Steve Murray discusses merger and acquisition activity, the onslaught of virtual and discount brokerage firms, and what the economy says about housing sales. Let's jump in.
From Real Trends, the trusted source for real estate industry news, this is REAL Trending episode 34. We're breaking down trends of the week and showing how they impact brokers and agents. I'm Steve Murray, president of REAL Trends. Today we're discussing merger and acquisition activity, the onslaught of virtual and discount brokerage firms, and what the economy says about housing sales.
Merger and acquisition activity, it's never been this hot, it's never been this strong, it's never been this puzzling all at the same time. First of all, every broker needs to understand that it doesn't matter whether you have five agents, or you have 5,000 agents, every brokerage has value to another brokerage company.
And the factors affecting what that value is are numerous, as we've commented before. Things like your commission plan, your profitability, your growth rates. Who are your competitors? But most importantly, who else might be interested in owning your company? And what is it about your company that makes it special, or unique? Lastly, housing sales, and the housing sale environment obviously have a big impact on valuations and hence, merger and acquisition activity.We commented nearly 18 months ago for instance, that if Realogy or Home Services, or both either slowed down their acquisition of brokerages, or stopped entirely it would affect valuations and, merger and acquisition activity throughout the industry. That has come to pass. Realogy announced about a year ago they weren't going to be buying brokerages anymore, and that completely changed the environment for potential buyers up and down the line.
Home Services announced last summer that they would be slowing down somewhat, and would likely be a little less favorable on prices and terms. But what's affecting activity most is the competition for agents, and the resultant decline in gross margin. That is, company revenue, the money that a brokerage has after the agents have been paid, and the impact on profit margins.
And number two, is that there is now a much bigger variety of brokerage companies than in the past. And it's very difficult for instance, for a cap company, dollar company to purchase 100% commission concept company, because the impact on agents may cause the loss of a lot of agents.
Cultural matters also affect merger and acquisition activity. However, given all those things it is the diminution of gross margin, and the drop in housing sales that is causing activity to go through the roof, because many brokers have been through this before. The 2006-to-2010 downturn. The downturn that took place, albeit a short one in 2001, and 2000. The downturn that took place in 1988 to 1993. Brokers remember downturns, and there's a lot of firms that are thinking right now, given the economics of the business, that maybe this isn't a great business to be in.
Our calls to do valuations, and to represent sellers and buyers has gone through the roof as the result of these things in the market, and in the industry at large. Merger and acquisition activity however, remains a strategic way to grow a brokerage company if your sight is still on the horizon to grow your firm, and to increase its share and reach.
There are literally dozens of firms in each market in this country that we know are looking for a dignified exit, and to get fair value for their companies. We also know there are many firms on the other side of that equation that are still looking to grow through a combination of some kind with other firms.
We expect this activity in mergers and acquisitions in a residential, brokerage industry, will continue at a very high rate for some time to come. As the economics of the business, and a certain flatness in housing sales create a ripe environment for growth through mergers and acquisitions.
On the second topic of the onslaught of virtual and discount brokerage firms we see the number of these kind of companies growing exponentially, and we've commented on it in the past. Flat-fee companies, those that offer plans for agents that are $100 a month, and $300 a transaction, or something like that, have multiplied over the last 10 years where, in almost every market in the country there is a firm that's in the top five or six companies that operate that kind of model.
And now we have firms like eXp and Fathom, and others that are truly offer that same model, or some variation of it. Either a flat-fee transaction, a monthly fee, or a capped commission plan that offer no office space. Agents and teams can work out of whatever space they choose.
These kind of firms are multiplying rapidly. It begs the question out of a lot of really strong traditional brokers is, "Well, if I've got one supervising broker for 500 agents in a virtual brokerage, or a flat-fee model, where is the real supervision? Where is the coaching and mentoring to make sure these agents are learning the business correctly? And doing it correctly."
Well, this topic has been brought up time and time again realistically, for the last 10 or 15 years. In our experience of dealing with regulators at the state level, while they express some concern about it, the most common question or statement we get from regulators is, "If you show me proof that agents in X, Y, Z where they have a 500 agents and one broker in charge, versus a more traditional company where you have an office manager supervising 50 agents, if you can show us any demonstrable evidence that consumers have been harmed by one model or over another, or that there is a ... If there is a significant difference of business complaints to the real estate commission from one model to another, then we will act. But until then, we're not going to act."
It is a challenge for the whole industry also, that we operate where the top 20% of agents and teams are likely doing 75% to 85% of all the business. Which means that half of the realtors in the country don't do more than one or two transactions a year. Maybe it's three. And that they will develop the expertise to know how to navigate a very complex sale process, a very complex contract, and inspection, and finance process. It begs the question of all the more traditional firms who have tens, of thousands of agents who do one or two deals a year, even if they have a manager supervising them, how in fact can we ensure that these people know what they're doing?
There are many leaders in this industry [who] rightfully ask how one person can supervise 500 agents, and it's a good question for us to keep having. In some states there are new regulations about teams particularly. And it's our belief that teams themselves will come under increasing scrutiny not just for advertising, and marketing, and licensure point of view, but from all kinds of other issues such as labor, and employee issues in teams. But that's for another day.
These virtual and discount brokers are going to keep growing. Primarily for two big reasons. One, half of the realtors in the country don't do enough business, nor do they seem to value what a traditional firm offers enough that they won't consider a lower cost alternative.
Number two, we have hundreds or thousands of agents who are top producers, who are in the last two to three years of their careers, and where most of their business is repeat and referral and all they're looking to do is maximize the income from that sphere of influence business in the final years of their career. And for whom there will be some attraction for lower-cost models. It's just a matter of economics.
Lastly, the economy and what it has to say about housing. Well, on the upside, unemployment remains at nearly 50-year low, household incomes are moving up finally, more rapidly than at any time in the last 10 years, more people have more jobs. The labor force participation rate is getting back to normal. Mortgage interest rates have backed off from where they were last fall making everything a little bit more affordable.
We have more inventory than we did six months ago in most markets in the country. So, we have all these good factors all saying the housing market should be healthy. On the other side of that, affordability is still a huge issue, and we have a generation of Americans, the GenX who were harmed greatly by the last downturn, and another generation, the millennials, who are having a difficult time first, raising the cash for the down payments needed to buy homes, and a percentage of whom are still encumbered by student loan debt, which hinders their ability to finance and afford new houses.
You have all these factors converging into what looks like a flat year for housing sales in the U.S. There's not overwhelmingly good news, and there certainly isn't overwhelming bad news. But leading up to this time, that is, leading up to 2018, we thought somehow, or let's say a lot of people in the industry thought somehow, that we would keep defying the laws of economics.
And while the asset, houses, were going up at eight, 10, 12, 15 percent in value per year, while household incomes were growing one and a half, to two percent a year, that we would not ultimately have to pay the piper. Well, 2018 showed that was false.
What we're doing in 2019 is continuing the process of rebalancing the ability of people to afford housing, with the availability of housing at a price people can afford. Learn more about industry trends, marketing and technology strategies, and other. As well as listen to past REAL Trending episodes on our website www.realtrends.com/blog/. This has been Steve Murray, until next time.
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