Inside Compass — Part 3: Valuation

Part One of this series took a detailed look at Compass’ growth strategies, while Part Two examined if Compass is a tech company, or a traditional brokerage. Irrespective of the answer, Compass unquestionably needs to be a technology company — both to support its massive valuation, and to be a sustainable business. Is Compass worth $4.4 billion, and is it being valued as a traditional brokerage, or a technology company?

Valuation overview

Compass has raised over $1.1 billion in venture capital, starting with $8 million back in 2012. Its latest $400 million round in September 2018 valued the company at $4.4 billion, up from $2.2 billion in December of 2017. Compass’ rising valuation is matched by its impressively growing revenue.

 
 

Compass’ peers in the real estate technology space, both public and private, feature an exciting range of valuations. In general, technology companies like Zillow, Redfin, and Opendoor have higher valuations, while traditional brokerages like Realogy and RE/MAX have lower valuations. Investors clearly favor technology companies.

 
source: public markets, april 2019. Private companies at time of last funding round.

source: public markets, april 2019. Private companies at time of last funding round.

 

(Both Realogy and Purplebricks have recently released news and earnings results that resulted in a significant drop in valuation. I’ve used numbers from April in an effort to provide a more fair, “moving average” valuation.)

Revenue multiples

One way to determine a company’s value is by using a revenue multiple. That multiple — say 1x or 2x — is multiplied by current revenues to establish a valuation. The higher the multiple, the more optimistic investors are about future growth prospects, and the more that company is worth.

Compass sports a relatively high revenue multiple — rivaled only by tech company Zillow. While its business model is most similar to peers like Redfin, RE/MAX, eXp Realty and Realogy, investors are significantly more optimistic about Compass’ future prospects.

 
based on last full year financials (2018 for most companies).

based on last full year financials (2018 for most companies).

 

Growth rates significantly factor into a company’s valuation; investors are generally more optimistic the faster a business is growing. This cohort of real estate tech businesses are growing revenues at vastly different rates.

 
Screen Shot 2019-05-13 at 8.53.18 AM.png
 

However, a high revenue growth rate does not necessarily correlate to a high revenue multiple, as evidenced by the following chart. Of the fastest growing companies — Compass, eXp Realty, and Opendoor — Compass boasts the highest revenue multiple, more similar to Zillow and Redfin. (Bubble size denotes overall valuation.)

 
Screen Shot 2019-05-13 at 12.51.25 PM.png
 

Over the past three years, Compass’ valuation has been closely tied to its revenue, which is growing exponentially. As discussed in Part One of this series, that growth has come from an aggressive acquisition strategy. The revenue multiple for each of Compass’ recent capital raises has remained consistent: 5x—6x. Investor sentiment has remained consistently optimistic.

 
Screen Shot 2019-05-13 at 8.58.05 AM.png
 

Transaction volumes

Another metric to consider when valuing companies — especially real estate tech companies that are involved in the transaction — is transaction volume. A number of the biggest companies in real estate, including those discussed here, are newly obsessed with building end-to-end transaction platforms. And an important part of that platform strategy is offering ancillary services such as mortgage and title.

Another angle is the predictive and educational power of data. Whether it’s Zillow, Redfin, Compass, or Keller Williams, all are talking about the power of data in their end-to-end platforms. Many companies consider it a potential competitive advantage, and are making heavy investments to build out enhanced data capabilities.

To fully realize its value, a platform needs to be used. The upsell opportunity around ancillary services and the predictive power of data all require transactions flowing through the platform, and the more the better. Similar to the benefits of network effects, more activity on a platform makes it more valuable. Thus, the more transactions a brokerage facilitates, the stronger position it should have in the overall ecosystem.

A transaction volume metric for company valuations is not typically used nor talked about in the industry. The number of transactions each company conducts, and the number of consumers they touch, again varies wildly.

 
SOURCE: SWANEPOEL MEGA 1000

SOURCE: SWANEPOEL MEGA 1000

 

Despite so much potential future value being attributed to ecosystems that touch consumers and facilitate transactions, it does not correlate to company value. In fact, it is exactly the opposite. The following chart shows company valuations divided by transaction volumes — or the “value per transaction.”

 
Screen Shot 2019-05-13 at 10.00.13 AM.png
 

Even though Realogy and RE/MAX have, by far, the most transactions flowing through their systems, investors are ascribing very little value to them.

Agent count

Part One of this analysis looked at how much Compass was paying for its brokerage acquisitions. Since the start of 2018, Compass’ agent count has increased from roughly 2,000 to 10,000. Of those 8,000 new agents, around 4,200 came from acquired brokerages. Assuming a total of $230 million spent to acquire fourteen brokerages with 4,200 agents, that’s a cost (or value) of $55,000 per agent.

When Compass raised its latest round in September 2018, it was valued at $4.4 billion, and at the time, had around 10,000 agents. Using the same methodology, each of Compass’ agents was worth — or valued — at $440,000.

 
Screen Shot 2019-05-13 at 2.07.07 PM.png
 

If brokerage valuations were driven entirely by the number of agents — which, incidentally, are the primary revenue drivers — investors are valuing Compass agents eight times higher than what Compass itself is paying other brokerages through acquisition.

What about profit?

There’s one word missing from this analysis so far: profit. What role does the ability of a company to operate profitably play in its valuation? Not much.

Out of the companies mentioned in this analysis — Compass, Zillow, Redfin, RE/MAX, Opendoor, eXp Realty, Purplebricks, and Realogy — collectively worth over $20 billion — only two are profitable: RE/MAX and Realogy. Realogy, the company with the absolute lowest revenue multiple of 0.2x, is profitable. Together, RE/MAX and Realogy are worth $2 billion, less than half that of Compass. Clearly, the potential of future profits trumps the certainty of current profits for investors.

 
profit = net income, not “adjusted ebitda”

profit = net income, not “adjusted ebitda”

 

Peer valuation scenarios

What would Compass be worth if it were valued like some of its peers (using their revenue multiples)? It’s already at the high end of the range for those with similar business models: RE/MAX, Purplebricks, Realogy, eXp Realty, and Redfin.

 
Screen Shot 2019-05-13 at 1.57.03 PM.png
 

Compass is valued far and ahead of its peers, even those in the same class of technology-enabled brokerage. If it were valued similarly to Redfin, which is a public company, it would be worth $3.5 billion — a $900 million discount to its current valuation. Clearly investors see something more in the company.

If Compass were valued at Realogy’s revenue multiple, it would only be worth $200 million — over 20 times less than its current valuation! Remember: Realogy is profitable, sees over 40 times the transaction volume and has over 6x the revenue of Compass. This stat alone highlights the massive opportunity investors see for Compass, contrasted starkly with the bleak future forecast at Realogy.

A sustainable model?

Investors clearly see something more in Compass — something that massively sets it apart from its peers. Its valuation is being driven by a combination of massive growth fueled by an aggressive acquisition strategy, and the promise of a tech-powered platform to give it a competitive advantage over peers.

It’s fair to say Compass is being valued as a tech company. In fact, Compass is being valued more optimistically than any other traditional or tech-enabled brokerage by a wide margin; it’s valuation more closely matches Zillow, a tech company with a completely different business model.

Having raised over $1.1 billion, Compass is unequivocally causing a revolution in the traditional real estate industry. But how sustainable is its model? Can it keep up its aggressive — and expensive — acquisition strategy, and achieve profitability? And will agents, without whom Compass wouldn’t generate any revenue, remain happy and stay under the Compass banner? Stay tuned: These topics will be explored in Part Four: Sustainability.

Inside Compass — Part 2: Brokerage or Tech Company?

The first part of this series took a detailed look at Compass’ growth strategies, fueled by over $1.1 billion in venture capital. The company often refers to itself as a tech company and a tech-enabled brokerage, which is part of the lure of the Compass vision — and the underpinning of its massive $4.4 billion valuation. Now we turn to that fundamental question: Is Compass a tech company, or a traditional brokerage?

Ingredients of a tech company

A real estate technology company that operates as a brokerage (representing buyers and sellers in a real estate transaction) is nothing new. There are tech-enabled brokers around the world: Redfin, Purplebricks, Duproprio, and dozens of smaller players. The defining characteristic of these companies is how technology provides an efficient platform to scale — at rates much faster and at lower cost than traditional brokerages.

A real estate technology company should have the following three attributes:

  • Tech staff: A technology company should employ technologists. 

  • Efficiency: By leveraging technology, operational efficiency should be higher than the industry average.

  • Scalability: Technology should enable the business to scale in a non-linear manner.

This analysis focuses on these key attributes and compares Compass to its industry peers, both technology companies like Zillow and Redfin, and traditional brokerages like NRT (Realogy) and HomeServices of America.

Tech staff

The first clue that a company may be a technology company is the number of software engineers it employs, both in absolute numbers and as a percentage of its total headcount.

Readers that follow my work may recall a previous analysis where I benchmarked the percentage of tech staff at various real estate companies. At the time, I observed that the most successful technology-enabled brokerages around the world (Redfin, Purplebricks, and Duproprio) had around 10 percent technical staff. The point was that the business of buying and selling houses is still very much a people business, even for leading tech companies.

Compass is clearly staffing up and aggressively building a tech team. Compared to total headcount, including agents, the percentage of tech staff is still quite low (reflecting the central role of agents). However, Compass’ tech team represents a significant portion of its salaried, full-time employees.

 
source: compass public statements

source: compass public statements

 

Many real estate technology companies, including Zillow, Redfin, and Purplebricks, don’t publicly disclose the size of their tech teams. This is where LinkedIn comes in handy. While its employee data is not an absolute representation of the truth, it does provide a helpful comparison between companies.

Looking at software engineering staff as a percentage of the total shows a comparison between companies. (Note: software engineers are just one part of a successful tech team.)

 
source: linkedin, may 2019

source: linkedin, may 2019

 

Backing out agents (independent contractors or otherwise) from the same calculation shows another way to look at the same data. Remember, this is just software engineers, and not the entire product team.

 
source: linkedin, may 2019, plus author’s estimates

source: linkedin, may 2019, plus author’s estimates

 

LinkedIn also shows the largest employee categories for each company. The top category for Zillow, which among its peer group is undoubtedly the most tech of the tech companies, is engineering. The same engineering category is ranked #4 for Opendoor, #6 for Redfin, and doesn’t appear until #11 for Compass.

 
Zillow

Zillow

compass

compass

 

Raw numbers help paint a complete picture. During a Bloomberg interview in April 2019, Compass stated that it currently employs 200 engineering staffers and wants to have 400 by the end of the year. At the time of its IPO in 2017, Redfin had “more than 200 engineers and product managers” (or 9 percent of its staff), and today has nearly 200 engineers. And according to LinkedIn, Zillow has an engineering team approaching 1,000.

On the one hand, Compass is clearly outgunned by tech powerhouses like Zillow and Opendoor, but on the other hand it’s backing up its claims by aggressively hiring a sizable engineering team.

Efficiency

A classic measure of business model efficiency is revenue per person. More efficient and lucrative business models — typically technology companies — are able to generate higher revenues with a smaller staff.

The chart below looks at revenue per person (including agents, which are the drivers of revenue) during 2018. Since Zillow, Redfin, and Compass each grew their headcount rapidly during the year (from 2,600 to 9,500 at Compass), I’ve used a midpoint headcount number to reflect a more accurate representation (6,050 for Compass).

 
Screen Shot 2019-05-08 at 8.17.40 PM.png
 

It’s worth noting that Compass’ target market is the luxury space, with an average home price well over $1 million. Given that a brokerage derives its revenues as a percentage of the sale price, overall revenues will correlate closely with average sale price. The average sale price of a Compass home is about double that of Redfin, yet Redfin still generates more revenue per person than Compass.

Organizational efficiency can be measured by looking at the average number of transactions an agent is able to close each year, called “production.” One would expect a technology company, or a technology-enabled brokerage, to provide its agents greater efficiency through the smart application of technology. Those efficiency gains should translate to the ability to work on and close more transactions.

The chart below compares the average agent production for Compass, Redfin, Purplebricks in the U.K, and the industry average in the U.S.

 
 

For this calculation I’ve again used the 2018 midpoint agent count for Compass, raising its average from four to seven transactions per agent, identical to the overall industry average. Redfin’s agents, on the other hand, are 4.5 times more efficient than the industry average — an exponential efficiency gain resulting from technology combined with a novel operating model.

Another way to look at efficiency is not by total agent count, but by total headcount. This method considers the entire organization that, directly and indirectly, supports agents in closing transactions.

 
Screen Shot 2019-05-08 at 8.20.07 PM.png
 

Two interesting things happen in this analysis. First, Compass drops slightly below the industry average (represented by NRT). Second, Redfin’s efficiency lead drops to 2.5 times the industry average, a reflection of how important its non-agent support staff is to its overall model.

Looking at agent efficiency of the top 20 U.S. brokerages shows Compass right in the middle of the pack (which, incidentally, is led by Redfin). Yes, Compass is more efficient than some brokers, but its agents are considerably less efficient than a number of others, many of which don’t even style themselves as “tech-enabled brokerages.” Even agents at traditional industry stalwart HomeServices of America are more efficient.

 
source: Swanepoel Mega 1000

source: Swanepoel Mega 1000

 

Overall sales volume (the total value of houses sold) per agent shows another angle. Not all houses are created equal, and by being in the luxury space (average home value of $1.3 million), Compass is near the top of the pack when it comes to agent sales volumes. Its agents can sell less homes and still make a considerable amount of money.

 
source: Swanepoel Mega 1000

source: Swanepoel Mega 1000

 

Combining both average transactions closed and sales volume per agent shows a more holistic view of agent efficiency. Redfin, the clear outlier, operates a model that is exponentially more efficient than the industry average. Compass is clustered with other luxury brands due to its high average sales price.

 
 

When evaluating Compass, the evidence shows a business whose agents are no more efficient than the industry average — by a number of different factors. Overall business model efficiency, as evidenced by revenue per person, is singularly driven by being in the luxury market where home prices are high. Technology and product development efforts in 2019 and beyond may deliver on efficiency promises, but for the time being it remains simply that — a promise.

Scalability

Technology businesses should scale non-linearly. They should be able to grow revenues faster than expenses, and leverage technology to become more efficient over time — especially when compared to traditional peers.

Between 2016 and 2018, each of the following businesses grew revenue and added headcount, but all at different rates. Each new hire at Zillow corresponded to around $300k of additional revenue, compared to around $80k for each new person at Compass (slightly below the traditional industry average, as represented by NRT).

 
Screen Shot 2019-05-08 at 8.25.10 PM.png
 

Measuring revenue per person over time gives another sense of business scalability. One would expect a scalable technology business to see efficiency improve over time. The chart below shows the changing revenue per person — including agents — over the span of three years, again using a midpoint count in 2018 due to the rapid headcount growth in all three businesses.

 
Screen Shot 2019-05-08 at 8.22.19 PM.png
 

The evidence shows a clear trend: each business is generating revenue more efficiently as it scales. That trend is more pronounced at Zillow and Redfin, and is the hallmark of a scalable business model.

Compass is scaling differently, and less efficiently, than its peers. This does not mean that Compass is any better or worse than Zillow or Redfin — there are a variety of business models, each with their own merits — just that it is a different type of business.

The valuation quandary

Is Compass worth $4.4 billion? Should Compass be valued as a traditional brokerage, or a technology company?

The disruptive companies leading the pack in real estate — Zillow, Redfin, Opendoor, and Purplebricks — all combine technology with a novel operating model different than a traditional brokerage. It is this combination that leads to exponential gains in efficiency.

Regardless of whether or not Compass is a technology company, it unquestionably needs to be a technology company — both to support its massive valuation of $4.4 billion, and to be a lasting, sustainable business. This topic is explored further in Part Three: Valuation.

Inside Compass — Part 1: Growth Strategies

Compass is one of the world’s proptech unicorns. With a valuation of $4.4 billion and over $1.1 billion in venture capital raised, this self-styled technology-enabled broker is now the third largest U.S. brokerage by sales volume.

But how has it grown so quickly? What’s the secret to its meteoric rise, and what is it that investors see that justifies its massive valuation? This multi-part deep dive into Compass looks to provide evidence-based answers to those questions — and more.

Fundraising and growth drivers

Compass’ fundraising prowess sets it apart from its peers. It is one of the select few real estate tech companies that has raised over $1 billion in equity (Opendoor is another), and counts SoftBank as one of its investors.

Compass raised its first capital in 2012, but it was not until recently that it started raising mega rounds: $550 million in 2017 and a further $400 million in 2018.

 
 

Compass has seen a corresponding increase in its revenue and transaction volumes. Revenue has consistently doubled over the past several years as the company has become the third largest U.S. brokerage in terms of sales volume. It completed around 35,000 transactions worth $45 billion in 2018.

 
Source: author’s estimates from numerous company statements.

Source: author’s estimates from numerous company statements.

 

In a relatively static world of real estate market share, Compass is clearly making an impact and seeing strong growth. And its growth strategy is as unique as its fundraising ability.

A New York Yankees growth strategy

Beginning in a big way in 2016 — after a $75 million cash infusion — Compass began a new strategy of growth through acquisition.

Over the years, several sports franchises around the world, including the New York Yankees, Real Madrid, and Chelsea Football Club, have executed a particular growth strategy based on their competitive advantage: access to capital. All three clubs are rich, have access to massive amounts of capital, and use it to buy the best players in the world.

Compass operates a similar strategy; its competitive advantage in the market is capital (over $1.1 billion of it). The Compass strategy is to deploy that capital by luring the best agents and brokers to its team. Like all real estate brokerages, agent count is the primary driver of revenue.

 
Screen Shot 2019-05-02 at 9.31.21 AM.png
 

Compass employs a number of methods to attract the best talent: high commission splits, bonuses, marketing funds, and stock options. These financial factors are in addition to the softer benefits of the Compass brand, which is slick, modern, exclusive, luxury-focused, and comes with the promise of marketing and technology support (this will be explored further in Part Two: Brokerage or Technology Company).

Beginning in 2018, immediately after its massive $550 million cash infusion, Compass upped the game by acquiring brokerages wholesale. Instead of luring away only the star players, management decided it would be faster to simply acquire entire brokerages, which significantly accelerated the growth of Compass’ agent count (note the blue line in the graph below).

 
Screen Shot 2019-05-02 at 10.19.12 AM.png
 

Since the start of 2018, Compass’ agent count has increased from roughly 2,000 to 10,000. Of those 8,000 new agents, around 4,200, or 52 percent, came from acquired brokerages. The remainder can be assumed to come from traditional, organic methods (recruitment of star agents and teams).

 
Screen Shot 2019-04-29 at 3.01.29 PM.png
 

Steve Murray from REAL Trends, whose firm closely tracks and values U.S. brokerages, estimates that the acquisitions listed above cost Compass a total of between $220 and $240 million, paid in a combination of cash and stock. Compass has stated that it typically pays between four and six times a firm’s annual pre-tax earnings.

Assuming a total of $230 million spent to acquire fourteen brokerages with 4,200 agents, that’s a cost of $55,000 per agent. Quite an expensive — and effective — recruitment method.

Marketshare merry-go-round

The real estate world revolves around agents. Agents generate revenue, and that revenue gets split between agent and broker. Each year, many agents change brokerages in an effort to increase their earnings through incentives like more favorable commission splits. It’s a recruiting tool.

This marketshare merry-go-round has been going for decades. There’s always a new player entering the market with a sweet deal to attract agents with the promise of earning more money. Today, that’s Compass and eXp Realty. But what about tomorrow? What’s to stop the next wave of players offering an even better financial proposition to lure agents to its ecosystem?

Compass has achieved a tremendous amount of growth in a relatively short period of time, and its competitive advantage is access to capital. It is parlaying that advantage into a massive agent recruiting tool at scale. But that advantage may not be sustainable nor unique; it’s possible for others to copy. Nothing is stopping a new or existing player from offering even more lucrative deals to attract agents.

Brokerage or technology company?

The vision, promise, and lure of Compass is that it’s a technology company, not a traditional real estate brokerage. And as a technology company, it will deploy tools unmatched by others in the industry. This potential competitive advantage will be key to attracting and retaining agents, and a cornerstone of the Compass strategy.

Using extensive data as evidence, part two of this series explores that singular, key question upon which this $4.4 billion company revolves: Is Compass a brokerage, or a technology company?

The Rise (and Fall?) of Purplebricks

If you believe everything you read in the media, you could be excused for thinking the U.K.-based online real estate agency Purplebricks is a company in crisis. The stock price is significantly down from the highs of last year, the U.S. and U.K. CEOs are out, and revenue guidance has been repeatedly downgraded.

 
 

Purplebricks faced a rocky international expansion, especially in the U.S. In a span of nine months, it quietly raised prices, completely pivoted its fee model, and then parted ways with its U.S. chief executive. During the same period, it lowered future revenue expectations not once but twice, down from total group revenues of £185 million to £140 million.

 
 

But like all irrational systems, the stock market trades not only on reality, but the perception of reality. While Purplebricks' stock has faced a turbulent three years, its underlying revenue has consistently grown by impressive margins.

 
 

The sharp rise in 2017 was driven by unrealistic optimism for international expansion, on the back of 100% growth in the U.K. In 2018 it was clear international markets were a tough nut to crack, while U.K growth slowed considerably.

Still strong in the U.K.

As I wrote in July 2018, Purplebricks' U.K. business model works, it makes money, and -- at scale -- is profitable.

 
 

It's a mistake to confuse Purplebricks' stock price with its overall success. The only challenge facing the U.K. business is growth, which is clearly slowing down as the company saturates the market. All online agents are not doomed to failure because of some fundamental flaw. 

Market share can only get so high. In November 2018 I was quoted in the Financial Times saying, "I rolled my eyes when analysts were talking about 20, 25 per cent market share [for digital leaders]." And it's true. Depending on the source, Purplebricks' U.K. market share is anywhere from 3.2 to 4.5 percent.

What's the problem in the U.S.?

The U.S challenge is simple: Purplebricks' massive marketing spend is not generating enough customers.

The company recently pivoted its business model in the U.S., from an up-front fixed fee (paid regardless of the home selling), to a success fee paid only when a home sells -- both at a discount. This move brings Purplebricks squarely in line with the traditional industry it was attempting to disrupt. The proposition is now also identical to Redfin.

In December of 2018, I estimated Purplebricks generated between 1,200 and 1,400 new listings over the preceding six month period. During that same time, Redfin reported around 22,000 closed transactions.

Also during that period of time, Purplebricks spent over $20 million in marketing, compared to Redfin's $16 million. The result is a customer acquisition cost of $15,000 for Purplebricks, compared to $730 for Redfin.

 
0b3baf87-5fa2-476b-85e7-5d0f24d276ae.png
 

Strategic implications

Purplebricks is still dangerous: it has deep pockets, a willingness to spend, and the self-awareness to pivot when things aren't working. I wouldn't count them out of the U.S. quite yet.

The biggest implication, however, could be the massive amount of money being spent on marketing by disruptive players (over $100 million between Purplebricks and Redfin alone in 2019). And what's the message of that marketing? Traditional agents are expensive, we offer the same service at a discount, use us instead.

Expand the scope to iBuyers like Opendoor and Zillow and the tens-of-millions they are spending on marketing. What's the message? Traditional sales are complicated and confusing, use us instead.

Disruptive companies are spending hundreds-of-millions of dollars on TV commercials, radio ads, and online advertising that hammers home a clear message to consumers: a credible alternative to traditional real estate.

Now, more than ever before, consumers are being bombarded with advertising offering them a choice. The industry may not change overnight, but consumers will be asking more and more questions.

iBuying is Zestimate 2.0

When Zillow launched in 2006, its Zestimate was its claim to fame.

The Zestimate was a lead generation tool that attracted consumers by giving them a starting point for determining what their home -- or any home -- is worth. It was online, it was fast, and it was easy.

Flash forward more than a decade later, and online valuation tools are a commodity. There are dozens of web sites that will determine a home's estimated value. Zillow’s unique advantage has diminished.

Zillow's strategic necessity

I believe Zillow's guiding strategic principle is that it must be consumers' first destination in the home buying and selling process. Zillow's sustainable competitive advantage lies in its massive audience and strong position at the start of the consumer journey.

In the past, other listing portal competitors were relatively undifferentiated. Zillow has been the clear market leader, and there was no credible threat that could unseat it from its powerful position.

However, the entry of iBuyers with a service that made instant offers on a home – online – was novel and compelling, just like the Zestimate in 2006. Suddenly, more and more consumers were beginning their home selling process not on Zillow, but on other web sites like Opendoor and Offerpad. This was a key existential threat for Zillow.

The iBuyer business model is Zestimate 2.0 – the natural starting point for determining your home’s value. What’s more accurate than an actual offer on your home?

Mass-market appeal

Opendoor's long-term vision is that every home owner will request an instant offer before selling their home. It's a natural starting point: It's easy, it provides value, and there's no commitment. What better way to value your home than an actual offer?

While Zillow only purchases around three percent of the offer requests it receives (that number is higher for the other iBuyers), a very large number of consumers are requesting offers each month. In established markets like Phoenix, anywhere from 25–35 percent of active home sellers request an instant offer before selling their home. The numbers are BIG.

 
fa500a88-4c85-4fd6-96d0-93b0e00cfe93.png
 

Given the growing mass market appeal of an instant offer (tens of thousands of requests each month) and the simplicity of the process, it's no surprise that Zillow launched its own iBuyer service.

Strategic implications

If you're in the business of providing consumers an estimate of the value of their home, the bar has just been set higher. The inherit power and appeal of the iBuyer model is quite clear:

  • Instant offers are simple, easy, and quick. All online.

  • Instant offers are at the start of the funnel -- they attract consumers at the start of the home buying or selling journey.

  • It's a novel concept that satisfies a consumer need, hence the high proportion of consumers requesting offers.

In other words, iBuying is the new Zestimate.

Rightmove's slowing growth: same problem as Zillow, different strategy

Rightmove, the U.K.'s top portal, announced its full-year 2018 results last week.

Why it matters: Not unlike Zillow, the growth in Rightmove's core advertising business continues to slow. The slowdown in velocity reveals the limits and highlights the challenges the business will need to overcome as it looks for new growth opportunities.

Overall revenue grows and slows

Overall revenue at Rightmove grew 10 percent last year -- respectable, double-digit growth, but also the lowest number recorded in its history.

 
68003b2b-ec3c-4731-ba35-b8c32321d00d.png
 

Rightmove's core revenue driver is its Agency business, which accounts for over 75 percent of total revenue (concentration risk!). Annual growth continues to slide over time. The 8.7 percent growth is the lowest number recorded, and reflects the growing difficulty the business has in charging its customers more money for the same service.

 
24da7cd0-4e58-4be7-8481-a5648324c8cf.png
 

Nearly all of Rightmove's growth is coming from price increases (average revenue per advertiser, or ARPA), as opposed to new customers. The amount that Rightmove is able to squeeze out of its existing customers is slowing over time.

 
 

Controlling expenses

Historically, Rightmove has demonstrated incredibly disciplined cost control. By managing its expenses, Rightmove is able to maintain its phenomenal 76 percent profit margins.

 
 

But while good for the bottom line, controlling expenses too much can limit the ability of a business to invest in future revenue streams.

One way Rightmove maintains its margins is limited headcount growth. In 2017 (which was a transition year when revenue growth slowed considerably as new pricing was rolled out), the business only added ten new hires. In 2018, Rightmove added sixteen new hires.

 
7c320a2d-8179-4360-ac67-d41138b89415.png
 

Strategic implications

While facing similar challenges, Rightmove's strategy stands in stark contrast to nearly every other major real estate portal around the globe. Zillow and REA Group spent tens-of-millions of dollars to acquire mortgage businesses, Scout24 acquired a finance comparison business for over $300 million, realtor.com acquired Opcity for $210 million, and Zoopla acquired a range of adjacent businesses for half-a-billion pounds.

The real estate portal business is evolving, moving closer to and getting involved in more parts of the transaction. But Rightmove has remained steadfast and stationary in its solitary focus (more on this in my Future of Real Estate Portals Report and 2018 Global Real Estate Portal Report).

 
 

Rightmove's revenue growth slowdown may sound similar to Zillow (as I wrote about last week), although the slowdown is less pronounced and immediate. But the trend and concern is the same.

Both portals are facing slowing growth in their core businesses. Zillow has invested heavily in new business lines (mortgage, rentals, Zillow Offers, and lead qualification to name a few) and appointed a new CEO, while Rightmove hasn't -- its eggs are still in the same basket.

Zillow's New Strategy: Insights, Implications, and Analysis

Last week, Zillow announced a major strategic shift: Along with a new CEO, it made clear that its top focus is its Zillow Offers iBuyer business.

Today's email covers the highlights of that announcement. Additionally, next week I'll be holding a 60-minute webinar that dives deep into the strategy, numbers, and implications of Zillow's latest move.

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Premier agent growth grinds to a halt

The most striking statistic from Zillow's results is the lack of projected growth in its flagship, billion-dollar premier agent program (which accounts for 67 percent of its revenue). Guidance for the first quarter of 2019 is only 1.5 percent -- a steep decline from past quarters.

 
 

And on a full-year basis, Zillow projects its premier agent program will grow at 2 percent -- a flattening from past, double-digit growth.

 
 

Both of these projections come on the back of difficulties rolling out new premier agent products focused on lead quality over quantity.

But what's most striking is the suddenness of the decline. Going from double-digit to flat growth in the span of a year is significant. More than rollout issues, I believe Zillow has reached the upper limit of what it can charge agents for leads. Which is what's driving such a significant shift in strategy.

Expensive homes and a longer hold time

Last week I wrote about Zillow's unsold inventory in its Offers program, and the significance of longer hold times. The latest data highlights the same challenge.

 
 

The homes Zillow sells are less expensive: an average sale price of $292,000. However, the houses it holds in inventory are considerable more expensive, with an average value of $320,000.

This data point matches up exactly with the latest data from Phoenix, which shows a considerably higher average purchase price for Zillow compared to the other iBuyers.

 
 

The more expensive the home, the higher proportion of unsold inventory. It takes longer to sell more expensive homes, and it looks like Zillow is more than dabbling in the expensive end of the market. This is a key metric to watch!

Profit projections

Zillow released a detailed financial breakdown for its Offers business, including initial profit margins on its sold homes. Adjusted EBITDA, which backs out a number of costs including stock-based compensation, shows a per-home profit margin of 0.6 percent, lower than the stated goal of 2–3 percent.

 
 

(As a form of employee compensation, I believe stock-based compensation should be included in a true EBITDA calculation, so I've provided both options above.)

It's still early days, but this benchmarks current performance compared to where the business needs and wants to go in the future.

Strategic implications

I believe Zillow's guiding strategic principle is that it must be consumers' first destination in the home buying and selling process. Zillow's sustainable competitive advantage lies in its massive audience and strong position at the start of the consumer journey.

Think of this latest move as "Zestimate 2.0." The original Zestimate gave consumers a fun and helpful starting point when thinking about moving or buying a house. Now that online valuations are a commodity, Zillow needs to up the game: Instead of an estimate of value, how about an actual offer on your house? It's a compelling consumer proposition -- even if it simply serves the same purpose as the original Zestimate (attracting consumers at the start of the journey).

There's a whole lot more to discuss! If you want to listen and watch as I dive deep into the subject, register for next week's webinar.

Zillow Offers' most important metric

 
 

Later today, Zillow will announce its fourth quarter and full year 2018 results. Its activity as an iBuyer continues, and it recently overtook Offerpad to become the second-largest iBuyer in Phoenix. But my attention is focused on one key metric: Zillow's ability to quickly sell houses.

Why it matters: Zillow's goal is to hold houses for an average of 90 days. Any successful iBuyer needs to hold houses for as little time as possible, otherwise unsold inventory builds up, finance costs rise, and the whole model starts to blow up.

Overall activity grows; #2 in Phoenix

Zillow's overall iBuyer activity continues to grow, both nationally and in Phoenix (its biggest market). Based on the total number of homes purchased and sold, Zillow overtook Offerpad to claim the #2 spot in Phoenix for the month of January. Zillow is -- for the moment -- the second-largest iBuyer in the important Phoenix market.

 
 

Buying more than it's selling

While Zillow's overall activity continues to rise, its purchases are quickly outpacing sales. This is to be expected in the early months of a new market, but it's now eight months since launch. This is creating a growing inventory of unsold homes: around 350 in Phoenix as of February 12th.

 
 

It's natural for iBuyers to buy more houses than they sell when entering a new market. But over time, this Buy:Sell ratio is a critical metric for any iBuyer. Houses must be sold for the business to work!

Expensive homes, longer hold time

There are early signs that Zillow may be having difficulty selling houses. For iBuyers, time is money. The faster they can turn around and sell a house, the better.

The magic number for total holding time is around three months; Opendoor and Offerpad hold for between 80-100 days. Zillow currently has around 350 unsold houses in its inventory in Phoenix. Of those, it appears that around 110 homes have been owned for more than three months.

Part of the reason Zillow appears to have longer holding times may be the price of the homes it is purchasing. On average, it is buying more expensive homes than the other iBuyers in Phoenix.

 
 

Nationally, Zillow has purchased over 700 homes with an unsold inventory of over 500 homes.

 
 

The more expensive the home, the higher proportion of unsold inventory. It takes longer to sell more expensive homes, and it looks like Zillow is more than dabbling in the expensive end of the market.

Strategic implications

The key metric to watch is how well Zillow can sell its houses. Buying is relatively straight-forward; only once a house is sold is the entire business model complete.

To succeed as an iBuyer and appropriately manage its risk, Zillow needs to hold its houses for a minimum amount of time (on par with the other iBuyers), and avoid building up a large inventory of unsold homes.

It's still early days and Zillow has been quite aggressive in growing as fast as possible. But with its one year anniversary four months away, the pressure is on to demonstrate a consistent ability to buy -- and sell -- houses.

My Inman Connect Presentation

Earlier this month I had the pleasure of presenting at Inman Connect in New York City. My session, "iBuying Goes Mainstream: How Big Can it Get?" covered a range of topics, from the evolving role of portals to the latest iBuyer analysis.

My key points are outlined below. Watch the video of my presentation and download a copy of my presentation slides.

Growing iBuyer traction

The rise of iBuyers continues. During my presentation, I shared some of the latest national data available; a "sneak peak" at my upcoming iBuyer Report.

Opendoor in particular continues its strong growth in terms of houses bought and sold, clearly accelerating in 2018. Overall, iBuyers are small but growing: around 5 percent of the market in Phoenix.

 
 

The consumer journey

If you're an Inman subscriber, you can read the provocatively titled writeup of my presentation, "Opendoor's 'nightmare': KW agents backed by their own iBuyer." To quote:

 His point is that Opendoor, a tech-powered homebuying and selling startup with $1 billion in venture capital, is vulnerable to competition from companies that already connect with consumers on a massive scale at the beginning of their home-buying or selling journey.

Who wins?

The best new business models are exponentially better than the status quo, and the biggest companies are exponentially outspending their competitors.

Whether it's materially better efficiency with models like Redfin and Purplebricks, or Opendoor raising (and spending) 10 times the capital than its nearest competitors, the stakes are big. The trends that are impacting the industry are not incremental.

 
 

My presentation

You can watch the video of my presentation, and download a copy of my my presentation slides. I'd love to hear your feedback!