lead directly, cutting out the agent in the middle?

Mortgage is already showing signs of flipping the script, with companies like Rocket Mortgage and Better reversing the flow: from real estate agent to mortgage to from mortgage application to real estate transaction. They haven’t completely flipped the script yet, of course, but the path seems clear and straightforward.

Are other ancillary businesses immune from this effect of technological advance? If so, which ones and why? If not, then what does that imply?

Implication: Move UP the Value Chain

As a general matter, it seems to me that one answer has to be that current players in real estate have to find a way to move UP the value chain. We’ve been seeing this play out slowly over the past couple of decades; maybe the pace of that moving up has to increase somewhat.

Helping buyers with paperwork is something that will be replaced by automation. The agent has to move up the value chain, perhaps to advice and negotiation. At some point, technology and AI and Big Data and whatever will replace basic advice and basic negotiation. The agent has to move up the value chain even more to advanced advice and advanced negotiation — things that software and computers are not as good at.

Simply sending one’s client over to “my mortgage guy” is probably going to be replaced by technology that goes direct to the consumer, like the DriveTime app or the Opendoor “new fashioned way to sell” will do. The agent has to move up the value chain, perhaps to an expert consultation on the buyer’s financial strategies and how they fit with customized mortgage needs. That could mean dual-licensing or partnering with a financial advisor, or some other way to climb up the value chain.

From a brokerage and MLS standpoint, whatever they are offering the agent today likely can be replaced by technology, or at least made far more efficient with technology… which implies needing to move up the value chain for the agent. Basic courses on lead generation might be free on the internet, so the brokerage will need to offer personalized one-on-one coaching. If that is made cheaper and cheaper due to technology, then the brokerage has to figure something out and move up the value chain. Maybe that’s unique technology. Maybe it’s unique leads that are available nowhere else. Maybe it’s charismatic motivation (like fitness coaches) or truly in-depth understanding of business operations. Who knows?

Considered Next… Deflation and Decentralization

Let me end this post here. I think deflation via technology is much easier to grasp and understand than what comes next.

Because the next set of concepts to consider is what happens when you combine deflationary effect of technology with decentralization as the key social and economic trend, globally. I actually think that technology is inherently decentralizing as well, despite the first order effect being greater concentration of power. Untangling that connection will take a bit more thought and a bit more time. So let’s tackle that next.

For now, it seems sufficient to look at existing business practices, existing business models, and existing strategies in light of constant deflationary pressure from technology. Combine that deflationary pressure with straightforward revenue growth from asset price inflation as we have in real estate, and it seems inescapable that our industry will be the prime target for all manner of disruptors everywhere.

The implication is (a) further concentration of market power, (b) likely future challenges to ancillary businesses as primary profit centers, and (c) a consistent need to move up the value chain at faster and faster rates as technology advances faster and faster.


2 thoughts on “Technology Deflation and Real Estate Business Models”

  1. Very interesting post Rob (as usual) but I’m wondering what happens if/when assets reverse and deflate? Either through increased supply or central banks raising rates to cool down growth and prevent inflation. Or do you see this as a long term trend regardless?

    • Thanks Patrick.

      I think my current position is that the only way we see asset deflation is after the collapse of the US Dollar, what Ray Dalio often refers to as a new world order. (See this article from Wealthrise for a good overview:

      I also do not believe that central banks can raise rates to cool down growth and fight inflation. I think their hands are completely tied because of government spending. I think I wrote about this when talking about Luke Gromen’s take on the economy, but I agree with Gromen that there’s no way that the U.S. government tells Boomers no more social security checks, or the urban poor no more EBT and Medicaid, or government retirees (think cops, firefighters, teachers) no more pension checks.

      I suppose the more likely threat is that capital rotates out of real estate as an asset class and into something else, which then leads to housing deflation in line with technology-driven deflation. But I’m just having a lot of trouble imagining that happening short of the Dalio-level revolution either politically or economically (or both).

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