JP Morgan on CoStar’s Residential Strategy

A reader sent along a short note that JP Morgan wrote after a meeting with CoStar “where management outlined the strategy for residential real estate and provided a couple demos/screenshots from its solutions.” It’s an interesting set of observations by Wall Street and I thought I’d tag along and see what I thought about their takes.

I can’t upload or embed the document for a variety of reasons, so if you have a relationship with JP Morgan, by all means, see if you can secure yourself a copy. Otherwise, I’ll limit quotes to a line here and there.

The general takeaway for JP Morgan is that CoStar’s strategy is familiar, is likely to work, and as a result, CoStar will generate over a billion dollars in revenue with above-average profit margins. So let’s see what we can glean from the short note about what CoStar probably told the analysts, as what they revealed makes some of CoStar’s plans quite a bit clearer.

What JP Morgan Heard

There are gems in this report, and maybe someone from the industry could ask CoStar management some questions the next time they’re able to have a meeting. I’ll have those questions at the end of this article.

Huge Market + Differentiation

First observation is that residential real estate will go from a $2B market opportunity to a $70B opportunity in the U.S. and $210B globally. How? CoStar’s take appears to be that the MLS today focuses on advertising agents, rather than advertising actual real estate properties. So by pivoting from advertising agents to advertising the agent and the properties, CoStar thinks they can 35x the TAM.

What does that mean? Well, here you go:

CSGP will differentiate itself through the production of original content specific to each neighborhood. The photos and videos can range from a local grocery store to a nearby school and will be the main driver behind this initiative. Currently, 60-70% of listings belong to a 3rd party and the goal of evolving the brand is directed at selling more of their own inventory.

I have noted after CoStar’s Q2/2021 earnings call that Andy Florance is a genius, and he understands the details of things in ways that most others do not. That line about “production of original content” is more important than you imagine. We’ll discuss that below.

The line about “60-70% of listings belong to a 3rd party” and the goal of evolving CoStar to sell more of their own inventory is a mystery to me. The simple suggestion is that CoStar will become an iBuyer. That can’t be true, could it? Because if it were, that would be major, major news indeed for a variety of reasons, the least of which is Florance dancing on the grave of Zillow Offers last year. But I’ll try to make sense of that below.

Disrupting the Traditional Real Estate Market

Second observation is how CoStar plans to CoStar-ify residential real estate. I think it’s a bit of a stretch to call it “disruption” but whatever. The idea is that agents will use Homesnap, while buyers and sellers will use Homes.com. That’s roughly analogous to how commercial agents use CoStar, while tenants and investors tend to use Loopnet. CoStar talks about a private messaging system but that’s no big deal.

Subscription + Listing Promotion

CoStar apparently went into some detail about their revenue model. Agents pay a subscription, which entitles them to “a number of paid listing slots” and then a subscription for any add-ons on Homesnap. Sellers can pay to promote their listings, just like owners can do on Apartments.com and on Loopnet. Nothing new here.

Timeframe

According to the Note, CoStar thinks break-even for its investment into residential will be 4-5 years and has a 2027 revenue target of $700M to $1B, with margins north of 50%. That’s a solid business if they can build it.

First Step: Citysnap

According to the Note, CoStar will debut this model with Citysnap, which is its partnership with REBNY, sometime in the summer of this year. This part is interesting and possibly important, so let’s look at what JP Morgan wrote:

The platform will exclusively feature data from REBNY’s RLS and will be loaded with CSGP’s unique videography and photography content upon launching. This strategic move by CoStar Group will take on competitors like Zillow and StreetEasy head on, while further integrating its residential innovations onto the new platform. [Emphasis added]

We should see a glimpse of what CoStar intends to do in the overall residential real estate space by looking at Citysnap this summer. And presumably, by the Q3 earnings call, we should have a better idea of how it’s working.

What I’m Seeing

That’s what JP Morgan heard during Analyst Day. Here’s what I’m seeing based on their reporting.

First of all, I think whoever wrote the Note probably didn’t express himself/herself clearly enough with this: “Currently, 60-70% of listings belong to a 3rd party and the goal of evolving the brand is directed at selling more of their own inventory.”

I think what CoStar likely said, and the author mis-stated, is that currently 60-70% of listings are sold by third parties, that is, other agents who represent the buyer. The goal of the brand — that is, Homesnap and Homes.com — is to have the listing agents sell more of their own listings.

That’s the only way the sentence makes any sense. We already know CoStar is all in on “Your Listings, Your Lead” and we also know that CoStar today doesn’t own 30-40% of the listings being sold. Unless CoStar has an iBuyer division no one knew about, I think the sentence was mis-written.

Second, however, that doesn’t change the core brand goal: have the listing agents sell more of their own inventory. In that sense, CoStar is aligning not only with those listing agents and brokers who really want “Your Listings, Your Lead” but also with the United States government and all of the policy wonks at various think tanks.

The MLS is dependent more on buyer agents than it is on listing agents, since the vast majority of their members are buyer agents. We know this because of the power curve within the industry means that the top 10-15% of the agent population do over 80% of the transactions, which in turn means that they have the lion’s share of listings. New agents, part-timers, and less experienced agents — these people typically make their money from representing buyers. The top producers focus their time on getting sellers to list their houses with them, and spin off buyer leads from those listings.

CoStar wants to be these listings agents’ best friend. Sure, they’ll likely end up paying more for CoStar than they do today for the MLS… but once you take lead generation costs (Zillow Premier Agent or Realtor.com) into account, it seems reasonable to expect that CoStar will actually be on-par or cheaper.

For example, say CoStar costs $500 per month but comes with 5 “paid listing slots.” That’s a dramatic increase in cost from the $50 per month the agent is paying her MLS. But it’s cheaper than paying Zillow 35% of the commission as long as the agent is doing more than $18K a year or so in GCI. What’s more, CoStar expects sellers to pay to enhance their homes for sale, just like sellers do in Australia with REA. That might reduce the cost to agents even further.

Wall Street Believes CoStar Is Building an MLS

What’s perhaps more important is that we have confirmation that CoStar is either building an MLS, or building something that Wall Street thinks is an MLS. Here’s the language:

The traditional MLS in the US focuses on just advertising agents, which provides a $2B market opportunity. Comparatively, shifting the platform’s purpose to advertising both agents and real estate opens CSGP up to a $70B+ domestic and $210B global market opportunity.

It may be that Andy Florance and crew said, “Yeah, we’re building a new kind of MLS that shifts to advertising both agents and real estate.” I doubt that’s what happened. What I think happened is that JP Morgan’s analyst is (once again) mis-stating what was said. I think what is likely is that CoStar pointed out that the TAM from agent subscriptions is $2B while the TAM from agent subscriptions plus paid promotion for listings is $70B. (After all, the MLS does not advertise agents, and Zillow and Redfin today advertise agents and real estate. There has to be a misunderstanding going on here.)

Nonetheless, it is significant that JP Morgan and other Wall Street analysts believe that CoStar is building a platform that can be compared and contrasted with the traditional MLS.

I think they’re right.

This feels like the case of “a rose by any other name would smell just as sweet.” Does it matter whether CoStar calls its thing that integrates buyer, seller and agent into a single platform an MLS or a portal or a doohickey? What it does is allow paying agent subscribers to advertise and promote homes for sale to buyers and other agents.

I suppose that since CoStar/Homesnap won’t be doing things like unilateral offer of compensation, it isn’t an MLS as we think of this platform. But call it what you like; Wall Street clearly thinks what it is is a disruptive new thing that takes the $2B addressable market opportunity of 600-odd traditional MLSs and takes that to $70B on a single platform.

The Key: Photos and Videos

I simply cannot overstate how big a deal the “original content specific to each neighborhood” is. Andy Florance is a genius, and he gets the details.

Back in Q2 of 2021, I discussed this exact issue after this passage from the earnings call:

We plan to grow Homes.com site traffic by offering homebuyers accurate real-time information straight from local MLS, supported by the best photography of multimedia content possible, along with good agent interaction traffic and a website that lets home buyers collaborate with the agents they trust. CoStar Group’s hundreds of talented architectural photographers have brought millions of properties live for millions of renters with the highest quality photographs, videos and 3D tours. Now this team is committed to providing an immersive and compelling presentation of residential properties in Homes.com. [Emphasis added]

What only those of us deep in the weeds of the MLS space know is that back in 2012, there was a little-discussed ruling in the MRIS v. AHRN lawsuit. Suffice to say that case, also known as the NeighborCity lawsuit, went all the way to the 4th Circuit which ruled in favor of MRIS.

However… the substance of the NeighborCity ruling is that under the Supreme Court case Feist v. Rural, only photographs and property descriptions are copyrightable. NeighborCity lost its case because it was copying photographs from MRIS, and its claim in the 4th circuit that MRIS didn’t have the copyright to those photographs did not succeed.

However (x2), the 4th Circuit’s holding basically said NeighborCity, a third party, can’t butt in on behalf of a copyright owner who isn’t objecting to an MLS asserting copyright. If the copyright owner himself objects, we have a different story… as we have learned in Stross v. Redfin, out of the 8th Circuit.

I’ve written thousands of words about this issue, including a giant Red Dot Report, so if you have questions, read that report or contact me. For our purposes, suffice to say that if the actual copyright owner objects, the MLS cannot assert copyright over photographs. And everything else that isn’t a photograph (or a property description that nobody cares about) cannot be copyrighted.

If “CoStar Group’s hundreds of talented architectural photographers” take the photos and videos which are “original content specific to each neighborhood” and presumably, “original content specific to each listing,” guess who owns the copyright to said photos and videos?

I assume that Citysnap, currently moving towards launch, is offering its agent subscribers (who are likely paying quite a bit for the subscription with the paid listing slots) free photos and videos of the listings taken by “talented architectural photographers.” If anyone from CoStar or REBNY would like to give me details of the Citysnap agreement on who owns the copyright to these photos and videos, I’m all ears. I further assume that REBNY, which is not an MLS, doesn’t care all that much as long as its members get value. I assume that the members don’t care about who owns the photos and videos, as long as they sold the property for over asking and got big phat commission checks from doing so.

Time Horizon: 4-5 Years

It is clear that CoStar is playing the long game. The Note mentioned revenue goals in 2027. Nothing much will happen between now and at minimum 2025, three years out. Until then, CoStar will just work on getting agents to buy Homesnap, make Homes.com prettier and more useful, and sell paid listing slots that all come with free professional photos and videos. What agent is going to make a big issue over saving thousands of dollars on professional photography?

CoStar will likely even supply the local MLS with these photos and videos when the agent uploads them into the MLS as per the terms of the license between CoStar’s photographer and the agent. Nothing changes for the MLS, for the agent, for Zillow, for anybody. It will just be business as usual.

That is… until things change, whether by government fiat, by changes in the market, or by one of the big antitrust lawsuits being decided. At that point, the world will discover that all of the data in the MLS can be freely copied and duplicated and used for whatever purpose. What can’t be freely copied and used are the photographs and videos… and CoStar will own most of them.

Zillow can have all of the data that the MLS has and provides; it won’t have all of the photographs. Only Homes.com will have those.

Where are consumers going then?

It’s f’ing brilliant. And not one MLS I can think of today is prepared for that day. I don’t think Zillow is prepared for that day. 2027 revenue targets of $1B seems low to me by that measure.

Things Could Change… Questions to Ask

JP Morgan’s Note was likely mis-written in big parts, but it was still very useful for giving us a peek into what CoStar is thinking. It goes without saying that this post is just my take as of today, based on what I know today. Nothing is certain, and the future is not yet written. MLSs could wake up and do something about this. Zillow could decide to make photos a priority.

There are questions to be asked, however, by somebody who understands the industry in greater detail than overworked Wall Street analysts do. Here’s what I’ve come up with:

  • Who will own the photos and videos that CoStar takes?
  • What will be the standard licensing terms, if the photos and videos are of properties?
  • Will agents be able to enter listings into Homesnap and have them be syndicated to their local MLSs, or will Homesnap require that the agents enter listings into their local MLS first? In other words, will Homesnap be “Downstream” from the MLS, or “Upstream” of the MLS?
  • Will brokers and agents be able to opt out of having listings displayed on Homes.com? On Broker Public Portal?
  • If the agents take their own listing photos, or have their own professional photographer do the work, what will be the required assignment of rights to submit them to Homes.com?
  • What will be the assignment of rights from the MLS to Homes.com?
  • Will Homes.com have “Premium Searcher” as Loopnet does?
  • Will consumers and agents have the ability to NOT use the centralized messaging function on Homes.com to contact each other?

I’m sure there are other questions that those who understand the details of the real estate industry could ask, if given the opportunity. I leave it to all of you to formulate your own questions, if any.

-rsh