Incentive Splits and Agent Retention

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Brokerages are employing a variety of incentives in the ever-expanding battle to win over the hearts and minds of real estate agents, including an innovative golden handcuff known as “Incentive Splits.”

Why it matters: Incentive Splits create an ever-increasing bill that an agent must repay if they leave a brokerage – which can effectively lock an agent into staying even when they want to leave.

  • This analysis focuses on Compass, where there is the most evidence, but the company is not alone in employing the practice.

Incentive Splits, a term included in some Compass agent agreements, are bonus commissions that range from 2–10 percent.

  • These commissions accumulate over time, creating an ever-growing balance that an agent must repay if they want to leave Compass.

 
 

The contract language states that if an agent leaves within two years of receiving any incentive, including an Incentive Split from a home transaction, the agent must repay all Incentives back to Compass.

  • In reviewing several contracts, this timeframe has ranged from one to three years.

The bill can add up quickly, especially for top performing agents that wish to leave: the invoice below (which may not be representative of the average Compass agent) includes over $72,000 in Incentive Splits, payable back to Compass.

 
 

Yes, but: It’s not clear how widespread this practice is – I’ve seen Incentive Splits included in the contracts of around 20 current and former Compass agents.

  • A Compass spokesperson told me that since the company stopped offering cash incentives to agents in 2022, this only impacts a small group of agents.
     

  • Compass is not alone: the invoice below from Corcoran includes a $43k bill for “Split Overpayments,” which is the same as an Incentive Split.

 
 

The incentive to agents is clear – extra cash in their pockets – but the mechanics are designed as golden handcuffs: financial incentives given to employees and contractors to discourage them from leaving a company.

  • But unlike other golden handcuffs, Incentive Splits don’t expire or vest after a certain amount of time. 

The bottom line: Incentive Splits appear to be an inventive mechanism to incentivize agents to stay with their brokerage – by creating an ever-growing bill that must be repaid if they want to leave.

  • Putting aside effectiveness and intention, the key takeaway for agents is clear: read the fine print.
     

  • Perhaps at the “brokerage of the future,” agents will stay because they want to, not because they have to.

Brokerage Winners and Losers

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The market crunch is on, with 1,096,000, or 18 percent, fewer residential real estate transactions in 2022 compared to 2021.

Why it matters: It's said that a rising tide lifts all boats – but a receding tide affects boats differently, once again highlighting important differences across the brokerage landscape.

Context: According to the latest data from RealTrends, the top 20 brokerages by transaction count in 2022 (and the sample set for this analysis) were led by eXp Realty, Anywhere, HomeServices of America, Compass, and Howard Hanna.

 
 

To maintain an apples-to-apples comparison, I typically exclude franchise operations like Keller Williams, RE/MAX, and Anywhere’s franchise group because the business model is substantially different.

  • But last time I got a lot of questions about Keller Williams, so for comparison here is where KW – and its hundreds of U.S. franchisees combined – ranks (#1).

 
 

As the tide recedes, it reveals a collection of winners and losers in terms of transaction growth and decline.

  • The big winners are eXp Realty and Real Brokerage, which added 65,000 transactions, while industry incumbents Anywhere and HomeServices of America lost a combined 150,000 transactions.

 
 

When Keller Williams is added to the list, we see that it lost 190,000 transactions in 2022 compared to 2021 – more than Anywhere, HomeServices of America, and Compass combined.

  • As a percentage, KW’s 15 percent decline outperformed an overall market decline of 18 percent, but on a unit basis (revenue comes from units, not percentages) the 190k decline is substantial.

 
 

What to watch: It’s tempting – and imperative! – to draw conclusions about brokerage models from the data. 

  • The winners – eXp, Real, Fathom, Realty ONE, and United Real Estate – have one thing in common: they all offer high agent splits, per-transaction fees, or 100 percent commission models.
     

  • Meanwhile, the biggest losers are typically seen as traditional industry incumbents (but somehow also include Compass and Redfin).

The bottom line: A rising tide may lift all boats, but a receding tide slams some boats against the shore.

  • In a year of belt-tightening and fewer transactions, agents – and their transactions – appear to be flocking to relatively newer models where they keep more of their commission.

Market Shift Highlights Brokerage Fundamentals

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2022 was a tumultuous year: the real estate market turned, transactions dropped, and the largest U.S. brokerages were all forced to chart new courses.

Why it matters: Agent count, transaction volumes, and the relative growth and decline of brokerages in 2022 are all powerful predictors of future performance.

Agent count continues to fuel the business of the major U.S. real estate brokerages.

  • eXp Realty is the clear stand-out, with an exponential increase in the number of its U.S. agents – which now eclipses industry incumbents Anywhere and HomeServices of America (HSoA).
     

  • Overall growth slowed across the board in 2022, and Anywhere has seen a recent uptick in agent count, which has yet to translate into a corresponding uptick in transaction count.

 
 

Transaction volumes and brokerage performance are directly correlated to agent count (MDP: “Technology doesn’t sell houses, agents do.”)

  • Among its peers, eXp Realty once again outperformed the market, growing its transactions by 12 percent in 2022, compared to an overall market decline of 18 percent.
     

  • eXp’s large brokerage peers all transacted less in 2022 than the year before, while Compass, also buoyed by recent agent count gains, experienced less of a decline than the traditional incumbents (and Redfin).

 
 

The declining market has forced companies across the industry, brokerages included, to cut costs. 

  • But those cuts are unequal among peers – cash flow and profitability dictate the speed and severity of cuts. 
     

  • Throughout the year, Anywhere and Compass, which have the highest operating expenses, have been forced to cut the deepest, while eXp and Douglas Elliman have increased their operating expenses (from a smaller base).

 
 

What to watch: Agent count growth and transaction volumes will remain sluggish in 2023.

  • A further slowing of the market will force some companies to cut even deeper.
     

  • It’s a numbers game: less transactions will go to fewer agents – so brokerages with strong agent count growth will outperform the market (just look at eXp).

The bottom line: The market correction is a great equalizer – and it’s accentuating the differences between brokerage business models.

  • In a market of musical chairs with fewer chairs available, companies with sustainable models, lower overheads, and strong recruiting are more likely to succeed.

Cash Burn Continues as Compass Navigates to Breakeven

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The results are in and Compass burned $143 million in cash during Q4 2022, leaving the company with a cash balance of $362 million.

Why it matters: With a clearly articulated goal of reaching breakeven after billions in losses, 2023 is Compass’ seminal make-or-break year. 

  • Despite another quarter of high cash burn, the company appears to be positioned to achieve breakeven in 2023 after massive cuts made over the previous 12 months.
     

  • Even in a much softer market, Compass’ Q4 2022 cash burn is less than a year ago, a reflection of the cuts already made to the business.

 
 

Compass started 2023 with a cash balance of $362 million – which includes a $150 million drawdown from its revolving credit facility

  • Without that additional loan, Compass’ cash balance would have been $212 million – dangerously low for a company that just burned $143 million in a quarter.

 
 

The key to breakeven is Compass’ ability to reduce its non-GAAP operating expenses (OpEx), primarily achieved through layoffs.

  • OpEx has dropped significantly over the past six months, and is on track to drop further through the rest of the year.
     

  • It appears that Compass is aiming for OpEx of around $950 million for 2023, down about 30 percent from $1.35 billion in 2022.

 
 

It’s fair to say that any brokerage, Compass included, falls apart if it’s unable to recruit or retain agents.

  • For the first time, Compass’ agent count has gone flat, reflecting the challenging market and environment for agents (less transactions = less agents).
     

  • Yes, but: It takes several data points to create a trend, and most brokerages are seeing a similar slowdown in agent count growth.

 
 

Analysis time: Assuming Compass’ national market share and revenue per transaction remain consistent with 2022, we can see what needs to be believed for the company to reach breakeven in 2023.

  • Compass’ current non-GAAP operating expense target of $950 million suggests that 4.5 million transactions in the national market are necessary to give Compass the revenue and gross profit necessary to break even for the year.
     

  • A bear case of 4 million transactions would require Compass to cut an additional $100 million of operating expenses to reach breakeven.
     

  • Please note: these are back-of-the-envelope calculations that provide directionality, not certainty.

 
 

What to watch: Like other brokerages, Compass only has so many levers to pull to reach breakeven.

  • On the revenue side, the company is considering franchising as a less-expensive growth strategy, and will be trying to accelerate its mortgage joint venture.
     

  • If the market remains soft and revenue drops, the only option is to cut even more costs out of the business.

The bottom line: Compass is not alone in needing to cut costs during a significant market downturn – its future depends on it.

  • The company dipped into its “emergency reserve” last quarter – $150 million from its revolving credit facility – for the home stretch to profitability.
     

  • It appears that Compass has made the deep cuts necessary to achieve breakeven this year, as long as nothing else unexpectedly goes wrong.

2 Key Learnings from a Purplebricks Retrospective

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U.K.-based Purplebricks remains one of the best examples in the world of a real estate disruptor going from zero to one.

Why it matters: It’s a complex growth story revealing two key learnings that apply to all real estate tech disruptors: the adoption ceiling and reversion to the mean.

The adoption ceiling is the phenomenon where a disruptor's market share stops growing and plateaus (also called market saturation).

  • This is common across many new models, but especially prevalent in real estate due to its highly fragmented, non-differentiated nature.

Purplebricks hit its adoption ceiling in 2019; there were only so many early adopters willing to try its substantially new model (pay a lower fixed-fee up front instead of a commission upon sale of a home). 

  • The Covid-19 pandemic and the growth of similar models contributed to an erosion in new listings (called instructions) -- and market share -- beginning in 2020.

 
 

Hand-in-hand with a plateauing market share are rising customer acquisition costs (CAC); with scale, it becomes more expensive to acquire each new customer.

 
 

Opendoor, the U.S.-based iBuyer, has experienced the same phenomenon as it scales, with customer acquisition costs substantially higher in 2022 compared to past years.

 
 

Reversion to the mean is the tendency of real estate disruptors, over time, to look more and more like the incumbents they are trying to disrupt.

 
 
 

The bottom line: Like so many real estate tech disruptors, Purplebricks is a "cautionary tale" about overreach and setting unrealistic expectations.

  • Back in 2018, I was quoted in The Financial Times about this exact topic. Not much has changed.

The power -- the gravitational pull -- of the traditional real estate industry is incredibly strong.

  • Over time, even the most well-funded, aggressive start-ups have a tendency to be assimilated into the traditional industry.

The Race to Cut Costs

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Across the real estate industry, companies are racing to cut costs in the face of a significant market slowdown. 

Why it matters: With dropping revenues, cost control is one of the only levers in a company’s control – and is the key to a sustainable, profitable business.

  • The need to cut costs – and the depth of those cuts – are a function of a company’s overall financial health and business model efficiency.

Some companies, like eXp, have the advantage of a more efficient business model with lower operating expenses (OpEx).

  • Compared to its peers, eXp is servicing a disproportionately high number of transactions with relatively modest operating expenses.
     

  • The more traditional industry behemoths, Anywhere and Compass, have a less efficient model with a much higher cost basis (and thus need to cut faster and deeper).

 
 

Dig deeper: Another measure of business model efficiency is the amount of revenue generated per $1 spent in operating expenses.

  • Based on this metric, eXp was about three times more efficient in Q3 2022 than its publicly-listed brokerage peers (who are all in the $3–4 range).

 
 

Compass has been racing to cut its operating expenses as quickly as possible (it also recently announced a third round of layoffs).

  • Compass is driving to cut its non-GAAP operating expenses by 40 percent, or around $600 million annually.

 
 

Layoffs are the most visible way that real estate tech companies are cutting costs.

  • Since June of 2022, Compass has shed around 1,700 employees (40 percent), while Redfin has also cut deep with 2,000 fewer employees (26 percent).
     

  • Many other real estate tech companies have also enacted significant layoffs to cut costs (and in some cases, in order to survive).

 
 

What to watch: Among the big brokerages, Anywhere, Compass, and Redfin have already made significant cost reductions, while eXp and Douglas Elliman are under less pressure to cut costs.

  • Cost reductions limit a company’s ability to invest in future growth opportunities (ex: Compass has "paused all expansion into new markets” and Anywhere shut down its cash buying program).

 
 

The bottom line: The market downturn is forcing all real estate tech companies to cut their expenses in order to achieve, or maintain, profitability.

  • Unprofitable companies with high cash burn and high fixed costs have no choice but to cut, and cut deep, to survive.
     

  • While other companies operating more efficient, low-cost operating models are under less pressure to make big cuts – and may be better placed to invest in future growth.

Two Key Charts to Contextualize the U.S. Housing Market

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Media headlines are focused on a crashing U.S. real estate market, but the truth is more nuanced with less hyperbole.

Context matters: The reality is that the market is down, but simple comparisons to a sky-high 2021 are amplifying the scale of the decline.

  • Arm yourself with the right data -- two key charts -- to understand and contextualize this dynamic market.

Monthly home sales are collected and published by the National Association of Realtors (NAR), but historical data beyond 2021 is not easily accessible and rarely included in analyses.

  • With help from NAR, I've published this data in the past -- and now I'm publishing a direct link to a live chart: U.S. Existing Home Sales.

 
 

While existing home sales are down in the second half of 2022, the deviation from historical averages is not nearly as extreme as the drop from last year.

Looking forward: A leading indicator for the future housing market is consumer demand for mortgage loans (specifically purchase loans).

 
 

The mortgage demand index shows that purchase demand is at record lows -- but just barely (compared to 2014).

  • Furthermore, there is a recent uptick in demand that corresponds to dropping mortgage rates.

The bottom line: The last six months of 2022 have been challenging, and it appears likely that low volumes will continue well into 2023.

Slowdown: The Velocity of Brokerage Revenue Decline

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Q3 results are in for the large, publicly-listed brokerages and revenues are down across the board – but that’s only part of the story.

Why it matters: The velocity of decline between brokerages varies, providing early insight into which companies may be at higher risk than others in a cooling market.

Dig deeper: Compared to the previous quarter, all brokerages experienced a drop in revenue – which is expected from a seasonal perspective.

  • Douglas Elliman and Compass experienced the largest decline, a likely combination of concentration in more upscale markets (NYC and California) that are cooling faster than others.

 
 

Behind the numbers: Driving the revenue decline is a drop in overall market transactions compared to the previous quarter.

  • Notably, Compass closed 18 percent fewer transactions than the previous quarter, which is double the 9 percent decline in transactions for the entire residential real estate market as reported by NAR.

  • Astute observers will note Douglas Elliman’s 7 percent decline in transactions compared to a 25 percent decline in revenue; this is driven by a 13 percent drop in average sale price.

 
 

Yes, but: In Q2, Compass outperformed the market with a 41 percent quarterly increase in transactions compared to an overall market increase of 28 percent.

Compared to last year, most brokerages experienced a significant revenue decline in Q3 (remember, 2021 was an outlier).

  • The exception is eXp, which is benefiting from tremendous growth in agent count, transaction volume, and market share.

  • eXp’s year-over-year growth stands in notable contrast to industry heavyweights Anywhere and Compass, which both experienced year-over-year declines in revenue.

 
 

What to watch: It’s exceedingly likely that revenue will continue to decline for the next two quarters, which is absolutely normal from a historical and seasonal perspective.

  • The key metric to watch is the velocity of decline and how it varies between peers and compares to the overall market.

The bottom line: All brokerages are entering the literal and figurative winter of real estate.

  • The next two quarters are always the slowest in the industry, and coupled with a cooling market, are going to be especially challenging.

  • Fewer transactions and lower revenue will put pressure on all brokerages, with some affected more severely than others.

Further Cuts on Compass' Path to Profitability

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Compass continued to burn cash in the latest quarter, but also demonstrated a reduction in operating expenses as the company aims for breakeven in 2023.

Why it matters: With a historically high cash burn in a cooling real estate market, Compass needs to cut costs extensively to achieve profitability.

  • Furthermore, the company signaled further cuts to bring expenses in line with revenue in 2023.

Behind the numbers: Compass burned $76 million in Q3 2022, continuing a run of cash flow negative quarters.

  • Of that $76 million, there were one-time restructuring and litigation expenses of $40 million.

 
 

Compass ended the quarter with $355 million in cash.

  • Historically, Q4 and Q1 is where cash burn is highest, due to the seasonal decline in revenue.

  • Coupled with a cooling market, the next six months are going to be tough.

 
 

What they're saying: On its earnings call, Compass signaled that further cuts are coming:

  • ”…we will be implementing additional cost reduction initiatives to get ahead of any future market declines.”

  • ”We are committed to driving our non-GAAP operating expenses well below the low end of our range of $1.05 billion in 2023.”

Compass' initial cost reduction program was an effort to get annual operating expenses to a run rate of $1.05–$1.15 billion (down from $1.48 billion).

  • In total, the proposed cuts would represent an overall reduction in operating expenses of around 33 percent -- a very significant change.

 
 

Dig deeper: If breakeven in 2023 is the goal, working backwards reveals the various revenue estimates needed to achieve that goal.

  • Compass' first set of cuts suggested a five percent revenue decline in 2023, but the latest cuts suggest a deeper 14 percent drop in revenue.

 
 

The bottom line: All brokerages, Compass included, are entering the literal and figurative winter of real estate; the next two quarters are going to be tough.

  • With a historically high cash burn, Compass needs to cut faster and deeper than most other brokerages -- and it is.

  • The question for all brokerages making cuts remains the same: can it be done while still remaining attractive to, and providing the same value to, agents.

Predators and Prey

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The real estate industry is in the midst of a massive financial reckoning: public company valuations down by billions, widespread layoffs, and a rush for venture-funded disruptors to conserve cash and demonstrate sustainable business models.

Why it matters: Amidst this turmoil, the industry is bifurcating into predators and prey -- companies that have the resources to expand through acquisition, and those burning cash that are vulnerable to takeover.

  • Companies with dwindling cash balances and high cash burn will be forced to raise funds or face insolvency (for example, Reali closing operations).

The predators have the financial resources -- namely, vast amounts of cash -- to take advantage of the current market situation and acquire vulnerable businesses.

 
 

Companies like Zillow, CoStar, and Rocket are certainly predators: flush with cash and opportunistically acquisitive in their outlook.

  • Opendoor is the outlier; although it has plenty of cash on hand, it’s about to enter (at least) two quarters of massive financial losses.

  • Private equity firms with plenty of cash to deploy are the other opportunistic predators.

The prey are the businesses that are vulnerable -- diminishing cash balances with high cash burn. In other words, a typical real estate tech disruptor.

 
 

The majority of prey are the hundreds of private companies whose financials are not publicly available.

  • The severity of their situation depends on when they last raised money, how quickly they're spending it, and how much they have in the bank.

  • If a company doesn't have at least 12 months of runway, they're prey.

 
 

What to watch: The name of the game for the next 6–18 months is VUCA -- volatile, uncertain, complex and ambiguous.

  • Expect to see a larger amount of mergers, acquisitions, consolidation, and liquidation.

The bottom line: Cash is king. In today's market, a company’s cash flow determines if it is in control of its own destiny.

  • If a company is burning cash and needs to raise additional funds, it will be forced to do so on someone else’s terms.

  • But, if a company is cash flow positive with a solid balance sheet, a VUCA environment presents incredible opportunity.

  • "Only when the tide goes out do you discover who's been swimming naked."
    - Warren Buffet

Behind the Scenes: Writing a 361-Word Article

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Last week I published 2021 Is An Outlier, Not A Benchmark, which turned out to be one of my most-read and most-shared articles of the year. Even though it was only 361-words long, it took a considerable amount of time and energy to create. I’d like to share a behind the scenes look at my writing and research process, and what it takes for me to produce a concise, high-impact analysis.

Step 1: Curiosity
All of my analysis starts with intellectual curiosity. Because I work to my own deadlines and I’m not paid to write, I have the freedom to explore. In this case, I was curious about the housing market. The key questions swirling in my head were:

  • The headlines around the number of houses sold are really negative; is it really this bad?

  • How does 2022 compare to the pre-pandemic years?

  • What else should I know about this situation?

These questions sat in the back of my mind, occasionally entering my consciousness, for months. I would pay more and more attention to the monthly reports from NAR, Redfin, and others, zeroing in on the percentage drops in volume compared to last year. This led to a thirst for more data.

Step 2: Data Collection
All of my work is evidence-based and data-driven, so I knew I needed data. In this case, the necessary data was quite straightforward: existing home sale transaction volumes. Luckily for me, the NAR tracks and reports on this, and after reaching out to them I had my hands on a significant amount of historical transaction data.

For a first, rough analysis, I threw the data into Excel and quickly plotted some charts. At first I was just looking at 2022 compared to 2021, and it was a grim visual indeed. From there I added 2019 and 2020 to build a broader picture. That’s when the first hit of adrenaline came: 2022 was performing better than 2019. I recall looking at the June numbers, and while the media headlines focused on the 15 percent decline in volumes compared to last year, I noticed that the volume in 2022 was exactly the same as 2019.

 
 

Step 3: Storytelling & Data Iteration
There was enough initial data to reveal an interesting story. Now I entered a phase of rapid iteration and exploration (more data, more visualizations, more insights). I collected ten years of historical data, back to 2012, and started plotting everything. It turns out that 2022 wasn’t a disaster after all and the monthly volumes fell within the bounds of several past years.

 
 

I also made my own estimates for the rest of the year. At the time, 2022 was running around 10 percent lower each month compared to 2019. What if volumes were down 10 percent for each remaining month? It’s rough, but it’s a start, and the result provided a relatively solid estimate on what the remainder of the year could look like.

Meanwhile, at this point I started rolling over various narratives in my head. The first was something along the lines of, “2022 isn’t as bad as it seems.” Yes, the market is slowing down compared to last year, but put within a wider historical context, the market is still active, people are still moving, and, most revealing, transaction volumes are within the bounds of historical averages.

It was around this time that I stumbled upon the answer to my question, “What else should I know about this situation?” The answer was the commission pool, and the insight produced a powerful one-two punch for the entire analysis. Not only was 2022 not as bad as the headlines suggest, but because of rising home prices, the commission pool was going to remain at near-record levels — far above the historical average.

 
 

The commission insight revealed itself thanks to my previous work. I had written about how big tech companies were coming after agent commissions in the past, so it’s a topic that occupies a permanent place in my mind. It simply appeared, like many insights do, during one of my mindless moments riding a bike, sipping coffee, driving across town, or hiking in the mountains.

For this article I also created a rough outline. My intention with an outline is to collect and order the various key insights and takeaways as I discover them.

 
 

Step 4: Data Visualizations
At this point I was committed to writing and publishing something. The bedrock of my analyses are clear, concise, and compelling charts — the creation of which is a non-trivial task!

It’s at this point I go back to my narrative; if the point is to show that 2022 isn’t so bad in the context of past years, how can I quickly demonstrate that with a clear chart? I started with a line graph showing monthly sales volumes.

 
 

The chart wasn’t compelling because the key takeaway wasn’t immediately clear. Back to the drawing board. Only after several iterations did I realize I didn’t need to show monthly volumes; annual would suffice to tell the story. Simplifying the chart helped to sharpen the narrative.

 
 

Adjusting a chart’s y-axis is a subtle way to influence how data is visualized and interpreted. It’s a mechanism that I typically steer away from (I’m generally a y-axis starts at zero purist), but in this case, I felt that adjusting the y-axis helped to tell the story in a clear and transparent way.

 
 

Step 5: Writing
Sitting down and writing a first draft may be the fastest part of my entire process. By this point, the story feels seventy-five percent clear in my mind. I start by putting all of the graphs I’ve created into one document and order them in a way that tells a clear story. Visuals first, then words.

My writing aims to weave the various data together into a clear and compelling narrative. I always start by describing the key takeaways for each graph.

For me, the most challenging part of writing is the introduction. Robert Caro, one of my favorite authors, distills down an entire book into 1–3 paragraphs before he starts writing. That’s what I endeavor to do; how can I summarize the entire analysis into one sentence? And next, why should someone care?

The writing went pretty quick for this analysis, and my subconscious chipped in with an assist. Over the weekend, the introduction simply materialized in my mind while hiking. I’m grateful for the parts of my brain that continue to tick away on something while I’m otherwise occupied.

Step 6: Editing
Just because I write something doesn’t mean it’s immediately worthy of your time. The entire piece, from data to charts to words, needs to be continually refined until it’s distilled down to its purest form. This process is agonizing and immensely enjoyable all at once, and usually lasts a few days. For this 361-word article, I read, re-read, and revised the draft at least fifty times.

Phrases like “less is more” and “quality over quantity” are often part of my everyday life. My editing goal is the same: to provide the smallest amount of information necessary to make a strong point. In this case, many extraneous sentences (and even a chart) were removed in order to provide a clear and cohesive narrative.

Every single word needs to add something to the analysis. If it doesn’t, I cut. And editing isn’t limited to words; it also includes charts. Adjusting chart titles and adding call-outs are just as important.

The following chart benefited greatly from the addition of several key percentages, explanatory text, and a visual representation of the historical average.

 
 

This chart also benefited from a pair of call-outs to reduce the mental load for the reader.

 
 

I also realized the commission pool chart would benefit from a clear visual of the additional $25 billion compared to 2019.

 
 

While editing, I send multiple draft emails to myself for the full mobile reading experience. It's important to read my drafts as my audience will, and the process helps with editing, readability, and overall flow. For this article, I sent three separate draft emails to myself.

During the editing process I occasionally nerd out a bit. I love grammar and punctuation. There’s an important difference between an en dash and a hyphen. And for this article, the Gregg Reference Manual helped me by providing guidance on how numbers should be written out in sentences. I write out “percent” instead of % on purpose. Three of my favorite books are within arms reach on my desk.

 
 

One of the final pieces of editing is getting the heading and subject line right. I don’t write headlines as clickbait — I aim for a brief, compelling summary of the content of my article. In this case, there was much agonizing over individual words: is it “2021 Is The Outlier,” or “2021 is An Outlier?” Details matter.

An important component of my editing process is time. I often do a few editing passes in a row, but then need to let it sit for a few hours while I do something else. There’s no point, at least for me, to power through the process. Once I hit a wall, I need to leave it and come back to it later, which never fails to produce a better outcome with a somewhat refreshed perspective.

Just Press Send
I could continue editing for weeks, but at some point the entire process comes to a close with diminishing returns (and my need to mentally move on to something else). I’m always thrilled to publish a new piece of work and to see the reactions. I enjoy the responses I receive from readers, oftentimes sharing their own perspectives and observations on what I’ve written about.

I enjoy writing. At times, the process can be laborious and mentally taxing, but I’m passionate about the topics I write about. My fulfillment comes from the journey, not the destination. In the end it’s the entire process — from initial curiosity to final edits — that makes me, and hopefully you, a little bit smarter.

2021 is an Outlier, Not a Benchmark

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The pandemic years, especially 2021, were a strange aberration where everyone moved, house prices skyrocketed, and nearly every real estate business posted record revenues.

Why it matters: 2022 is constantly being compared to 2021, which was anything but normal, and year-over-year comparisons are painting a deeply negative picture.

Dig deeper: Assuming a fairly conservative 5.15 million existing home sales in 2022, the comparison to last year is a sobering 16 percent drop -- but 2021 is an outlier, not a benchmark.

  • Compared to the historical average of the previous eight years (2012–2019), transaction volumes in 2022 would be down only 0.9 percent.

  • By contrast, compared to the same historical average, transaction volumes were up 9 percent in 2020 and 18 percent in 2021 -- notable outliers.

 
 

Comparing 2022's monthly volumes to the historical average reveals recent volume declines that are still significant, but less extreme than a year-over-year comparison to 2021.

 
 

But in reality, 2022 has tracked favorably to the historical average and is still in somewhat "normal" territory, even considering the recent market slowdown.

 
 

The big picture: Despite dropping volumes, the commission pool -- which fuels the revenue of real estate agents, brokerages, portals, software providers, and more -- is set to be 34 percent, or $25 billion, higher than 2019.

  • This massive increase is being driven by rising home prices.

  • It would take a drop to 4 million existing home sales for the commission pool to hit what it was in 2019: $73 billion.

 
 

(These estimates assume 5.15M existing home sales at an average price of $375,000, with a commission of 5.06 percent as tracked by RealTrends. Things may change.)

The bottom line: The pandemic years of 2020 and especially 2021 were radical outliers on a number of levels, real estate being just one.

  • Issues of home affordability, dropping sales volumes, and rising interest rates are all contributing to a challenging 2022.

  • But, if we consider 2021 the outlier and not the benchmark, the market in 2022 doesn't look nearly as catastrophic as headlines suggest.

  • In fact, from a business perspective, there is significantly more money flowing through the system (from commissions) than any year other than 2021.

The Real Estate Portal + Mortgage Conundrum

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The largest global real estate portals are attempting to diversify and expand their revenue streams by offering mortgage -- with mixed success.

  • Zillow, Redfin, and Australia's REA Group have all made major forays into mortgage with large acquisitions.

  • Despite being technology companies, revenue growth is closely tied to employee count, and profitability (in the U.S.) remains elusive.

Dig deeper: Redfin's mortgage revenues jumped after its recent acquisition of Bay Equity for $138 million, but the overall business remains unprofitable.

 
 

Zillow's mortgage business has been unprofitable for over five years, recently spending $1.85 for every $1 in mortgage revenue.

 
 

Australia's leading portal, REA Group, has managed to grow a profitable financial services business by acquiring two large mortgage broking businesses.

  • Financial services now accounts for six percent of REA Group's total revenue.

 
 

Behind the numbers: Mortgage growth is very much tied to people -- mortgage brokers and mortgage loan originators (MLOs).

 
 

Mortgage business growth is tightly correlated to an increase in mortgage advisors (brokers and MLOs).

  • Redfin's mortgage originations are up 10x while MLO count is up 12x after acquiring Bay Equity.

  • REA's financial services revenue is up 2.8x while its number of mortgage brokers is up 2.7x after acquiring Mortgage Choice.

 
 

Broader context: The number of MLOs is an important bellwether for the ability of other real estate tech disruptors to grow in the mortgage space.

  • Some companies have shed MLOs through recent layoffs (Reali, Tomo, Homie, Knock, and Flyhomes), while others have grown organically and through acquisition (Orchard and Homeward).

The bottom line: Billions of dollars are being invested to disrupt the mortgage process -- which is the path to profitability for many real estate tech companies.

  • Instead of leading to greater profits, mortgage has turned into a money pit for the big U.S. real estate portals.

  • And at the end of the day, the evidence is clear: it's the number of brokers and MLOs that drives meaningful business growth.

Deeper Cuts Announced as Compass' Cash Burn Continues

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Compass' second quarter results are in with a higher than (I) expected cash burn rate for the quarter, but paired with a robust set of new cost cutting initiatives.

Why it matters: Compass has a cash burn problem (it spends more than it makes) and it needs to significantly reduce expenses to remain solvent -- which is exactly what it's doing.

  • Management's top goal is "generating free cash flow" as it announces a new, $320 million cost reduction program.

  • Compass' CEO took the unusual step of asserting that "Compass will not run out of cash."

Go deeper: Compass' challenge is that it burned through another $45 million in Q2, typically the most profitable quarter of the year for real estate brokerages.

  • Last year, Q2 was the only quarter when Compass generated free cash flow with a $41 million gain.

  • Cash burn was higher in Q1 than last year, and higher in Q2 than last year; in a rapidly cooling market, the pressure is on for the rest of the year.

 
 

Between Q1 and Q2, Compass grew its brokerage revenue in line with its peers (except Douglas Elliman for some reason).

  • The cooling market appears to be affecting all brokerages evenly, regardless of brand, tech platform, agent compensation, or anything else.

 
 

Compass is retaining its agents; there has yet to be a noticeable decrease in agent growth, a positive sign for the company.

 
 

After layoffs earlier in the year, Compass is cutting deeper with a $320 million "cost reduction program."

  • These cuts will target technology spend and agent incentives (remember, Compass has a 1,000 person tech team).

  • For reference, Compass is on track to spend $360 million on technology in 2022 (excluding stock-based compensation expense) -- the cuts will likely hit its tech team hard.

The bottom line: Compass continues to have a cash burn problem, but running out of cash would be a weird outcome.

  • To become cash flow positive, Compass is making major cuts -- the question is, can it do so while still remaining attractive to, and providing the same value to, its agents.

eXp's Business Model Advantage

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eXp has an exponentially more efficient cost structure than any of its brokerage peers.

Why it matters: In the highly uncertain market of 2022, with transaction volumes falling and brokerages responding by cutting costs, financial efficiency is more important than ever.

  • During my previous research on Compass' Cash Burn Problem and the Coming Brokerage Slowdown, I stumbled across a fascinating metric: operating expenses per transaction.

  • This metric measures the amount of company overhead -- support staff, office expense, technology, etc -- per closed transaction.

While its publicly-listed peers are all in the same ballpark, eXp has a remarkable advantage when it comes to operating expenses -- 10x more efficient than its peers.

  • And with over 110,000 transactions in Q1 2022, eXp is leveraging this advantage at scale.

 
 

The bottom line: The real estate industry is entering a period of heightened uncertainty with rising interest rates and falling transaction volumes, leading to a shrinking commission pool.

  • With a limited ability to affect revenue, brokerages will be forced to cut costs -- and in this environment, brokerages like eXp have a distinct advantage.

Brokerage Slowdown Begins

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All real estate brokerages experience a seasonal decline in revenue during the first three months of the year -- but the amount varies between brokerage.

Why it matters: The degree of revenue decline highlights which companies are under- and over-performing "the market" -- a possible leading indicator of who may be in more or less trouble during a turbulent year ahead.

  • Quarterly revenue has declined the most at Redfin and Realogy, the least at eXp and Douglas Elliman, and Compass sits right in the middle.

  • Consequently, Compass and Realogy are in the midst of a steep, seasonal revenue drop while eXp slowly makes it way closer to the top.

 
 

The market is slowing and real estate agents are doing fewer transactions.

  • For example, the number of transactions per agent at Compass is at record lows, lower than Q1 last year and on par with the early days of the pandemic.

 
 

The bottom line: The market is softening. Less transactions mean less brokerage revenue.

The Opendoor MLS

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Tucked away in Opendoor's recent earnings call was an enlightening statement by its CEO, Eric Wu, which sheds light on its exclusive supply strategy.

Why it matters: Exclusive content is a strategy being driven by VC-funded real estate tech disruptors, with important implications for consumers and a spotty track record of success.

  • A possible endgame for Opendoor is to match exclusive supply with demand directly -- off the MLS -- through an Opendoor ecosystem.

 
 

The benefits to Opendoor are clear: avoiding agent commissions, controlling the consumer experience start to finish, and streamlining the sales process.

Opendoor is not alone in wanting to build a supply of exclusive inventory to draw consumers to its private platform.

 
 

Compass also uses exclusive content to drive consumers directly to its platform, a clear endgame for the business.

  • Compass encourages sellers to list exclusively and privately on its platform.

  • Nearly a quarter of Compass' current listings are exclusive; a homebuyer has to call a Compass agent for access.

 
 

Yes, but: This isn't new.

The rise of exclusive content in real estate risks fragmenting the search and discovery process -- with considerable implications for consumers.

  • Buyers lose easy access to a complete view of the market by being forced to visit multiple sites (or call an agent like it's 1995).

  • For sellers, it fragments and artificially reduces the number of possible buyers, which could lead to less demand and a lower price for a property.

The bottom line: There is incredible value to whoever controls the home search platform. In the U.S., that's Zillow, realtor.com, and hundreds of MLSs.

  • New platforms -- leveraging exclusive content -- are a significant threat to these incumbent platforms.

  • And so far, the benefit to consumers is questionable.

Go deeper: I've previously explored this topic in my Strategic Analysis of The Top Threat to Real Estate Portals. Spoiler alter: It's exclusive content.

This analysis looks at several case studies from around the world.

Compass' Cash Burn Problem

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Compass' latest financial results reveal a company that burned $142 million in cash during the first three months of 2022, with $476 million left in the bank.

Why it matters: Manufactured profitability metrics aside, cash is the fuel that powers all businesses.

  • Compass has a track record of significant cash burn (over $400 million in the past 15 months), with high fixed operating costs and expensive acquisitions.

 
 

There's a widening gap between Compass' gross profit (revenues after commission expense) and its operating expenses.

 
 

Compass is burning more cash and operates more unprofitably than any of its publicly-listed peers.

  • Realogy, eXp, and Douglas Elliman all have gross profits higher than their operating expenses.

 
 

Compass' cost base is significantly higher than last year; operating expenses are up 50 percent from Q1 2021 (excluding stock-based compensation).

  • But revenue growth is soft; Compass is only projecting eight percent revenue growth in Q2.

  • This is only operating expenses, and doesn't include capital expenditures and acquisitions.

 
 

Compass' cash burn over the next 12 months is highly dependent on the overall real estate market.

  • There's not a lot of margin of error; a challenging 2022 market will depress revenue and increase cash burn.

  • Specific projections aside, there is an undeniable downward trend in Compass' available cash balance, which is becoming more difficult to ignore.

 
 

What to watch: Compass is not in immediate peril, but it is approaching a critical juncture where it will either need to raise more money or reduce expenses.

  • The Compass business model relies on massive amounts of investment capital to subsidize massive financial losses.

  • It's not clear that the business can achieve breakeven on its current trajectory; its cash burn is unsustainable.

  • Compass may be forced to enact significant layoffs to recalibrate its burn rate.

Cash is king: After years of big spending, access to seemingly unlimited amounts of capital, and sustained unprofitability, the time has come for Compass to demonstrate a durable, self-sustaining business model.

A note on projections: This analysis uses the midpoint of Compass' guidance for Q2 revenue ($2.1 billion), and seasonal estimates for Q3 and Q4.

  • Gross margin is assumed to be 18 percent (Q1 2022 actual).

  • Operating expenses remain flat at Q1 2022 levels.

  • Roughly $50 million of capital expenditure and acquisition costs for the year (much lower than historical amounts; there was $190 million in 2021).

 
 

The Ever-Shifting Landscape of Mortgage Disruption

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Recent growth and contraction in the mortgage, iBuyer, and Power Buyer space has resulted in a reshuffling of the largest businesses aiming to disrupt the industry.

Why it matters: Mortgage is an emerging battleground in real estate, and the number of Mortgage Loan Originators (MLOs) employed by a company is an important leading indicator of that company's firepower and strategic intent in the space. Of note:

  • Opendoor has surged to #3 after acquiring RedDoor.

  • Significant layoffs at Knock and Homie have pushed Homeward into the #1 spot of emerging Power Buyers (full disclosure: I'm an advisor to Homeward).

Zillow and Knock have shed MLOs during a series of recent layoffs.

  • Zillow's MLO headcount is down 17 percent and Knock is down a massive 50 percent from December.

 
 

Better Mortgage and its employees have had a tough five months. So far, the business has lost about half -- around 600 -- of its MLOs through a series of layoffs.

 
 

Comparatively, Zillow still has significant firepower at its disposal; all eyes are on what's next for Zillow Home Loans in a post-Zillow Offers world.

 
 

Redfin and Prosperity Home Mortgage (a subsidiary of mega-broker HomeServices of America) dwarf Zillow and the others in the space, highlighting the latent power of incumbency.

  • Redfin (through Bay Equity), Prosperity, and Zillow operate more traditional mortgage businesses, while the others offer more disruptive services.

  • It's also important to differentiate between purchase and refinance business; many of the Power Buyers and iBuyers are focused on purchase.

 
 

The bottom line: Real estate tech disruptors are investing billions to build integrated brokerage and mortgage experiences.

  • Tracking MLOs over time reveals who is marshaling resources for future growth, who is making strategic retreats, and who has the most potential to effect change in the future.