REAL Trending Episode 24
Steve Murray talks about the plunge in real estate brokerage equity values, what everyone’s missing about Zillow, and a commentary on the exchange of value. Let’s jump in.
From REAL Trends, the trusted source for real estate industry news, this is Real Trending, episode 24. We’re breaking down the trends of the week and showing how they impact brokers and agents. I’m Steve Murray, President of REAL Trends. Today we are discussing the plunge in real estate brokerage equity values, what everyone’s missing about Zillow, and a commentary on the exchange of value.
The Plunge In Real Estate Brokerage Equity Values
In the last few weeks, and over the last few months in particular, shares of industry stalwarts Realogy, RE/MAX, Redfin, and Zillow have all toppled, almost a straight downhill line over the last three- to six-month period of time. Many of them are trading now 30% to 50% below where they were at their peak 6 to 12 months ago. What’s going on here? Well, here’s the facts.
The housing market is slowing down. Seven of the last eight months, we’ve seen declines in year-over-year existing home sales, and the last report indicated that new home sales had declined in the last three consecutive months. Is it any surprise then that companies like those I’ve mentioned who have their entire business in the residential brokerage industry, have seen their stocks decline? Now, that shouldn’t be surprising to anyone about Realogy and RE/MAX. They are what they are.
They don’t proclaim to be something they aren’t. They are real estate brokerage owner-operators, in the case of Realogy, and franchisers. RE/MAX is a pure franchise organization. They’re seeing the growth rates in their businesses slow over the last 12 months, which means their earnings growth will be slower than it would have been, because housing sales are down, which mean commission revenues will be down, which means franchise fees will be slowly growing, if at all.
So, it shouldn’t be any surprise that their stock prices have declined to reflect that. On the other hand, you look at Zillow and Redfin and for years, they have positioned themselves as technology companies, not real estate brokerage companies. But the truth is that most of their revenues come from real estate brokerage and from transactions. If those transactions are slowing, then their revenue growth may slow, which may mean their earnings growth will slow. Now, there are other things going on, obviously with Zillow, which we’ll get to in a second.
The fact is, while that’s happening, equity values of residential real estate brokerage companies have also softened. Now, this started in January of this year when new Realogy CEO Ryan Schneider announced that heretofore, Realogy would not continue to buy large residential brokerage companies to add to NRT. But rather, [Realogy would] focus on roll-ins to their existing NRT operations, number two, to finance their own affiliates’ acquisition of other brokerages, and lastly, for on behalf of NRT, to finance the acquisition of agents and teams and their practices, which they have been doing throughout the U.S. from time to time, for a couple of years now. It may indicate a big shift in the whole industry. Following up on that, in our mergers and acquisition work at REAL Trends and our valuation work, both of which are at all-time highs, we’re seeing the prices and terms soften somewhat for all kinds of brokerage companies across the board.
With NRT not buying, home services is not as pressured to pay super-high prices or increasing terms, and they themselves have indicated to us that they are resetting the price targets and terms of the acquisitions they’re going to continue to do. They also let us know that they would be doing those at a slower pace. So, we have not only the publicly held real estate companies seeing their values decline, but in fact, the values in the private market have softened over the last 12 months.
The housing market is down, it makes rational sense that equity values of those involved in the residential brokerage industry will decline somewhat. It’s the way things are supposed to work, which doesn’t necessarily explain the Compass round of fundraising, which today values Compass at more than Realogy and RE/MAX and in fact, Redfin combined. So, it’s going to be interesting to see what the future holds, but equity values are down because housing sales are down, because commission levels will likely be off, which means there’ll be pressure on brokerage margins. And there’ll be pressure on margins across the industry, simple fact of life.
What Everyone’s Missing About Zillow
Let’s talk about Zillow as a second topic, specifically. So, Zillow has now lost nearly half of its equity value in the last 6 to 12 months, from a peak of nearly 12 and a half billion dollars in market value, last I looked, they were trading between $6.25 billion and $6.5 billion. Now, there are a lot of people saying, “Well, Zillow missed their revenue targets in the third quarter.
My God, they missed them by less than a million dollars”–$340 million versus $344 million. That shouldn’t cause a 25% drop in somebody’s value, unless of course that value was already super-inflated because of super-high expectations. But Zillow also let the market know that the range of revenues for the fourth quarter and the whole year were going to be a little bit lower than Wall Street had expected.
That probably had a bigger impact on Zillow’s market valuation. The other thing that took place is Zillow is getting pounded by their move into home acquisition. Jim Kramer and other people on Wall Street have just had a field day pounding Zillow for getting away from their listing portal, online advertising platform, and actual home buying. They totally missed the point. By the way, at least for this editor, and this commentator, I’ve learned over 30+ years of watching Wall Street and equity values that anybody who thinks that Wall Street has some specific special knowledge of the value of companies, well, you need to get a grip on life, because the people on Wall Street do not have a monopoly on intelligence.
I personally think they’re totally missing the shift at Zillow. They’re focusing on what they’re going to be in the home-buying business, which is capital-intensive, which is not going to add to their listing revenues and their advertising revenues, but what they miss is that Zillow is a platform that generates prospects for agents, particularly for premier agents, and their premier broker network, which is still growing and doing fine.
What they miss is the Zillow, if you will, iBuyer program, is a lead-generation tool. For every home that Zillow might have to buy, they get thousands of seller leads, thousands of seller leads. Where the listing portal that we know as Zillow.com may be a great generator of buyer prospects, the iBuyer program has the potential to be an enormous success for them in terms of generating seller leads. Enormous possibilities. Now, will Zillow also change its business model? That’s another big question people in the industry are asking. There’s a lot of chattering about it. The answer is probably yes. They may move into more of a referral-fee model, and just charge industry referral fees for their seller leads.
The numbers can be staggering. If you take some typical listing prices and average commission rates and an average referral fee, Zillow could get $1,500 to $2,000 on average for each closed seller lead they generate, and you can do the math. If they were to generate 10 or 20 or 100 or 200,000 seller leads a year, with reasonable capture rates, this could be a substantial new revenue source for Zillow and actually solidify their position in the residential brokerage industry.
I think the market has overreacted, I think that Zillow is still a highly valuable company. I’m no expert whether they’re really worth $6 billion or it’s $3 billion, or $10 billion. I have no comment on that. But I think Wall Street beating the pulp out of Zillow because of their iBuyer program just proves that Wall Street once again is missing the point of an important industry trend.
The Exchange Of Value
Lastly today, let’s talk about the exchange of value. Everyone’s talking about valuations, everyone’s talking about value proposition. But here’s the fact. Since RE/MAX launched on a national basis, 40 years ago, their 100% commission concept, various broker models have been in the agent-acquisition business by either paying agents money or giving them a higher split, and in fact, what’s the difference? It is the recognition that agents who were top producers, they generate their own prospects, they service their own clients and customers, they do all the work necessary to get to a closing, they handle the mortgage application processes, inspections, the closing documents, and all the hundreds of special things that really good agents do to earn a commission.
Is it any surprise that top-performing teams and top individual agents are garnering 80, 85, 90% of the commission when in fact that generate most of the value that’s delivered to a housing consumer? A buyer or a seller. Our own recent consumer studies, which we’ve commented on, show that 69% of consumers choose an agent because they’re someone they know, or someone referred them to someone. It had nothing to do with what business model they were operating under, what brand they were operating under, what their private office looked like.
It had to do with the fact that somebody referred someone to someone else, 7 out of 10 times. The value exchange in our industry recognizes that top teams and agents deserve most of the value in a real estate transaction. It’s not that they don’t value anything the broker does. Clearly, they do, because if you look at the REAL Trends America’s Best Agent Rankings, most of the top teams and top individual agents are with identifiable national or regional or local brokerage companies.
The preponderance of them are, our own studies of teams last year with the California Association of Realtor showed that they value having a well-known, recognized, reputable brand name. They value that. One of the other things top teams said they valued was legal and regulatory guidance that a broker can give them. In fact, when asked what else a broker could do to add value, legal and regulatory came up again. It’s not that top individual agents or teams don’t value their broker, but they have a view of that brokerage and the value it delivers that’s different than most broker owners.
So, today when we get into an argument about NRT or Compass aggressively buying agents by offering upfront bonuses or stock options or other perks, why is everyone surprised? This has been going on for 40 years. Whether it was RE/MAX’s 100% commission concept, or Keller Williams capped company dollar concept, or the myriad of other programs. $100 a month and $300 a transaction from people like Realty One Group and HomeSmart, Fathom and others. eXp as a cap, all of it is financial incentives to attract good producing agents.
One last thing about this whole topic: Brand-new agents have different views of the value that a broker delivers than a top-producing agent. Now, over history, over a long period of time, we recognize this with graduated commission plans. The fact is, most brokerage companies in the country are not doing a great job at recruiting and developing new agents. They may be recruiting them, but are they really developing their talent and their skills and their practice where there is a great deal of value to be had?
It’s interesting to note that our recent study with again, the California Association of Realtors on the economics of teams show that teams typically pay their own agents only about 35% commission split. Well, how is it that most brokers are paying out 85% and teams are paying out 35%? Well, that 50% gap is the fact that most great teams that we surveyed generate prospects. So, you might say or comment that the value exchange, the most valuable thing we can generate for agents if we want to retain higher gross margins, or higher portions of the commission, is if we can generate live prospects for them. It’s a real tip for brokerage companies looking out into the future.
More on this later from REAL Trends. Learn more about industry trends, marketing, and technology strategies, as well as listen to past REAL Trending episodes on our website. This has been Steve Murray. Until next time.