Purplebricks struggles in Phoenix

I had high hopes when Purplebricks launched in Phoenix earlier this year. It was the first U.S. market in the "sweet spot" for the Purplebricks proposition. However, the latest numbers show quite modest traction: 75 listings and 26 sold properties over five months.

Why it matters: This data presents a healthy counter-balance to Purplebricks' rapid, national expansion. Launching in a new market is very different than gaining meaningful traction in a new market.

Mid-market America

In July, I analyzed Purplebricks' FY18 results. The analysis highlights the massive investment the business made with its U.S. launch, with an effective cost per listing of over $21,000.

There's also the question of if Purplebricks launched in the wrong markets. Southern California and the New York metro area are expensive markets, while the data clearly shows the Purplebricks proposition resonating with mid-market customers. Phoenix is that market.

After a slow start, Purplebricks is averaging a few dozen new listings per month in Phoenix. With a listing fee of $3,600, that's around $75,000 in revenue for November.

Purplebricks is also struggling to recruit and retain brokers in Phoenix. Agent numbers are stagnant, and the average number of listings per broker is two. If we assume a broker is paid $1,000 of the $3,600 listing fee, that's a very low effective annual pay package. (Broker numbers can be tracked on the Arizona Department of Real Estate web site.)

The right market

I still believe Phoenix is the right market for Purplebricks. The 75 Purplebricks listings are right in line with the median average for the Phoenix market (Maricopa County), which is a positive sign. This -- not more expensive markets -- is the sweet spot for the fixed-fee proposition.

Growth is the name of the game

The U.S. real estate market is undergoing significant change. New (and existing) players like Redfin, Compass, and eXp Realty are rapidly growing market share -- at the expense of traditional incumbents.

All of these players, including Purplebricks, have raised massive amounts of capital to grow market share. Growth is measured in tens-of-thousands of new listings.

Phoenix is just one market out of several in the U.S. where Purplebricks has launched. In its first eight months, Purplebricks had 582 total listings nationally. After five months in Phoenix, 75 total listings is a comparative drop in the bucket. If Purplebricks wants to make a dent in the U.S., these numbers need to be in the hundreds and thousands.

Another data point: A quick check on Zillow shows 288 active listings for Purplebricks (primarily in California); it had 289 back in June. By comparison, Opendoor grew from 721 to 3,163 active listings in the same period.

Strategic implications

Purplebricks' success in the U.S. market is not assured. Raising a lot of money doesn't guarantee success. And an organic pathway to growth takes large amounts of time, patience, and capital.

Execution of this model is very much market-specific, and a lot of hard work. The business model scales linearly with people; technology is just an enabler.

Is Compass really a tech company?

Earlier this month, The Real Deal published an excellent article about Compass. And the article included one of my favorite things: numbers.

Why it matters: Opinions aside, the latest numbers allow us to compare Compass to its peers, and really answer dual questions: Is Compass doing anything novel in the industry, and is it really a technology company?

Comparing growth rates

I'll be comparing Compass to two of its peers: Redfin and Purplebricks. Both businesses, which I know well, represent the most successful new models in real estate that are changing the way people buy and sell houses. They are successful in terms of overall revenue and transaction volumes, demonstrating market traction at scale.

Overall revenue growth for all three firms is growing impressively. It's undeniable that Compass' revenue growth is accelerating.

The core of the Compass business model is making acquisitions. Armed with $800 million in venture capital, it is aggressively buying up agents and brokerages.

Transaction volumes are all increasing. Again, Compass' projected growth in 2018 is impressive, but that's what happens when you buy market share. By comparison, Redfin and Purplebricks are growing organically.

Is the Compass model novel?

The Compass investment thesis centers around technology. It claims that it is a tech company (with tech company valuations), and is building the "first modern real estate platform" that provides "real estate agents tools that increase efficiency."

The data has yet to prove out this thesis. Starting with another tech company, Redfin, the numbers show that it is clearly a more efficient business than Compass -- because its operating model is different.

For Compass 2018, I've included two numbers: 7,480 is the total current number of employees, while 4,800 is the midpoint between 2017 and 2018. Given that Compass is growing so quickly, it makes sense to look at both to calibrate the comparison.

The data above is total number of employees. If we look at overall agent efficiency, as I did earlier this year when comparing Compass, Redfin, and Purplebricks in the U.K., the contrast is more pronounced.

The evidence shows that, at best, Compass agents may be incrementally more efficient than the industry average, but Redfin and Purplebricks agents are exponentially more efficient.

Compass' growth strategy is novel: raise a massive amount of capital and use it to acquire market share. But the operational model of the business is fundamentally the same as every other traditional brokerage -- as the data around efficiency shows. It's not really changing the industry in the same way that Redfin, Purplebricks, or Opendoor are -- it's just moving market share around.

Is Compass a technology company?

Analysis I conducted in early 2018, as part of my Emerging Models in Real Estate Report, showed that -- roughly speaking -- about 10 percent of the staff of global leaders was technical. Compass was the outlier at 4 percent.

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Using the latest data (7,480 total employees and a 200-person tech team), that percentage has dropped to 2.7 percent.

Even if you calibrate for Compass' fast agent employee growth through acquisition, the overall percentage is still considerably lower than its peers.

Strategic considerations

There are a few final points to consider when looking at Compass:

  • Being a tech company is not a binary thing, but what is clear is that Compass is less of a tech company than its peers.

  • As opposed to Purplebricks and Redfin, Compass' customer is the agent. The technology it is building is for agents, not consumers.

  • True, exponential efficiency gains come with technology combined with a novel operating model. Technology alone won't deliver it.

How Psychology is Holding Back Real Estate Tech

I was recently on the opening panel at Inman Connect, where the topic was the future of real estate. The conversation centered around the role of technology in the real estate transaction, and the future role of agents (watch the full video).

When I think about the modernization of the industry and technological adoption, my position is that what’s holding us back is psychology, not technology.

It's the psychology, stupid

The big U.S. real estate incumbents can’t stop talking about technology. Each week brings a new announcement about plans for new tech platforms, investments, and initiatives. And while industry gurus love to talk about the impending perfect storm of technology that will revolutionize the industry, I think they’ve got it wrong, and are repeatedly missing a key point.

That key point is human psychology, and the principle is loss aversion. In cognitive psychology and decision theory, loss aversion refers to people's tendency to prefer avoiding losses to acquiring equivalent gains: it is better to not lose $5 than to find $5. (Read more about loss aversion on Wikipedia).

In other words, consumers will prioritise avoiding costly mistakes over making (or saving) more money. 

It’s relatively easy for technology to disrupt high-frequency, low-value transactions. The risk (or potential loss) is low, both due to the small value of the transaction and the frequency with which it occurs. Think services like Uber, Airbnb, and Netflix.

On the other end of the spectrum, it is more difficult to disrupt low-frequency, high-value transactions with technology, because the potential loss from a mistake is so much greater. People typically go to specialists to help with these transactions: divorce lawyers, investment bankers, and expert consultants.

A real estate transaction, by comparison, is off the charts: it is ultra low-frequency, ultra high-value. The potential loss that occurs from making a mistake is huge.

The psychological desire to engage a specialist in these high-value transactions is loss aversion at work. People are willing to pay top dollar to secure a form of insurance on the transaction; someone to hold their hand through the process. Even when cheaper, tech-focused alternatives are available.

It's not technology holding the industry back, it’s psychology. And no software platform, artificial intelligence chatbot, or mobile app is going to change that.

The role of technology

When it comes to real estate, technology has a dual role: making agents more efficient, and providing a better customer experience. It’s not about replacing agents or removing the insurance of having a specialist involved.

This is where the incumbents — with their regular announcements of big technology plays — are at a disadvantage, and the newcomers have the advantage.

It's the businesses that are built from the ground up around efficiency that have the advantage. More efficient agents means less agents. For a big incumbent to make this change would require an entire retooling of the business, and firing a massive amount of staff and agents. It's too disruptive, and classic innovator's dilemma.

The best way to illustrate this point is agent efficiency: how many deals a typical agent closes each year.

Compass, for all its talk about using technology to make agents more efficient, has yet to demonstrate a significant impact. On the other hand, businesses built from the ground up that utilize technology to improve agent productivity are seeing dramatic gains in efficiency: a 7x improvement at Redfin and a 10x improvement at Purplebricks in the U.K. That's exponential improvement vs. incremental improvement, and is the real eye-opener in the industry.

Strategic implications

Successful new models in real estate understand the key point: smartly combine people and technology. They understand of the role of technology (efficiency and experience), and the role of psychology.

Investors and entrepreneurs assuming that tech will disrupt the real estate industry in the same way it has with low-value, high-frequency transactions are taking a myopic view. It's psychology holding us back, not technology.

If you're interested, be sure to check out the video from the full panel discussion (around 25 minutes) from Inman Connect 2018.

Analyzing Purplebricks' FY18 Results

Earlier this month, Purplebricks announced its full-year financial results for 2018, with revenues doubling to £93.7 million.

Why it matters: This is the first public glimpse into Purplebricks' U.S. launch, and across the entire group, there are a number of key takeaways:

  • The U.K. business is materially profitable.
  • The U.S. launch is very expensive, and tracking behind Australia in key metrics from the first eight months.
  • Marketing ROI in the U.K. is flat.

Coverage of Purplebricks

The media and the overall industry's response to Purplebricks' really grinds my gears.

The headlines are all negative, and revolve around "mounting losses" at the business. Some alternate -- and just-as-true -- headline suggestions:

  • Revenues double (again) at Purplebricks
  • Purplebricks' international expansion makes gains
  • Purplebricks maintains steady growth and profitability in the U.K.
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But none of these are as sensational -- nor do they play into the existing narrative -- of mounting losses for a doomed business.

Then you have the inevitable "the sky is falling" comment from the investment bank Jefferies, whose singular achievement has been being consistently and definitively wrong on the sector for the past three years (if you invested money on their recommendation you would have lost 88%). It's alarming that they still have enough credibility to be the go-to quotable source for these matters.

The narrative of "mounting losses"

What's most surprising about the "mounting losses" narrative is that it is unsurprising. Purplebricks recently raised £100 million from Axel Springer. The value of £1 sitting in the bank is exactly £1. Wouldn't you expect Purplebricks to spend it instead?

And like all growing businesses (the financial markets still like growth, right?), you need to spend today to make money tomorrow. The majority of growth-stage businesses are in the same boat -- which is exactly why they are raising money and spending it.

When you spend money today in an effort to grow your business, it's called investment. It's "losing money" in the same sense that you are "losing flour" when you bake bread. It's not about "mounting losses" in your flour reserves; it's about what you can make with that flour.

Materially profitable in the U.K.

Now on to the analysis! The first and most important takeaway from the results is that the U.K. business is materially profitable. The model works, it makes money, and -- at scale -- is profitable.

Whether you look at operating profit (£4.2 million), adjusted EBITDA (£8.1 million), or my preferred EBITDA with stock-based compensation added back in (£5.7 million), the business is finally generated profits after years of investment.

 
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The U.S. launch takes shape

The big question on everyone's mind is how the U.S. launch is tracking. Based on the numbers reported in its full-year results, Purplebricks USA generated $2.6 million in revenue from around 580 listings.

 
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That comes out to a hefty cost per listing of around $21,000 (compared to around $400 per listing in the U.K.). To put that in context: it's still early days so that number should be high, and, wow, that number is pretty high.

Comparing the first eight months in a new market: Australia vs. the U.S.

What I find most interesting is a direct comparison of Purplebricks' first eight months in Australia and the U.S. It's clear that Purplebricks is going big in the U.S., spending more than double what it spent for its Australian debut.

 
 

But the increased spend isn't yielding results (yet). Despite the massive spend, revenues in the U.S. are still small, with a return on investment about 1/4 of that in Australia. Remember: this is a direct comparison of the first eight months in a new market.

You're probably wondering why. It's a complex situation, but for starters Purplebricks may have launched in the wrong U.S. markets, as I've written about previously.

A few other points to note when comparing launch markets:

  • The price points are about the same: $3,200 in the U.S. compared to $3,300 USD in Australia at launch.
  • The first eight months in Australia yielded around 1,050 listings, compared to around 580 in the U.S.

One factor that's really driving costs in the U.S. is the sales and marketing spend, which is expensive in the launch markets of Los Angeles and New York City. Compared with its Australian launch, Purplebricks is spending more than double.

 
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Marketing ROI flat in the U.K.

One impressive aspect of the Purplebricks operation is its marketing efficiency. I've always been interested in the customer acquisition costs, as it's a critical KPI for the online agency model.

As we can see, the cost per instruction (CPI) has improved slightly from last year, but is relatively flat. (My chart is on the left, with Purplebricks' own chart on the right.)

A more granular view of the overall marketing ROI (revenue / sales and marketing) shows an overall improvement, but with a recent dip.

 
 

This is no cause for alarm. Marketing ROI is still positive and a number of factors may be at play here, including the overall housing market in the U.K. But the data does show a change from what we've seen in the past. Keep an eye on this.

Purplebricks expands to Canada in a big way

Last week, Purplebricks announced that it had acquired DuProprio/ComFree, the leading fixed-fee and for-sale-by-owner business in Canada, for £29.3 million.

Why it matters: This is a great deal for Purplebricks and further strengthens its position as the online agency leader with global ambitions.

Disclaimer: I played a small but important part in this deal, and in the past I have done strategy work with DuProprio. All information in this update is in the public domain (and sourced), and the opinions are my own.

Deal background

If you're looking at the leaders that are changing the way consumers buy and sell houses, two of the biggest global names are Purplebricks and DuProprio.

DuProprio/ComFree is one of the most successful real estate companies no one has ever heard of. I've written about the business in past. Why is it a big deal? With a model similar to Purplebricks, it lists over 40,000 properties each year (about the same number as Purplebricks last year), generates over $40 million (Canadian) in revenues, and has over 20 percent market share in Quebec (by comparison, Purplebricks has around 5 percent market share in the U.K.).

This deal represents two global leaders combining forces under one banner, and an excellent market entry into Canada for Purplebricks.

A big boost for Purplebricks

This acquisition is a big deal for Purplebricks. From a revenue standpoint, Canada immediately becomes Purplebricks' second-largest market.

 
 

That's a 25% bump in revenue from just one deal. And what a deal it was.

Deal of the year?

Purplebricks acquired DuProprio for a steal. Let me illustrate by looking at the relative enterprise value (EV) of each business compared to their revenues (source).

 
 

This is huge. The financial markets are valuing the Purplebricks business at a ratio ten times higher than the implied value of DuProprio.

In other words, when Purplebricks spent £29.3 million to acquire DuProprio, it instantly created nearly £240 million in value to shareholders (£23 million in revenues valued at Purplebricks' revenue multiple).

The big question is why DuProprio was valued so low. It was acquired by the Canadian Yellow Pages in 2015 for $50 million Canadian, and sold in 2018 for $51 million Canadian. This quote provides our only clue:

"As we continue to streamline and focus our operations, we believe the divestiture of [DuProprio/ComFree] is another very positive step for Yellow Pages and our stakeholders. Under the terms of our senior secured notes, the cash proceeds will be included in the next scheduled note redemption payment, on November 30, 2018" said the Company's Chief Executive Officer, David A. Eckert. 

DuProprio's revenues in 2014 were around $40 million Canadian (source), and Purplebricks' guidance is for around $43 million Canadian in revenues for its next financial year. So while the business has not gone backwards under Yellow Pages, growth has been muted.

Build vs. Buy

The question of build vs. buy is always top of mind when a business looks to enter a new market. Does it spend big money to launch an operation from scratch, or simply acquire an existing player?

Including Canada, Purplebricks has now entered three new markets. In the case of Australia and the U.S., it started from scratch, spending big to build market share over a number of months and years.

 
 

Based on its full-year financial results, Purplebricks spent £17.8 million to generate £2 million in revenue in the U.S. Those are expensive -- but not surprising -- start-up costs for a big new market.

Over the past 20 months in Australia, Purplebricks has spent £26 million to generate £17 million in revenues. It's taken a long time and a big investment, but that business is finally approaching breakeven.

By comparison, Purplebricks spent £29.3 million for £23 million in revenues in Canada, a materially better ROI, that took no time at all. And keep in mind that's a one-time expense; the revenues keep on coming year after year.

It's not every day an opportunity like this comes up. But given the chance, buying its way into Canada was a smart move for Purplebricks.

Strategic implications

A few key takeaways stand out from this deal:

  • Global by design. International expansion is a unique and key tenet of Purplebricks' strategy. No other company in this space (Opendoor, Redfin, Compass, Emoov, Yopa, and dozens of others) has expanded beyond one market. Purplebricks is now in four.
  • A great deal. This was a good use of capital and has manifested in a new, valuable asset for Purplebricks. Good deals like this exist in the space; you just have to know where to look.
  • Canadian growth potential. With new (and arguably better capitalized) ownership, DuProprio/ComFree is primed for growth, with Purplebricks ready to invest £15 million further into the business.