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Redfin IPO: Hot or Not Edition

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Redfin IPO: Hot or Not

Redfin’s long-awaited IPO is here. Rob’s as-usual-lengthy breakdown is here. It’s full of interesting angles to consider, and some real positives for Redfin’s outlook. As you probably guessed, since I’m here guest posting again, I think a few points might need refining.

Why, you might ask, would a broker be giving credit to a competitor? We’re all talking about it, whether publicly or privately. There are some really interesting things happening at Redfin that all brokerages should be watching, whether or not they follow suit. This is Notorious, so I’ve taken a few to their potential extremes, which some of you will dislike very much.

Since this is a “hot or not” edition, some extra music seemed appropriate. On to the hotness:

Market share

Annual growth of market share is about 20 percent in Redfin’s most mature markets (1.66% share in Seattle, SF, LA, Boston, DC, and Chicago combined), which is admirable, even if currently nonthreatening to the bigger players in these markets. The trend bodes well for the brand if its service levels engender repeat customers. Market share is less than half a percent in newer market entries.

Brokerage revenue

This stood out in the S-1:

“Brokerage revenue grew 48% during the year, primarily attributable to a 47% increase in brokerage transactions and a 1% increase in real estate revenue per brokerage transaction. The increase in brokerage transactions was primarily attributable to higher levels of customer awareness of Redfin and increasing customer demand and market share in most of our markets.”

Customer awareness is key to Redfin’s success since there’s no brick and mortar or independent agent prospecting. Consumers have to seek the company out online, and if this revenue growth is truly due to customer awareness, it says a lot about the brand’s strength.

Of course, if I was a potential investor, I’d want to confirm that there’s truly brand awareness/loyalty behind the growth and not just huge additional spending when cost of revenue is near 90 percent. Brand loyalty has to be grown to attain long term profitability.

Brokerage technology

Redfin’s tech is top notch. There’s really no industry argument against that. From the S-1:

“Our proprietary Redfin Agent Tools automatically captures information on millions of customer interactions every year, and provides templates for our lead agents to recommend listings, follow up on tours, prepare comparative market analyses, and write offers. “

Having employee agents allows Redfin to require adoption of its tools. That’s something that traditional brokerages really struggle with. Since Redfin’s agents all use the same tools, the brokerage can focus its technology spend there with greater effect on the bottom line.

Community

For consumer-facing tech, it’s clear that many other brokers’ clients use Redfin’s tools for a reason. They’re totally focused on the consumer experience.

This is where Redfin’s technology rubber hits the road. The best brokerage tech keeps agents and consumers in contact with each other. Redfin has built community and loyalty to an extent through its forums, reviews, feedback, etc. in its VOW platform. These things could have staying power.

Lab Rats

Many brokers (like me) quietly appreciate the investors who’ve allowed us to watch Redfin test out a wide range of pricing structures and technology ventures. I don’t have $200 million to lose on experimentation.

We’ve learned that buyer rebates are good for some initial press, but they’re limited for long-term buyer attraction. Glenn Kelman himself called Redfin’s continued offer of rebates irrational. The company has minimized rebates repeatedly and will only service certain property classes that it views as in its financial wheelhouse. The model requires the company to be choosy.

Discounts may have some staying power on the listing side. This is an area of growth for Redfin, especially in new markets that the company moves into. Sellers are more price (commission) sensitive than buyers. Is there a limit on the segment of society looking for a discount listing broker vs. a person they already trust? We’ll see.

Instant Transactions

This is a fascinating piece that Rob pulled out of the S-1:

“Moreover, we believe listing more homes and drawing more homebuyers to our website and mobile application will let us pair homebuyers and home sellers directly online over time, further improving our service and lowering our costs.”

Let’s go down this rabbit hole. It would be monumental compared to the other instant offer platforms currently available. Redfin flipping homes to outside buyers isn’t nearly as transformative as doing in-house transactions between its own registered buyers and sellers who never step foot outside its own toolset.

Redfin can take a commission on the sale. Zillow can’t. Opendoor has to charge much higher fees and pay taxes to fix and flip properties.

If Redfin can continue to grow its online market share, and create a critical mass of buyers and sellers, there’s a potential for this direct sales model to have legs. Don’t expect competitors to let that happen without a fight.

Many others have tried and failed to create this direct connection marketplace—it’s a monumental task. Probably none of them had this much financial and online heft, though.

Is a direct sale on Redfin a bad idea for a consumer? For most, of course it is. Full market exposure trumps all when seeking maximum financial return. But could it happen at a highly discounted commission rate? Likely. Are there some folks who’d eschew the additional full market equity for a quick sale? Absolutely.

The sneak peek marketplace

Buckle up, brokers, because you’re not going to like this. While we’re in “what if” land, let’s lay out an unlikely, but plausible scenario. Assume that Redfin grows its brand identity to national prominence at a level where it can move the consumer mindset significantly (a huge assumption). Might it then leverage its online customer base to create a proprietary marketplace for sellers to test brand new listings out in a low cost environment?

Today, there’s really no successful pre-listing marketplace. Zillow has “Make Me Move”, but it’s a drop in the bucket. In general, the traditional MLS is known as the place to first access all new listings.

What if Redfin created a 14-day “sneak peek” brokerage listing agreement, with no MLS advertising, to be marketed only on Redfin? Homeowners might list solely on Redfin for 14 days. If a consumer wants to buy the home through Redfin, the company charges a highly reduced commission (1% total ?) to close the transaction. Maybe Redfin offers 1% on each side if the buyer has an outside agent. If it doesn’t sell in 14 days, sellers are free to re-up and list on the MLS with Redfin, or relist with any other brokerage.

My fellow brokers are shaking their heads at me right now, wondering why I’d even suggest it out loud. I guarantee you that some of Redfin’s investors are at least thinking about these kinds of ventures. Tell me that Realogy and RE/MAX aren’t toying around with ideas about instant offers, etc. If we’re not exploring these possibilities, we have our heads in the sand.

In a low inventory environment, the sneak peek market could potentially attract enough attention to become the brand of the pre-listing marketplace. If buyers recognize that some homes are only available on Redfin for the first two weeks, and sellers are willing to take the risk of limited exposure in return for a massive discount on commission, it might be enough to move the marketplace a bit. It’s Zillow’s Make Me Move, but with broker representation.

Could other brokers with huge brand awareness do the same? Depending on local MLS rules, they could. Would most? This limited exposure model is not beneficial for most sellers. MLS exposure would still be a much greater benefit for the vast majority.

Lest we forget in our terror, sales are initiated by real people who often first call their trusted agent and say “How do we get started?” Those loyal clients will be guided to the MLS in most cases.

Still, it could be an attractive brand play for Redfin…or I could be completely wrong and I’m sure I’ll hear it from you. The dynamics of client loyalty to agents, buyers’ agents’ duty to clients, etc. in this scenario are a huge can of worms that I won’t open here. But there are cans of worms exploding all over the industry right now. It’s an interesting time to be in business.

Now, we apply a little cold compress to the Redfin Fever.

From Rob’s post:

  • $16.2 billion in sales volume in 2016, which makes (Redfin) #5 in RealTrends 500.

  • 25,868 transaction sides in 2016, which makes them #10 in RealTrends 500.

  • 763 employee agents (“lead agents” in Redfin parlance)

“…it looks like 34 transactions per lead agent.

It also looks like Redfin makes $350,000 per lead agent in revenue. Anybody out there with over 50 agents want to claim the same?
As a point of comparison, the only publicly reporting brokerage in the country, Realogy’s NRT did 77,536 transaction sides in 2016 and generated $4.3 billion in revenues out of 780 offices and 48,000 agents. So… that’s 1.6 transaction sides per agent, and $89,583 in revenues per agent. So Redfin makes 4 times in revenues what NRT does from its agents?”

Per Agent Productivity

Lies, damn lies, and statistics…Redfin’s lead agents may write the contract, but they also have showing agents who are contractors, and transaction coordinators who carry the sales through. We don’t know how many licensees touch each transaction, we just know it’s a lot more than 763 total.

So that’s a big nothing burger for statistical comparison, but it looks good in an S-1. I imagine (hope) that investors understand this. It’s very possible that NRT is equal, worse, or better on agent productivity, but we just don’t know.

Biggest “Brokerages”

“(Redfin has) $16.2 billion in sales volume in 2016, which makes them #5 in RealTrends 500.”

This is true. But it’s probably misleading to those who don’t know how our convoluted definitions of brokerages work in rankings.

Redfin is a national brand. NRT is a multi-brand brokerage in about 30 states. Investors want to know if Redfin can compete with RE/MAX, not RE/MAX Results in Eden Prairie, MN. Redfin’s ranking would drop significantly and the gaps above it would be exponentially larger with a true brand comparison. Start with Coldwell Banker ($166 billion) and on to RE/MAX, Sotheby’s, Keller Williams, Berkshire Hathaway Homeservices, Better Homes & Gardens, Century 21, and Windermere ($30 billion as a regional brokerage). Maybe there are others.

That’s not to scoff at $16B in sales, which is quite a feat, nor the credibility of even being in the company of those industry giants. It’s just context. Redfin has 1.66% market share in its best markets. It’s nowhere near the #5 brand (brokerage to the layperson) in real estate sales.

Web traffic and the Zillow crutch

“Comparables are hard to come by in the real estate space. But let’s just take one stat: website traffic. And let’s just take Zillow as a comparable — which we might as well since the entirety of the financial press is doing that.”

No, let’s not. Until Redfin starts selling advertising next to its listings on its websites (which isn’t going to fly with MLSs’ IDX/VOW rules for brokers), the revenue models are vastly different. These companies are competitors in some facets of business, but my brokerage is a competitor with moving companies in some facets of our business. That doesn’t make us good comps.

Read an article on Realtor Magazine or Inman News about a new technical development in real estate and you’ll get the scoop. Then read the financial press’s attempt to understand/relay it.

They know finance, but they’re often significantly under informed when comes to the deep dives in real estate logistics.  I know this because they’ve called me in increasing numbers over the last couple of years. Hedge funds, banks, investment groups—I was surprised at first. Most of them are extremely smart people, but they don’t always understand our inside baseball. That’s why they use Zillow as a comp.

Redfin is not a brokerage; it is an agent team.”

“Let that sink in for a moment.

Redfin is not in the recruiting & retention business like 99.99% of brokerages are today. They could care less about recruiting the superstar elite agents.

Redfin is in the business of helping people buy and sell homes — just like an agent team. They have employee agents who must use Redfin’s systems, must follow Redfin’s procedures, and the people they work with are not their clients, but Redfin’s clients — just like an agent team.

And just like an agent team must have a superstar lead-generation lead agent, Redfin has one… in its website and mobile app.”

This is a really interesting way to analyze the company. Redfin’s “#1 team in America” did $16.2 billion in volume last year. It lost $22.5 million. Investors are still lining up to fund it.

So if Redfin is a team, and investors are willing to keep ponying up cash, is the value of this team actually in its systems and not its agents? Why wouldn’t these investors just pour money into Ben Kinney’s team, which has been growing the team model for many years and has multi-millions of profits on an annual basis? Is removing the super agent the goal?

“What today’s Realogy, Long & Foster, Howard Hanna, HomeServices of America, Keller Williams, Re/Max, and others have to figure out is whether their superstar agent teams can play the game that Redfin is playing. And the answer is not good.”

It’s possible that brokerages aren’t building well-oiled teams quickly enough, and Redfin will catch up with them. So far, though, it looks like brokers who are embracing teams—and paying them hefty commissions splits–have a pretty good idea how to compete. Brokerage margins may be slim, but they’re better than Redfin’s…and there’s always that service level question that we’ll get back to later.

What are Redfin’s defensible assets?

Web traffic

SEO can be very powerful for generating traffic and customers. But, just as many formerly popular online businesses have learned, it can be a fickle lifeline.

Maybe Redfin’s rankings and traffic will continue to grow organically. Maybe Google will flip a switch on its algorithm and turn the table upside down. Maybe Amazon will drop a billion dollars on a competing venture. Without strong relationships built between consumers, agents, and a brand, a loss of search traffic would be disastrous for Redfin. The next big thing would steal away that bleeding edge customer base quickly.

Discounts

Discounts are the most disruptive thing in real estate since listing books were printed in color. Most agents at traditional brokerages are taking discounts on listings when it’s a lead-in to a multiple transaction situation, or when it’s just the best way to start a relationship. Redfin doing it out loud isn’t defensible, it’s just a loss leader until the investors make a margin call.

Online reviews, VOW websites with property feedback, community forums

Redfin has built superior products. They’re susceptible to being copied and improved upon by other companies, though. In fact, it’s faster and less expensive for the new entrants to rebuild these tools as they stand on the shoulders of Redfin’s experience and see what has and hasn’t worked.

Brand Loyalty

Redfin’s brand and its ability to create a loyal customer base will probably be its most defensible asset if it can deliver quality service. There’s no barrier for another well financed group to build the same tools, starts its own instant investor offers platform, and offer the same discounts. They’d be light years behind in development of the user base and brand recognition that Redfin has grown, and that’s where Redfin will have to capitalize.

Can Redfin provide a service level that retains clients when the best and brightest agents have much higher paying options? Will its training program merely be an incubator for other brokerages with higher splits?

Hiring

Can Redfin grow an agent base that keeps customers “just happy enough” because they value its tech and discounts? Call it anecdotal, but in Seattle, we hear repetitive stories about overextended agents and frustrated customers. Redfin is, respectably, open with their agents’ reviews.

This call to our agents is not uncommon: “Can you show me this home Friday, my Redfin agent says he can’t get there until Monday”. Buyers in a fast-moving market who finally give up on the discount because their agent is overextended are not rare.

There are, of course, hourly-wage door openers available. But anyone with experience knows that what’s said inside the home between agent and consumer is a massive part of the value proposition. It’s a transfer of customized knowledge, on-site, on-demand.

Most consumers today still seem to prefer the concierge service of an almost-always-available consultant to guide them through the home sale process. The transaction won’t be commoditized like a flight or a hotel room. So Redfin will have to be able to hire and retain quality agents, and find consumers willing to work in the production line process for the tradeoff of great tech and discounts. The company is doing that now to an extent. Whether that agent and consumer pool is limited is in question.

If Redfin can’t/won’t work with homes below a certain price point, or on transactions with complicated logistics, it might hamstring itself on brand loyalty. Great agents work with anyone, often even at a loss, because their friends are referrals and eventually they’ll transact again. Does the current model allow that kind of personal loyalty to flourish?

Conclusion: It’s complicated.

From Redfin’s prospectus statement:

“And we pay Redfin lead agents based in part on customer satisfaction, not just commission, so we’re on the customer’s side”.

“In part” says a lot about the evolution of the company’s mindset. You can’t change everything in the industry at once. If you’re going to be a tech broker, and a discounter broker, you might not also be able to remove a salesperson’s ambition for commission-based pay at the same time. The purity of Redfin’s initial credo has become a less grandiose, more pragmatic vision.

There’s a lot of value in Redfin’s tools, its ability to drive traffic, and its willingness to experiment. There just aren’t similar companies for a good financial comparison. Portals aren’t. Traditional brokers aren’t. Other discounters aren’t. Investors are going to have to hedge their bets somewhere between a tech company and a brokerage.

When the IPO happens, there will still be 1 million-plus agents saying to their friends and family, “Are you thinking about buying or selling any time soon?” That kind of loyalty can be chipped away over time, but as Redfin’s 13 year progress has shown, market share grows slowly in real estate, even for the best-financed ventures.

Brokers should keep an eye on what’s working in Redfin’s model, and either adapt parts of it to their own businesses, or define themselves with a distinctly different or superior value proposition. If it’s not defensible, it’s susceptible to being replaced.

Will the IPO meet expectations? We’ll all be watching. We’ve been waiting to see this for a long time.

-swd


Sam DeBord is a guest contributor to Notorious R.O.B., VP of Strategic Growth for Coldwell Banker Danforth, and President of Seattle King County REALTORS®

11 COMMENTS

  1. Extremely well done Sam. What makes this so valuable (for me) is your broker perspective. You think Glenn will get you in on the “friends and family” list?

  2. Hi Sam,

    A couple of thoughts to your excellent piece. There aren’t many analogs to Redin because building a true national brokerage firm (not brand) is unbelievably hard. That said, I disagree with the notion that Redfin has to have dominant market share in ANY MSA in order to be hugely successful as an entity that is super profitable and that investors love.

    You say “Investors want to know if Redfin can compete with RE/MAX, not RE/MAX Results in Eden Prairie, MN. Redfin’s ranking would drop significantly and the gaps above it would be exponentially larger with a true brand comparison. Start with Coldwell Banker ($166 billion) and on to RE/MAX, Sotheby’s, Keller Williams, Berkshire Hathaway Homeservices, Better Homes & Gardens, Century 21, and Windermere ($30 billion as a regional brokerage). Maybe there are others.” Actually, Goldman (which is underwriting the IPO) does not want that comparison. The balance sheets and P/Ls of a franchise company and that of a brokerage are completely different. I believe that investors really want to know if Redfin can become a technology platform on which brokerage is done. The key word there is “platform”. Redfin has to prove its a tech company first and foremost (BTW, spending $40M this year on dev is not a bad start). Not a brokerage, not a franchise company. A great recap of that idea is here.

    https://www-geekwire-com.cdn.ampproject.org/c/s/www.geekwire.com/2017/key-question-redfin-ipo-will-valued-tech-company-real-estate-brokerage/amp/

    Again, thanks for the great piece!

    • Great points, Russ, and the GeekWire article framed the valuation question well.

      Goldman wants Redfin valued as a technology company (as does Redfin). Rob laid that out beautifully on GW. But that doesn’t negate the fact that brokerage is difficult and regulation-laden, even on top of a great technology platform.

      So how far in between traditional brokerage and tech platform is Redfin? If its goal (as it currently seems) is to continue to expand its brokerage and hire agents itself–not franchise out the platform or focus on paper brokerage–then there’s probably a whole lot of brokerage in the valuation.

  3. Not certain of the outcome of all this noise for consumers or even for the industry but in terms of those that invest – “another IPO in real estate, another day.” If you throw enough #@*! against any wall it has been said that some of it is surely going to stick. These days it’s simply a numbers game, and while most of the bets on Wall Street are NOT being placed on the longevity of the game of the traditional players, by no means should anyone now “place it all on red.”

  4. Rob and Sam: Thank you both for your thoughtful analyses of Redfin’s impact. You gave me a lot to chew on.

    Here’s what I’m noodling on: employees say Redfin isn’t just aiming to be a brokerage that helps people buy/sell homes, they are going to be in areas that will shock people — and they’re running multimillion dollar “secret projects” to see what’s viable. In the land of what if, what Redfin expanded into home improvement services, on demand quotes and scheduling. Here in the Bay Area, getting a contractor into your house might be tougher than getting your offer accepted. What if Redfin could line up contractors to get the work done and/or a line of credit for fixups, upon close?

    With their on-demand showing scheduling app, the tech is already there to extend that concierge almost-always-available service: what if they introduced on-demand home improvement services with a “Book it Now” contractor? Seems like a compelling value prop for buyers who are busy with work and family, and just want it handled. What do you think?

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