Zoopla's private equity strategy shift

Zoopla recently announced that it has removed all non-property advertising from its listing pages. This is one of several significant strategy changes after its acquisition by private equity firm Silver Lake.

Why it matters: The benefit of being a private company is that Zoopla can be more aggressive, focus on longer-term opportunities, and be less sensitive to a stock price that focuses on short-term earnings growth. This move is an example of that strategy in action.

The advertising revenue dilemma

A number of real estate portals generate revenue from non-property advertising on their listing pages. Zoopla's move puts it in line with arch-rival Rightmove by banishing banner ads from listing pages.

Note: REA Group and Domain do not have advertising on featured property listings, but do have non-property advertising on "normal" listings.

Banner advertising can be an important source of revenue for portals. However, it comes at the expense of the user experience. If a visitor clicks on a banner ad, their attention is diverted away from the property listing, reducing its effectiveness.

Often times user experience loses out to finances, especially for publicly listed companies under pressure to deliver revenue growth. And given that core revenue growth is slowing at a number of mature portals, the decision is even harder. But for a private company that's focused on the long-term opportunity, the decision is easy.

A shift in strategy

Aside from jettisoning nearly its entire management team, Zoopla has been up to quite a bit post-acquisition; there is the appearance of a significant change in strategy.

Zoopla's aggressive diversification strategy has been a leading factor making it unique in the world of real estate portals. It's been a world leader in acquiring adjacent businesses to dramatically grow revenues (for more on this, check out my 2018 Global Real Estate Portal Report).

The company's narrative has centered around a cross-sell strategy, where acquisitions are deeply integrated across Zoopla's network of web properties.

I've questioned the effectiveness of the cross-sell strategy, most recently in my Future of Real Estate Portals Report. The evidence didn't suggest a runaway success when it came to integration and cross-sell synergies.

Notably (and here's the big strategy shift), Zoopla's new managing director recently stated that, "Going forward, the former comparison and property businesses of ZPG will be managed largely separately, but we will continue to achieve synergies between the two wherever it is appropriate and relevant.”

To me, that sounds like a "back to basics" approach with a deep focus on the core product: tools for agents with a fantastic consumer experience. Cross-sell synergies and deep integration across the portfolio are taking a backseat.

Which is an interesting development for Scout24, which recently purchased financial comparison site Finanzcheck for $330 million, and Domain, which has been running the Zoopla diversification playbook for some time. Oops?

Strategic implications

Public companies that are focused on short-term revenue growth are at a distinct disadvantage to private companies backed by private equity. And private equity is getting more involved in the sector:

• General Atlantic acquires a majority stake in Hemnet, December 2016.

• Silver Lake acquires Zoopla for £2.2 billion, May 2018.

• General Atlantic invests $120 million in Property Finder, November 2018.

• Apax Partners offers $2.5 billion NZD for Trade Me, December 2018.

• Rumors circulate that several private equity firms are looking at Germany's top portal, Scout24.

It's going to be difficult to compete with private equity-backed portals given their fundamental advantage: they can be more aggressive, focus on longer-term opportunities, and be less sensitive to a stock price that focuses on short-term earnings growth.

Trade Me's private equity adventure

In recent weeks, Trade Me, New Zealand's leading classifieds and marketplace portal, has received two, multi-billion-dollar buy-out offers from private equity firms.

Why it matters: There is a growing trend of private equity getting involved in portals around the world, which allows these businesses more freedom of action as private companies -- but with significant change.

Private equity and portals

Trade Me is New Zealand's leading portal, with property, automotive, and jobs classifieds and a general marketplace business. I worked there as head of strategy between 2012 and 2016.

British firm Apax Partners and American firm Hellman & Friedman have both offered around $2.5 billion NZD for the business, a 25 percent premium to the existing share price.

This news follows several other examples of private equity getting into the (property) portal business:

• General Atlantic acquires a majority stake in Hemnet, December 2016.

• Silver Lake acquires Zoopla for £2.2 billion, May 2018.

• General Atlantic invests $120 million in Property Finder, November 2018.

Slowing growth

Since its public debut eight years ago, Trade Me has grown revenues 100 percent and net profit 39 percent.

Revenue growth has slowed over the years, especially recently, in a story reminiscent of Rightmove's growth dilemma.

The stock price has seen a steady rise with its ups and downs, but has been relatively flat since 2017.

In August of 2018, Trade Me announced a special dividend to return $100 million in capital to investors. This comes on top of the normal dividend, which represents around 80 percent of profits. Returning capital at that scale can be a signal that the company has run out of ideas.

Many businesses believe it is more beneficial to reinvest profits to improve efficiency, expand reach, create new products and services as well as improve existing ones, and further separate themselves from competitors.

Like Rightmove, Trade Me is in a difficult position. With growth slowing, it is less likely to make big investments for fear of depressing earnings and upsetting investors. It's a delicate, public-company balance. Enter private equity...

Upside potential, with change

Private equity invests in businesses for one and only reason: to make money. It's clear that these P.E. firms have evaluated Trade Me's business and believe there is significant upside potential under new ownership and management.

But significant growth comes with significant change. When Silver Lake acquired Zoopla in the U.K., nearly the entire executive team was let go as part of the restructuring. It's the same story in Sweden, when General Atlantic appointed a new management team after acquiring a majority stake in Hemnet.

Strategic implications

If consummated, a private equity takeover of Trade Me would have a number of implications for the business, competitors, and the entire online ecosystem:

• A private ownership structure will allow Trade Me to be more aggressive, focus on longer-term opportunities, and be less sensitive to a stock price that focuses on short-term earnings growth.

• Private equity firms demand a return on their investment, and this transaction will be no exception. Expect costs to be trimmed, earnings maximized, and a more aggressive posture on pricing and monetization.

• If you're competing with Trade Me, expect a dramatically different business to emerge that's tougher, less conservative, and more willing to throw its weight around.

Trade Me has long had a friendly, home-grown feel in New Zealand. New owners -- and new demands on the business -- may change the equation.

Zillow's billion dollar seller lead opportunity

Last week, Zillow announced its latest financial results, and the stock dropped 25 percent (losing $2 billion in value). But the story everyone is missing is the Zillow Offers iBuying business, and the huge potential of seller leads.

Why it matters: Last week I was quoted on MarketWatch saying, “If you’re thinking about Zillow doing iBuying and you’re not thinking about seller leads, you’re thinking about it the wrong way.” Seller leads are the real billion dollar opportunity.

Slowing premier agent growth

Here's the reason why Zillow's stock tanked 25 percent last week, in one chart:

Zillow's premier agent program accounts for over 70 percent of its revenue, or nearly $1 billion. Growth is slowing down. I'm not sure why this surprised anyone on Wall Street; I've been writing about it since early this year (Zillow's revenue growth slows and Zillow's strategic shift to iBuying and mortgages). I believe it's the primary reason Zillow has aggressively expanded into adjacent businesses.

The value of seller leads

Zillow's iBuyer business continues to grow, and the latest results crystalize the opportunity in seller leads.

Zillow says that since launch, nearly 20,000 homeowners have taken direct action on its platform to sell their home. Of those, it has purchased just about 1 percent of homes (around 200). That leaves about 19,800 leads who remain interested in selling their homes.

If Zillow simply sold those leads at $100 a pop, they're worth nearly $2 million.

But the real opportunity is giving those leads to premier agents in exchange for an industry-standard referral fee, about 1 percent, if the property sells (similar to the Opcity business model).

Here's the kicker: Zillow claims about 45 percent of consumers that go through the Zillow Offers funnel end up listing their home. That's a high conversion rate reflective of a high intent to sell; about 10 times higher than Opcity's conversion rate.

Assuming a 1 percent referral fee, a $250,000 home, and a conversion rate of 45 percent, those 19,800 leads are worth $22 million in revenue to Zillow, almost all profit.

Compare that to the estimated profit of its iBuyer business (1.5 percent net profit), which, on 200 houses, is $750,000. The value of the seller leads is worth almost 30 times the profit from flipping houses!

Total addressable market

Zillow says that based on its current purchase criteria, if Zillow Offers were available in the top 200 metro areas in the U.S., sellers of nearly half of the homes sold in 2017 across the entire nation would have been eligible to receive offers from it to buy their home directly. That equates to around 2.75 million homes annually.

Last quarter, Zillow said that it received offer requests from around 15 percent of the total for-sale stock in the Phoenix market. Interestingly, that number increased to 25 percent in September and 35 percent in October. That's a reflection of the strong lead generation power of Zillow Offers across its various web properties.

Based on these numbers, if Zillow goes national (200 metro areas) and sees 35 percent of the for-sale stock, it would receive 962,500 offer requests each year.

The billion dollar opportunity

Taking the latest numbers, which have been validated to the tune of 20,000 offer requests over five months in two markets, the total opportunity becomes clear with a national rollout.

Seller leads can be a billion dollar business for Zillow if you believe the current numbers. Even if a national conversion rate is lower, or the % of for-sale stock fluctuates, it's still worth several hundred million dollars in revenue annually.

Should Zillow even buy houses?

Given the value of the seller leads, should Zillow even be in the business of buying houses? Yes, if it wants a credible product for consumers. The real question is: What proportion of houses should Zillow actually buy?

Zillow's "big picture" is 5 percent national market share, which equates to buying around 10 percent of all offer requests (it is currently buying around 1 percent of offer requests). At a 1.5 percent net margin, that's around $1 billion in profit.

But to reach that scale, Zillow would need to spend $68 billion to purchase 275,000 houses annually. Assuming an average holding time of 90 days, it would need a credit line of $17 billion to fund the effort. Big numbers.

A more realistic target would be to only purchase around 1 percent of requests. Nationally, that would be 27,500 homes, which is only around double what Opendoor is currently doing, so it's feasible.

In any case, the point is clear: Zillow doesn't need to actually buy and sell a lot of houses for this model to generate significant profits for the company in a national rollout.

Strategic implications

Zillow is a lead generation machine, and its recent foray into iBuying is no exception. 

If you're in the industry and your value proposition to agents is seller lead generation, there's a new game in town. Zillow will be able to generate a massive volume of seller leads with higher intent than almost any other source. If successful, this will have significant implications across the industry.

Further analysis

If you're looking to dive deeper into the world of iBuyers, consider the following:

• iBuyer Business Model Overview and Analysis: all of my free research and reports on the iBuyer space.

• iBuyer Intelligence Briefing (Recording): a 60-minute conference call I conducted on the latest iBuyer news, key insights, and strategic implications for the real estate industry.

• Phoenix iBuyer Report: the only source for accurate, timely iBuyer market data for Phoenix. Available as a monthly subscription.

Mobile contact form analysis

Inspired by a recent talk on the importance of mobile experiences, I've conducted an analysis of the mobile contact forms for the big real estate portals. These are the forms that turn visitors into leads.

Why it matters: Mobile is huge. My research of the top real estate portals shows that, on average, 70 percent of leads come from mobile. Mobile contact forms should be optimized to be as efficient as possible.

Notable UX highlights

Pre-selecting checkboxes is a real-world example of behavioral science (specifically nudge theory) in action. In the U.S., Zillow and realtor.com take different approaches to encourage (or discourage) users to request additional financing information. Overseas, Propertyfinder, PropertyGuru and Otodom do the same when it comes to signing users up for property alerts.

Trade Me has the unique distinction of having the easiest and most difficult mobile form. On the positive side, it is the shortest form from my survey, simply asking for a message. On the negative side, it requires users to sign in to send a message. Luckily, almost the entire population of New Zealand is a member of Trade Me, but in the case of a new user (or someone who isn't logged in), this introduces a significant form completion hurdle.

The more required fields, the more difficult to complete a form. I know Germans can be formal at times, but does salutation really need to be a required field for ImmoScout24?

Redfin has split its form across three screens, each quite simple. But the additional effort to click a submission button three times instead of one, plus additional page load time, adds significant (and unnecessary) overhead.

Hemnet has decided to do away with forms all together and simply list an email address, leaving communication entirely in the user's hands!

Mobile usage

Many thanks to the portals that were willing to share their data with me (both anonymously and on the record). The collective intelligence is a benefit to all!

The percentage of leads that come from mobile (native app or mobile web) varies greatly: from 40 percent in Poland (Otodom) to 91 percent in Singapore (PropertyGuru). 

The biggest markets average somewhere in the middle: around 65 percent in the U.K. (Zoopla) to 72 percent in Australia (Domain).

On average, around 70 percent of all leads come from a mobile device, underlining the importance of a smooth mobile user experience.

User experience best practices

Best Practices for Mobile Form Design is an incredible resource for designing simple and effective mobile forms. Looking at the mobile forms from this survey, there are several best practices to remember:

• Avoid dropdown menus (dropdowns are especially bad for mobile).

• Don't slice data fields (when asking for a first and last name).

• Mark optional fields instead of mandatory ones (don't use asterisks).

A number of real estate portals do a great job at keeping the mobile experience simple and easy by following best practices and keeping the form as short as possible. My hope is that next year the forms will be even easier for users to complete. And if you're wondering just how important leads are, just ask Zillow.

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Before entering the high-octane world of real estate tech strategy, I was a product guy. My master's degree was in human-computer interaction, and I spent the first years of my career as a user interface designer. So I'm passionate about great design!

Why incumbents can't beat Zillow (and the power of network effects)

Recently, several large incumbents have announced big consumer plays aimed at Zillow: Rocket Homes' new consumer portal, and Keller Williams acquiring SmarterAgent as part of its consumer strategy.

Why it matters: Zillow benefits from practically unbeatable network effects in the consumer space. Both of these moves ignore basic strategic principles of playing to your strengths, and picking battles you can win.

Network effects and wide moats

In his best-selling book Zero to One, Peter Thiel provides an elegant definition of network effects: “Network effects makes a product more useful as more people use it. For example, if all your friends are on Facebook, it makes sense for you to join Facebook, too.”

Online marketplaces such as Craigslist, LinkedIn, and eBay are classic examples of businesses that benefit from network effects. The more people that use them -- buyers and sellers -- the more valuable the service becomes.

Businesses that have the benefit of network effects are incredibly difficult to displace. As Tren Griffin writes on a16z, "Nothing scales as well as a software business, and nothing creates a moat for that business more effectively than network effects."

Zillow benefits from the power of network effects. By developing the most popular means of searching for real estate, it attracts buyers and sellers in a virtuous cycle. It has cemented an incredibly strong position with a near-impenetrable moat from competition. This is Zillow's key strength.

Comfortably number one

Logically, the most likely competitor to challenge Zillow's dominance is realtor.com. It is the runner-up portal backed by a multi-billion dollar international media company (News Corp) that also owns several top portals around the world.

But as I've shown in the past, Zillow's ever-important traffic dominance remains constant, undisturbed by realtor.com or anyone else.

If anyone could dislodge Zillow's dominance, it would be realtor.com. But it hasn't; not for lack of trying, but rather an understanding of network effects and the futility of such an effort (remember, it owns the top portal in Australia and knows the power of network effects better than most). News Corp doesn't want to overtake Zillow because it knows it's impossible.

Strategy basics: play to your strengths

Sound strategic planning requires two key elements: leveraging your strengths, and playing where you can win.

A business should build its strategy around an understanding of its key competitive advantages and operational strengths. Those strengths should be applied in areas where it can win (typically where its competitors are weak).

To illustrate this point further, the following chart looks at four examples of Zillow and realtor.com smartly leveraging their strengths and exploiting their competitor's weaknesses.

Less experienced strategists can be reactionary. They see a threat and attempt to counter it, on a battlefield where they are at a distinct disadvantage to a competitor. Keller Williams and Rocket Homes have done just this; choosing to do battle with Zillow on its home turf, where it is strong and they are weak.

Keller Williams and Rocket Homes

Zillow's strength lies in its massive consumer reach through its search portal. This business benefits from strong network effects and has a wide moat to protect it from competition.

Keller Williams is building a new consumer-facing app to "compete directly with search giants like Zillow and Redfin." Rocket Homes is launching a portal to "rival Zillow," which will "let consumers search for homes and apply for loans."

In their efforts build end-to-end homebuying platforms, both businesses have decided to go from positions of strength (mortgages and agent reach) to ones of weakness (consumer listing portal). It's the most difficult battle possible.

What Rocket Homes and Keller Williams are missing in their end-to-end platforms -- the consumer search portal -- is nearly impossible to deliver because of Zillow's dominance and the power of network effects. There's a certain futility in going after Zillow (or Facebook, or Ebay, or Craigslist).

Strategic implications

Keller Williams and Rocket Homes (part of Quicken Loans), are both incredibly large and powerful businesses; Keller Williams has the largest network of agents, and Quicken Loans is the largest retail lender in the U.S. But in the changing world of real estate, they aren't playing to their strengths.

All businesses should know their strengths. Deeply understand your competitive advantage and what value you offer -- and focus on that. 

By going directly after Zillow, Keller Williams and Rocket Homes demonstrate a fundamental misunderstanding of the power of network effects. There's simply no purpose for these new consumer portals to exist, because they don't meaningfully benefit consumers.

In the accelerating race to build end-to-end real estate ecosystems, businesses should focus on leveraging their strengths to gain advantage over competitors and deliver true value to consumers.

Opcity, lead conversion, and the journey down the funnel

Last week, News Corp, owner of realtor.com in the U.S. and the majority owner of REA Group in Australia, announced the $210 million acquisition of lead qualification service Opcity.

Why it matters: With this acquisition, realtor.com dives deeper into the lead conversion funnel in a major way. Opcity features a referral fee business model where customers are worth 36x more than a lead -- which highlights why the U.S. portals are diving deeper into the funnel.

Lead generation vs. lead qualification

Zillow and realtor.com are both lead generators. They drive traffic to their web sites, advertise real estate agents, and generate leads in the form of consumers who are looking to buy a house. This is the lion’s share of their revenues and the core of their business models.

The conversion of leads to actual, paying customers is left up to individual real estate agents, and nominally occurs offline. But this is changing.

In Zillow’s last earnings update, it shared its goal of "moving beyond lead generation and actively evolving toward being a deeper funnel real estate industry partner.” It launched a new, super-charged concierge service where Zillow sales reps qualify leads before matching them with a premier agent.

News Corp’s acquisition of Opcity is the same move: deeper down the funnel. Opcity takes raw leads, qualifies them, and then matches them with an agent. It does not charge per lead, like Zillow or realtor.com, but charges a referral fee for any leads that turn into paying customers (typically 30%-35% of a buyer’s agent commission).

The cost per lead on Zillow ranges from $20 to $220. I estimate the average to be around $55 per lead. For Opcity, assuming a $250,000 home, a buyer’s agent commission of 2.75%, and a 30% referral fee, each customer is worth around $2,000 — or 36x higher than the value of a lead.

Providing a superior experience, to everyone

The rationale for Zillow and realtor.com to move deeper down the funnel is simple: a better experience.

In the case of both Zillow's concierge service and Opcity, consumers are able to speak to a human being faster, and are matched (not just sent) to an agent faster. Agents are matched with pre-qualified consumers, saving them time and energy. Plus the return on investment for the concierge model is far superior to simply buying leads.

At first glance the Opcity and referral fee model may seem like a bad deal. Why would an agent pay 30%-35% of their commission (around $2,000 for an average transaction) for a referral when they can buy leads for a fraction that price? 

It comes down to the math. Buying leads and converting them to customers costs an agent, on average, around $7,500 per customer -- compared to $2,000 for a customer through Opcity.

It all comes down to the conversion rate. Operating at scale and singularly focused on doing one job, Opcity and Zillow have the scale and technology advantage to convert leads more quickly and efficiently. They have call centers, teams, data, and a long list of agents if the first one contacted doesn’t answer the phone. It's no surprise their conversion rate is higher.

A big revenue opportunity

So how big is the opportunity from a revenue standpoint? (The analysis below is based on Zillow, simply because there is so much more data available, but the same logic applies to realtor.com and Opcity.)

Back in FY16, when Zillow last reported the figure, it generated around 17 million leads during the year. If we assume Opcity’s 4% lead conversation rate (between 3x-5x the industry norm of 1%) and a 30% referral fee, those 17 million leads are worth $1.4 billion in revenue to Zillow (about 50% higher than the ~ $930 million in current premier agent revenues today).

Both Zillow and realtor.com can better monetize their leads if they qualify them and adopt a referral fee structure. Realtor.com now has that option through Opcity.

Given the industry upheaval it would create, it's unlikely that Zillow would change its fee structure. Rather, it will likely approach the same commission rate through the existing premier agent program and share-of-voice bidding system (similar to Google AdWords). Zillow will get there in the end, but through a different path: by providing more value to agents and growing the revenue per lead.

Implications for real estate portals

The core of this entire model is the buyer lead, which only works in markets where there are buyer’s agents. In international markets like the U.K., Australia, and New Zealand — where there are only listing agents — buyer leads are not nearly as valuable.

A similar lead qualification service still has merit for seller leads, when consumers are looking for a listing agent (see Homelight, OpenAgent, or REA Group’s Agent Finder service). But real estate portals generate significantly fewer seller leads with a lower intent.

To sum it up for portals: Pay close attention to lead qualification if you operate in a market where you can monetize buyer leads. It's a superior experience with a big revenue opportunity.

Strategic implications

For anyone involved in this sector, there are a number of key takeaways:

• A concierge, lead qualification model provides a superior experience for consumers and agents. And for agents, it delivers a superior return on investment.
• Real estate portals like Zillow and realtor.com can monetize qualified leads much better than raw leads. More value to agents = more revenue.
• The recurring theme here, which I discuss often, is the importance of people in the process. Augmenting -- not replacing -- humans with technology is the winning formula.
• Lead conversion is important! Small teams can't compete, but the larger platform plays (Keller Williams, Compass, etc) can absolutely build products (technology + people) that improve lead conversion at scale. But are they?

If you work for a real estate portal or lead generator and want to capitalize on the lead conversion opportunity, I can help. I currently advise a select number of real estate portals on an exclusive basis (to avoid competitive issues). Drop me a line if you’re interested in exploring the opportunity for your market.

Analyzing the top portals' financial results

Over the past month, a number of the biggest real estate portals around the world have released financial results: Zillow Group, REA Group, Domain, News Corp, Scout24 Group, and Trade Me.

Why it matters: While the results themselves are fairly dry and self-congratulatory, it does give a glimpse into business performance. When viewed as a whole, the results show a number of interesting trends, and give me a chance to highlight the insights behind the numbers, and the numbers behind the story.

Revenue growth comparison

Overall revenue growth sets the foundation for this analysis, and it's quite varied around the world.

The Australian portals are seeing exceptional growth due to the magic of vendor-funded marketing. In the U.S., both Zillow and Realtor.com are starting to slow down, with Zillow investing in adjacent revenue streams. And in Germany, ImmobilienScout24 sees a positive result after a period of relative flatness.

What blows me away, however, is the massive result in Australia. REA Group and Domain recorded huge revenue gains, and nearly all of it from depth products.

The growth strategy isn't rocket science. REA Group generated $100 million in additional revenue by selling bigger photos.

It's worth noting what is driving the revenue growth in each market: more customers, or a higher average revenue per advertiser (ARPA). In the case of REA, Domain, and Trade Me Property, it is all ARPA, which are customers (agents and home sellers) paying more for each listing. However, IS24's revenue growth is entirely driven by an increase in customers and flat ARPA.

In other words, the portals in Australia and New Zealand are fully penetrated but can still raise prices. In Germany, IS24 is struggling to increase revenue per customer, but still managed to sign up more customers over the past six months.

In my latest report, The Future of Real Estate Portals, I introduced the following portal value curve. In essence, it states that product development is becoming more expensive, delivering less value to customers.

The key takeaway is where the revenue growth is coming from: low effort, high value products that promote agents and properties (essentially larger photos displayed more prominently). That's where the big gains are coming from.

The higher-effort products (predictive analytics, lead qualification, etc) aren't a significant contributor to revenue.

Catching the leaders

On a recent call with an investment analyst, we discussed the opportunity for a runner-up portal to overtake the leader. Can Domain take market share from REA in Australia? Can Realtor.com catch up to Zillow in the U.S.?

The evidence suggests that the answer is a resounding no.

The data from the past two years shows an uncannily steady state between the leading and runner-up portals in both markets.

In the core residential listings business, Domain has remained at 27% the size of leader REA. Both business are growing at the same rate; nothing is changing.

In the U.S., the runner-up portal, Realtor.com, has actually lost a small amount of ground when it comes to growth. Zillow is growing revenues faster.

In the important realm of traffic and consumer eyeballs, Zillow and Realtor.com have remained constant for the past three years. Even with all of the hoopla against Zillow for raising prices in NYC, agent revolts, and increased pressure by Realtor.com, it hasn't meant a thing in terms of overall traffic and revenue numbers.

There's a big difference between a catchy headline and the facts of a situation. Always look for the facts.

Mixed results in adjacent revenue streams

The final area of interest is around portals' expansion into adjacent revenue streams. If you follow my work, you know this topic is of particular interest to me. You may read more of my thoughts, specifically around Zillow, in my analysis of Zillow's Strategic Shift.

The question is no longer whether real estate portals are expanding into adjacent revenue streams, but how they are doing it. There are a variety of strategies at play, with vastly different results.

In Australia, both REA Group and Domain are expanding in different ways. REA bought a mortgage broker in 2017, Smartline, while Domain has launched a trio of new services (mortgage, insurance, and utility switching) via joint ventures. The financial results couldn't be more different.

Both business units are generating decent revenues (more so in the case of Domain, because the overall revenue base is smaller), but only one is profitable. REA's acquisition of an existing business running at scale is returning immediate profits, while Domain remains in the start-up zone of continual (and significant) investments: $27.1 million in FY18.

A deeper look at REA and Domains' mortgage products highlights one final observation. Both are quite similar: well-integrated on the listing pages, a robust loan calculator, and then...

Spot the difference? REA's (top) call to action is a phone number, while Domain's (bottom) call to action is the start of a long online form (without even the first field pre-populated like it was on the calculator -- shame!).

This highlights the importance of consumer psychology in transactions of this magnitude, a topic I recently wrote about in How Psychology is Holding Back Real Estate Tech. REA recognizes the importance of actual human beings in this process, and puts them front and center.

If you have an interest in Zillow's recent acquisition of a mortgage brokerage, look no further than REA Group's Australian acquisition to see how it might play out. Purchased over a year ago, the business is profitable, generating good revenue at good profit margins.

Strategic implications

These latest financial results highlight a few key takeaways:

• Revenue growth is still primarily driven by core premium products that increase exposure for agents and property listings.
• The runner-up portals are staying in the runner-up position. There is no data to suggest they are catching the leaders in their markets (this shouldn't be a surprise).
• Launching into adjacent revenue streams is not a sure thing. Initial investment is very high with no guarantee of success. There are a number of different paths to take, and the initial evidence suggests acquiring existing businesses is the most effective strategy.

A Deeper Look at Zillow's Instant Offer Numbers

Zillow's Q2 financial results include some insight into its Instant Offers business and traction to date, but the data is five weeks old. Let's take a look at the most updated data; it's more interesting.

All of the data below is for Phoenix, is based on public records, and is accurate as of August 8, 2018 (yesterday).

A quickly growing business

Zillow announced that it bought 19 homes during the second quarter (through June 30). The current total is 62. That's an additional 43 homes purchased in July and the first week of August. A good ramp up.

Of those 62 homes, 10 have sold, with the remainder either under contract, for sale, or coming soon.

Zillow is purchasing more expensive homes than its iBuyer competitors in Phoenix (Opendoor and Offerpad). The average purchase price for the 62 homes Zillow purchased is $324,000, 25 percent higher than Opendoor.

It's worth noting that the median purchase price is materially higher than the estimates being used by analysts and what was suggested in Zillow's Q1 announcement, $257,000.

For the iBuyer model to work, the home must be sold for more than its purchase price. I call that price appreciation. As a percentage, the price appreciation on the 10 homes Zillow has sold is 3.3 percent.

But because Zillow is purchasing more expensive homes than its competitors, when translated to a dollar value the amount is about equal to Opendoor at $9,600 per home.

Keep in mind that this number is not the net profit per transaction. It does notinclude any of the costs associated with buying and selling a home, including agent fees (which are considerable), buyer concessions, finance, holding, and repair costs.

Moving fast

The 10 homes Zillow sold moved very quickly. The sample size is small so it shouldn't be used as an assumption for the business at scale.

Having said that, of those 10 homes it has taken an average of 20 days to get a contract, and an additional 22 days on average to close. These sales are not indicative of long-term numbers. They are quick sales by definition so they have unusually low times on market.

Strategic implications

A few takeaways to keep an eye on:

• Zillow is ramping up fast, buying 43 homes in the last five weeks. It's serious.
• Zillow is buying more expensive homes than its competitors and what the market predicted. It's still early days, so let's see if this changes over time.
• As a dollar value, price appreciation on the ten homes sold is in line with expectations and local competition.

Real time data

You may have noticed the market reacting strongly to Zillow's Q2 announcement, which contained five-week-old data. If you're a serious investor and don't want to live in the past, drop me a line.

Zillow's Strategic Shift

Zillow announced its Q2 financial results today, along with the acquisition of a mortgage broking business.

Why it matters: This is another big move that signals Zillow's clear intent to get closer to real estate transactions.

A major move into mortgages

In my opinion, the most interesting part of today's announcement is Zillow's acquisition of a mortgage broker, Mortgage Lenders of America LLC.

Why? Two reasons:

• This is exactly the same move REA Group pulled off in Australia last year when it acquired the mortgage broker Smartline (both businesses even have roughly the same number of employees).
• In addition to its Instant Offers program, this is another huge example of Zillow moving closer to the transaction in a big way.

Closer to the transaction

In my latest report, The Future of Real Estate Portals, I provide a strategic framework for how to think about portals expanding into new businesses. There are two ways: getting involved in more of the transaction, and getting closer to the transaction.

There are two big examples of real estate portals making big moves to get closer to the transaction: Zillow's Instant Offers program, and REA Group's acquisition of mortgage broker Smartline.

Zillow's announcement today is yet another major -- and not unexpected -- move in that direction. That's a big deal; it's a clear signal of intent and strategy, and one that no other portal is matching around the globe -- yet.

A strategic shift

What we are seeing is the result of a strategic shift at Zillow, likely started in 2017, and now moving full speed ahead. It is an intentional move to get closer to the transaction is all areas of the business, and move away from simply being a marketplace that connects buyers and sellers. 

As I mention in my report, it is a move from search engine to service engine. And it's a move to larger revenue pools. Zillow's existing mortgage lead gen business generates about $4 per lead. Mortgage origination can generate hundreds to thousands of dollars per customer.

It is a big move. While all the iBuyers talk about providing mortgage solutions to streamline the process, no one has purchased an existing mortgage broker. This isn't testing the waters; it's jumping straight in and hoping for the best.

Premier agent growth as catalyst 

I believe one of the big drivers of Zillow's strategic shift was the slowing growth of its flagship premier agent program. As I've written about in the past, it is naturally slowing down.

To Zillow's credit, with slowing growth in its main revenue driver, it did two things:

• Made the aforementioned strategic shift to get closer to the transaction through Instant Offers and Mortgage lending.
• Made significant investments into its premier agent program to improve lead quality and value to agents.

The first action opened up new areas of growth. The second arrested the decline and stabilized the premier agent program.

Strategic implications

There are a number of key takeaways from Zillow's latest move:

• Moves to get closer to the transaction are people-intensive. At scale, Zillow's Instant Offers will have hundreds of employees on the ground. Mortgage Lenders of America has around 300 employees. Unlike a classic marketplace business, these new growth areas are expensive and low margin.
• This is going to happen everywhere. Expect every major real estate portal to get deeper into the mortgage and finance space.
• Zillow is not standing still. Its business today looks quite different than it did 12 months ago. Does yours?

Rightmove's Growth Continues to Slow

Rightmove announced its half-year financial results today, with revenue growth continuing to slow (down to 9.7 percent).

Why it matters: This is a continuation of the "Rightmove dilemma" of a narrow strategy with slowing growth, and no other revenue streams. It's neither good nor bad, but a fact that investors (and my readers) should be aware of.

A narrow strategy with slowing growth

Rightmove, the U.K.'s leading real estate portal, is a company that I frequently analyze. It is a global leader in the field with a unique, focused strategy.

In my latest report, The Future of Real Estate Portals, I discuss the Rightmove dilemma extensively. Unlike many other portals, it has not diversified its products or revenue streams beyond the core listing advertising business.

The strategy has served the business well for the past decade, but the strategy is beginning to show limitations. Revenue growth is slowing, and today's announcement shows a continuation of that trend.

The two key numbers

The key narrative is growth, with two key numbers: revenue growth and ARPA (average revenue per advertiser) growth.

Once an additional decimal is added, Rightmove's results show annual revenue growth of 9.7 percent (which it rounded up to 10 percent). This is the lowest number in years, and is the first time it has dipped below 10 percent.

Because Rightmove has not diversified its revenue streams, revenue growth is almost entirely driven by ARPA growth (how much it is able to charge its customers). This number, too, is dropping.

ARPA growth for the half-year is down to 8.3 percent, and is projected to stay at that rate for the full year. Once again, this is the lowest number in years. Rightmove can only raise its prices so much.

Implications for Rightmove

This is not the demise of Rightmove. It is still an incredibly strong business, with nearly-impregnable network effects that will likely protect its core business for years. The dilemma is about growth, and the right strategy to match its ambitions. Its growth prospects are challenged.

Rightmove is bumping up against the glass ceiling of price rises; growth is slowing. Slowing revenue growth is leading to tighter cost control, which could inhibit its ability to invest for the future.

Rightmove has not diversified its revenue streams. Nothing new is taking up the slack in the revenue slowdown. It has been promoting new premium features and new products for over a year, but they are not stopping the decline in growth.

Implications for real estate portals

For other real estate portals, there are a number of takeaways to this story:

• Despite your market dominance and powerful network effects, there is a limit to how much revenue you can extract from your customers each year. It will slow over time.

• Additional premium products and services take more effort to build, and are valued less by your customers.

• Continued revenue growth comes from diversification into adjacent revenue streams.

Zillow's revenue growth slows

My analysis on Realtor.com earlier this week surfaced a particularly interesting chart on Zillow's revenue growth. The slowing growth piqued my interest, so I dug deeper into the data and strategic implications.

Zillow has been growing fast over the past few years. The company topped $1 billion in annual revenue for the first time in 2017. But the gravy train can't last forever. How big can Zillow really get?

In its FY17 annual report, Zillow had this to say about its future growth prospects: We see significant opportunity to expand our addressable market over the long term. As we dive deeper in the funnel we see more opportunity to increase the number of transactions and commissions to our partners. 

Many people think Zillow is right at the beginning of its journey, and that it is just scratching the surface of the U.S. market opportunity. However, the numbers tell a different, more nuanced story.

Sources of growth

Zillow generates the vast majority of its revenues (71%) from its premier agent program, which is essentially lead gen for buyers agents.

Other revenue streams, such as display advertising, mortgage leads, and rentals, form a small percentage of overall revenue. Zillow is very much a business centered around -- and reliant on -- its premier agent program. So it is natural to focus on premier agent revenue growth to frame the future prospects of the business.

The key question is: How much runway is left for Zillow to monetize and grow its premier agent business? Are we just at the beginning, or is the opportunity maturing?

Premier agent growth slows

Zillow's year-on-year premier agent revenue growth, broken down by quarter, shows a clear trend of slowing growth. Keep in mind this is off a large revenue base ($760 million annually) so is to be expected. But the trend is clear: growth is slowing.

The chart below shows the same metric, but with absolute year-on-year dollar growth, instead of a percentage. After running up to a high in Q2 2017, the growth rate is dropping, and Zillow is forecasting that trend to continue.

We can also look at the numbers from a full-year financial perspective. The chart below shows steady year-on-year growth in the premier agent program, but Zillow's own guidance shows that it is -- for the first time -- forecasting a slowdown in that growth on an annual basis.

Most businesses eventually reach a terminal growth rate, or a rate at which the business grows in perpetuity. At property portals around the world -- in mature markets where the leaders have effectively saturated the market -- this rate ranges from around five to 15 percent.

Zillow's premier agent program hasn't reached maturity yet, but it appears to have hit its peak growth rate. Now the question is, where will it settle?

Strategic implications: Where to from here?

With Zillow's primary revenue stream slowing, it needs to look at new revenue streams to drive future growth.

One area where Zillow is seeing strong growth is in rentals, where it saw a 124 percent increase in revenue. This is undoubtedly driven by the decision to start charging for rental listings on StreetEasy in NYC in July of last year. You can see the corresponding bump in revenue below.

In 2018, expect Zillow to begin aggressively monetizing new revenue streams. My guess would be a continued focus on rentals and back office tools (dotloop), with additional efforts around new construction and mortgages. This is relatively consistent with the strategy of its international peers.

Also expect Zillow to continue to aggressively monetize agents. By its own admission, "as we dive deeper in the funnel," is code for doing more and charging more. Zillow will attempt to increase the value of existing leads while becoming the technology partner of agencies with transaction management tools like dotloop.

Zillow's slowing premier agent revenue growth will put pressure on the business to develop and exploit new revenue streams. Expect that to be the theme of 2018.

Australia's REA Group vs. Domain

Key points

• Both businesses are growing at the same, strong rate, with all revenue growth coming from depth products.
• Domain has a much more diversified revenue stream, at the expense of profitability.
• Domain is generating 1/4 the listing revenue of REA Group, and is not having a competitive impact.
• Adjacency revenues are small, and in Domain's case, quite expensive.

Australia is home to two leading real estate portals, REA Group and Domain Group. Last month, both businesses released their half-year results.

REA is the clear market leader and one of the biggest and most profitable portals in the world (read more in my Global Real Estate Portal Report). Domain was recently spun-out from Fairfax Media and listed on the Australian stock exchange, and is now able to invest and focus on its core mission.

Growth from depth products

Both REA Group and Domain are growing strong. Their latest financial results show impressive revenue growth in their core residential listing business lines (and for REA, I'm only looking at its Australian business).

Proportionally, both businesses are growing at nearly the same rate (around 19%). This is especially impressive for REA, which is already operating on a large revenue base.

For both businesses, nearly all of this impressive revenue growth is coming from depth products. These are the incremental fees paid by vendors and agents to promote a property listing on the site. $50 million is a big number!

Over time, these depth products are accounting for an increasing percentage of overall revenue (the remainder being subscription fees).

REA is generating about 4x the revenues as Domain in the core residential real estate listing business. I've included Rightmove and Zoopla from the U.K. as an additional data point.

This number isn't changing over time. Both businesses are keeping pace with each other, almost down the the decimal point. In other words, Domain as a strong #2 in the market is not having an adverse impact on REA's ability to grow.

Revenue diversification and profitability

REA Group generates the vast majority of its total revenue from listing fees (depth and subscription), around 84%. Domain, on the other hand, generates only 47% of total revenues from listing fees.

This trend is identical to the U.K. market, where Rightmove, the #1 portal, generates 76% of its revenue from listing fees, compared to 25% for Zoopla, the #2 portal. The #2 players have diversified their revenues in an effort to grow through other avenues.

The market leaders have high profit margins (EBITDA) from the profitable listing business, while the #2 players have lower profit margins from their diversified revenue streams (which tend to be lower margin).

REA's profit margin continues to improve, while Domain's is going down as the business invests in new growth areas. The market leaders are able to continue monetizing their audience without needing to diversify. 

Adjacent services

In Australia, both REA Group and Domain have launched adjacent businesses in financial and transaction services. For REA, this represents a small, but profitable, percentage of total revenue.

Domain, on the other hand, is investing heavily in its transaction services business (which includes utility switching, loan, and insurance products -- and the last two are just getting off the ground). It's generating revenue, but is not yet profitable. In other words, it's spending $12.8 million to generate $11.1 million in revenue -- expensive!

While many in the industry talk up the opportunity in adjacency revenues, the evidence suggests a much smaller (and less profitable) opportunity -- and one that is quite expensive to get off the ground.

Strategic implications for Domain

Domain is clearly operating from Zoopla's playbook: to grow, it must diversify. However, their strategies differ. In the U.K., Zoopla fully owns all of its adjacent businessess. However, Domain prefers joint ventures, owning 50% of its comparison business, 60% of its loan business, and 70% of its insurance business.

Domain is effectively starting its loan and insurance businesses from scratch, while Zoopla acquired existing businesses. Starting from scratch is expensive and will take years of investment.

The scope of the adjacency plays also varies. Zoopla generates and monetizes leads through a comparison portal, while Domain is playing a greater role in the transaction. This is a more expensive, more uncertain, but potentially more lucrative opportunity. The key word is potentially.

Domain's foray in adjacencies should not be viewed as a sure thing. While the intent mirrors Zoopla's strategy in the U.K., the execution is materially different, with the result being far from certain.

Is Realtor.com in it to win it?

On March 7th, this report on Realtor.com owner News Corp piqued my interest. Chief Executive Robert Thomson, referring to Realtor.com, said, "Obviously we’re in a competition, long term, to be number one..."

He went on to say, “...I think it’s fair to say that we turned what was the number three company into a very strong number 2 and, depending on the quarter, depending on the metric, in some quarters the fastest growing."

Here's the thing: I don't think Realtor.com is really competing to be number one.

Growth metrics

If we look at the most important metrics, I don't see evidence that Reator.com is the "fastest growing" in any category. These self-reported traffic metrics are essentially static: Zillow has around 3x the traffic of Realtor.com.

Zillow is growing its revenue (from a larger base) considerably faster than Realtor.com.

On a quarterly basis, Zillow blows away Realtor.com in terms of year-on-year revenue growth (again, from a much higher base).

The last chart does show an interesting trend, which is slowing revenue growth at Zillow compared to rising growth at Realtor.com. But in absolute terms, during the last quarter Zillow increased its revenue by $54 million while Realtor.com increased by $17 million -- a big difference!

There's still a lot of distance between the two, but it's true that Realtor.com is trending upwards while Zillow's revenue growth is slowing.

I'm not sure I'd agree that Realtor.com is the "fastest growing" in any meaningful metric, but the last three quarters show the start of a promising trend for the business.

Is Zillow concerned?

If Zillow were genuinely concerned with Realtor.com's growing momentum, I'd expect its sales and marketing expense to increase. If Realtor.com's market share were growing, Zillow would be spending more advertising money in response.

Aside from a slight bump a few quarters ago, Zillow's sales and marketing expense as a percentage of revenue is relatively flat and trending downwards.

Serious competition for top spot?

You can't argue with the fact that Realtor.com would like to be the #1 portal in the U.S. market. But are they really in a serious competition to be #1?

News Corp has been a major investor in REA Group, the leading portal in Australia, for almost two decades. More than most, it understands the power of network effects and how expensive and futile it can be to unseat a #1 player.

So is News Corp realistically expecting to overtake Zillow in the U.S.? I doubt it. I believe it's happy to run slipstream to Zillow and operate a strong, profitable business in its own right, but remain the #2 player. Attempting to overtake Zillow would be incredibly expensive and uncertain, and the resulting marketing war would drain all profits from both companies.

News Corp would never admit this strategy (who would admit they're happy to be the runner-up?). Being the underdog and striving to overtake the market leader is a great story and good for morale, but it will probably remain just that: a story.

Zillow Group's FY17 Results

Zillow Group's FY17 Results from Mike DelPrete

Zoopla's FY17 Results: Key Takeaways

Zoopla's FY17 Results: Key Takeaways from Mike DelPrete

Why investing in OnTheMarket is a horrible idea

I’ll cut right to the chase: OnTheMarket, the online property portal challenging Rightmove and Zoopla, does not offer more value to consumers compared to the existing alternatives. It serves no purpose and investing in such a business would be a horrible idea.

The power of network effects

The fully understand the case against OnTheMarket, we need to start with the concept of network effects. Simply put, network effects is the phenomenon whereby a service becomes more valuable when more people use it (Facebook is a great example).

Online marketplaces such as Rightmove and eBay are classic examples of businesses that benefit from network effects. The more people that use them -- buyers and sellers -- the more valuable the service becomes. If you’re selling something, you want to advertise to the biggest audience possible. And if you’re looking to buy something, you want access to the largest selection possible (think Amazon).

Businesses that have the benefit of network effects -- again, marketplaces and social networks are the best examples -- are incredibly difficult to displace. Because even if a new entrant’s product is objectively better, a smaller audience of potential buyers and sellers equals an inferior proposition. If you’re holding a garage sale, would you rather sell to an audience of 100 people or 1,000 people?

Providing value to users

As I’ve previously written in The 2 Principles of Startup Success, a new venture needs to provide more value to users than the other available options. If we use Clayton Christensen’s framework of “jobs to be done” as a basis (booking a flight, hailing a cab, keeping track of customers, or buying groceries), then the value of the new needs to exceed the value of the current.

Value can be defined many ways: cost, utility, and convenience are fairly standard measures. The value is what the user perceives and experiences on an individual basis, not what the provider thinks. Value originates with the user, not the new venture.

If you must explain your value, it’s not as great as you think.

If the value of the new is relatively close to the value of the current, you enter what I call “The Grind.” This is the unenviable position where you need to convince customers of the value you provide. As Jeff Jarvis eloquently states in What Would Google Do?, if you must explain your value, it’s not as great as you think.

The customer proposition of property portals

The value that property portals provide to consumers is straightforward:

• For buyers: access to the largest inventory of properties for sale (tracked as the total number of listings)

• For sellers: advertise your property to the largest collection of potential buyers (tracked as the total number of visitors)

Why OnTheMarket is a horrible investment?

Critically, OnTheMarket is a bad investment because it doesn’t provide value to users. There is no compelling reason for consumers to use the product compared to the existing alternatives (Rightmove and Zoopla).

Exhibit #1: OnTheMarket has a fraction of the total number of properties for sale

According to excellent research conducted by Exane BNP Paribas, OnTheMarket has around 5,700 agency customers, which is a fraction of the existing players (see the graph below). In fact, this number is down from 6,300 customers when last reported in 2016.

Earlier research conducted by MyOnlineEstateAgent showed that OnTheMarket had around 36 percent of the listings of Rightmove and 50 percent of the listings of Zoopla.

Looking at one region today, Bristol, shows 2,945 listings on Rightmove, 1,940 listings on Zoopla, and 659 on OnTheMarket. The market leaders have between 3x and 4.5x the total number of listings as compared to OnTheMarket, a non-trivial difference!

So: OnTheMarket has considerably fewer for sale listings than the existing alternatives.

Exhibit #2: OnTheMarket does not have the most visitors

In 2016, this story on EstateAgentToday discussed the relative traffic numbers of the major property portals. In it, OnTheMarket.com reported April traffic of 7.25 million visits, compared to Zoopla attracting close to 50 million average monthly visits to its website and mobile apps, while Rightmove receives more than 120 million visits each month.

In other words, the market leader, Rightmove, has over 16 times the traffic -- also known as potential buyers -- than OnTheMarket. Where would you want to advertise your home for sale?

The following charts from Similarweb show the same story (albeit with slightly different numbers, as web tracking is more an art form rather than a science). The market leaders have anywhere from 10 to 20 times the traffic of OnTheMarket -- and it’s not changing.

Web Site Visitors: Rightmove (orange) vs. OnTheMarket (blue)

Web Site Visitors: Zoopla (blue) vs. OnTheMarket (orange)

So: OnTheMarket has exponentially fewer visitors (potential buyers) than the existing alternatives.

Exhibit #3: OnTheMarket’s user interface doesn’t offer any advantages over the alternatives

In the same EstateAgentToday article linked previously, OnTheMarket’s CEO commented: “We have provided consumers with an alternative search platform which is clean, clear and responsive… There are no third party adverts cluttering the pages and the properties are displayed in the best possible light.”

He posits that the user interface of OnTheMarket provides a superior experience compared of the alternatives. Let’s take a look.

I’ll let you make your own judgement call, but from my perspective the user interfaces are basically identical: clean, simple and intuitive. I don’t see a massive value-add in what OnTheMarket is providing. If OnTheMarket was providing a superior experience, perhaps we would expect its web traffic to be increasing?

According to OnTheMarket, another value add they offer consumers is the ability to set up property alerts to be automatically notified of new listings. But both Rightmove and Zoopla also offer this functionality.

So: OnTheMarket offers, at best, an undifferentiated product compared to the market leaders, providing no additional value to users.

Why does OnTheMarket exist?

All of this begs the question: why does OnTheMarket exist? According to its CEO, it provides an “alternative search platform” for consumers. Which is really no answer at all.

OnTheMarket launched in 2015 to challenge the duopoly of Rightmove and Zoopla in the U.K. market. It was founded by a broad consortium of traditional real estate agencies who didn’t appreciate the market and pricing power enjoyed by the existing portals.

So: OnTheMarket’s reason for existing is to the benefit of existing estate agency owners and shareholders. Along the way, it forgot that it needs to provide actual, legitimate value to users other than an unnecessary “alternative search platform.”

Is OnTheMarket a good investment?

Rule number one in launching a new venture is to provide actual value to your users. It’s impossible to succeed without that key component.

On the verge of its IPO where it is seeking to raise around 50 million pounds at a valuation of between 200 million and 250 million pounds, you have to wonder who would be foolish enough to invest in the venture.

OnTheMarket provides no additional value to consumers. Investing in a business that serves no purpose and adds no value for its users is a horrible idea.

Disclosure: I am not an investor in nor do I have any financial relationship with any of the businesses mentioned in this article. I simply can’t stand bad ideas.

Zillow: Killing the golden goose?

Over the past week, real estate has been dominated by news of Zillow Group’s Instant Offers. The new program, which allows prospective home sellers to receive instant offers on their homes, has been covered across the industry, with the reaction – as one would expect – largely negative.

A thought-provoking article in VentureBeat rhetorically wondered whether Zillow could “Uber-ize” the hundred-billion-dollar real estate brokerage business. The author claims that Zillow is well-positioned to disrupt the industry and capture an even larger share of the brokerage market.

All up, there’s an immense amount of interest related to Zillow disrupting or displacing the traditional real estate industry structure. It’s a huge opportunity, but one fraught with risk.

I’m going to approach this situation from two angles: my own time as head of strategy for a publicly-listed, multi-billion dollar business, and what the data tells us.

Instant Offers: offensive, defensive, or opportunistic?

The key strategic question in all of this is whether Instant Offers is an offensive, defensive, or opportunistic move by Zillow?

If Instant Offers is an offensive move and amounts to Zillow’s first salvo against the real estate industry, it’s a strange one. It’s just too far removed from the endgame of displacing real estate agents. The risk doesn’t match up with the reward.

Or, perhaps it’s a defensive move against the rapid rise of Opendoor and its growing list of national competitors. With Opendoor raising over $300 million U.S. and valued at more than $1 billion U.S., it’s difficult to ignore. But, even a disruptive operation such as Opendoor still needs to sell houses, and those houses will appear on Zillow. And with a two-percent market share in the Phoenix market, it still has niche appeal – not exactly an existential threat to Zillow.

So, the most likely answer is that Instant Offers is an opportunistic move by Zillow. It wants to capitalize on the growing consumer demand for instant home offers, and sees it as a potential new revenue stream, whereby it can collect and monetize seller leads.

This fits well with Zillow’s existing business model: It continues to operate as a marketplace, monetizes leads, and sells those leads to real estate agents. It’s a natural extension, rather than a radical disruption.

Real estate websites versus agents

Real estate websites around the globe have the same problem: a love-hate relationship with their biggest customers – real estate agents. The top sites are fighting a constant battle to extract more money from their customers through regular price rises and value-added services.

On the other hand, real estate agents pay the sites for advertising, exposure, and leads, because of the clear return on investment, but do so begrudgingly and with a sense of fear. Most agents are afraid of these sites gaining too much power, continually raising prices, and perhaps even replacing them with an online-only offering.

So, while real estate sites are best positioned to disrupt the real estate industry by displacing agents, they’re also the least likely to do so, because agents are their biggest customers and source of revenue.

Case in point: The Trade Me Property price rise. While I was at Trade Me, New Zealand’s dominant horizontal, we initiated a modest price rise for agents. It was a change from an all-you-can-eat model with a flat subscription fee towards a pay-per-listing fee. It was not well-received.

Real estate agents across New Zealand were angry. They did not take kindly to a price rise and organized themselves around our rival and No. 2 on the market, the industry-owned RealEstate.co.nz. The impact was a material narrowing of the traffic gap between both sites – arguably the most important performance indicator for a real estate website (see Network Effects for more on that). 

Source: Properazzi

Trade Me Property’s traffic lead went from five times to three times the traffic of the No. 2 rival, a huge drop. Increasing prices for real estate agents – let alone disrupting them – isn’t easy.

(Zillow’s traffic is approximately three times higher than its top competitor in the U.S., namely Realtor.com.)

I believe there are a number of critical preconditions for a real estate website to truly disrupt real estate agents:

1. A monopoly on traffic. Ideally, there is no major No. 2, but if there is, the top site needs to have a massive traffic advantage.
2. Revenue diversification. The less reliant the site is on revenue from agents, the better able it will be to withstand a revenue hit.
3. A strong brand. It should be well-known in the market and be seen as a leader in the field, the equal of any strong brokerage.
4. Online tools to disintermediate brokers. A site needs to offer all the tools and capabilities that a brokerage offers, including CRM, document signing and management, marketing and promotional tools, lead capture and management, and inventory management.

Revenue diversification and risk

Most real estate platforms capture their revenue from agents. Whether spending their own money to promote themselves or buy leads or spending their vendor’s money to advertise a property, the agent controls the purse strings.

In the case of Zillow, around 70 percent of its revenue comes from real estate agents. While not surprising, it’s still a big number that reflects a poor level of diversification. Furthermore, as we can see below, that number as a percent hasn’t changed over the past four years. Zillow does not look like a business trying to diversify its revenue.

Zillow fully believes it is at the beginning of its journey, not the end. It sees plenty of runway left to grow its revenue even higher as more spend goes online. And the numbers prove it: revenue grew 31 percent from FY 2015 into FY 2016, higher than any of its global peers.

In other words: Zillow is making a ton of money with its current business model and sees plenty of growth left. Why put that at risk and kill the goose that lays the golden eggs?

We can also see that Zillow’s revenue share from agents is on par with its global peers. Most of the major players illustrated above receive between 65 percent and 75 percent of revenue from agents. 

Zoopla, the single exception, has taken a proactive strategy to diversify its revenue streams away from agents. In 2015, it acquired uSwitch, a price comparison business, for £160 million and the acquisitions have continued at a brisk pace since then, all in an effort to expand along the value chain and become a one-stop-shop for consumers and real estate professionals.

As opposed to Zillow, Zoopla looks like a business that is diversifying its revenue streams. With that clear strategy in place, revenue diversification has followed.

Of all the major real estate websites in the world, Zoopla is best positioned from a revenue diversification standpoint to disrupt the industry.

Given what we know about its strategy and what the data shows us, I consider it unlikely that Zillow is making moves against the industry. The existing business is just too lucrative with plenty of growth left to put it all at risk.

Rather, Instant Offers is about giving consumers choice, expanding the existing lead marketplace, and a new source of revenue with seller leads. It’s also just a test.

Zillow is not well-positioned to make a big move against the industry. Its revenue is not diversified and there is a strong No. 2 on the market.

Regardless, Instant Offers should be instantly interesting to all of the major real estate websites around the world. It’s capitalizing on a pro-consumer offering that can make these sites more valuable to consumers around the world. I guarantee many – myself included – will be watching this test with great interest.

Zillow: Is profitability in sight?

What’s interesting in the Zillow Group results for Q1? Here are highlights, with charts and commentary. In a nutshell:

• Zillow continues to edge toward profitability, with overall expenses coming in line with revenue.
• Overall revenue growth is re-accelerating, matched by increased spending on sales and marketing.
• Technology-and-development spend has slowed considerably, contributing to slower overall expense growth.

First: The profitability chestnut. Cutting out all the noise for a moment (including stock-based compensation), let’s focus simply on revenue and expenses.

One of the biggest questions for Zillow is: Can it turn a profit? Zillow has lost millions of dollars during the past few years and has yet to turn a profit, even though it’s on track to generate more than $1 billion U.S. in revenue this year.

So, any signs that give clues to whether Zillow can and will become profitable are quite relevant. Zillow has done a good job over the past three quarters; expenses are finally matching revenue.

Quarterly revenue growth has picked up steam as well, up from a relatively slow Q4. In Q1, revenue was up 8 percent from Q4, and 32 percent from Q1 in FY2016.

In particular, the sales and marketing expense is quite illuminating. While Q1 revenue was up 8 percent from the previous quarter, expenses were up 9 percent overall and the sales and marketing expense was up 18 percent.

In absolute terms, revenue was up $18 million U.S., expenses were up $19.7 million, and sales and marketing $15.8 million.

But, looked at over the past year, the story changes. Compared to the same quarter last year, revenue is up 32 percent, expenses up 10 percent and sales and marketing 7 percent.

Again, looking at year-over-year growth in absolute terms, revenue was up $60 million, expenses $22.6 million and sales and marketing up $6.8 million.

Looking further, we can see a rough proxy of how effective sales and marketing spend is in driving revenue. For the past several quarters, each dollar spent on sales and marketing generates from $2 to $2.50 in revenue. And it’s slowly trending upwards.

There was a big increase in sales and marketing spend in Q1 of FY2017, so relative effectiveness has dropped slightly. But, overall it’s a good direction to be heading in — upward, that is.

Another interesting metric is technology and development spend. It’s finally leveling off. In fact, it’s flat when compared to the previous quarter.

Technology is surely a critical component of Zillow’s consumer and customer proposition, so tech spend will always remain high. But, if you’re anxious for Zillow to turn a profit, the relatively flat growth is an important factor and a good signal.

Overall, it was a good quarter for Zillow. Not simply for the headline revenue growth, but for the drivers behind it, that signal a meaningful turn for the company towards sustained profitability.

Observations on Zillow's 2016 results and the U.S. market

Hey, Zillow! Thanks for reporting your full year financial results for 2016. It provides a great opportunity to update my international property portal analysis and draw out a few observations on the U.S. market.

Let’s start with EBITDA

The first thing we need to understand when talking about Zillow is its EBITDA. As I have written in the past, Zillow reports non-GAAP “Adjusted EBITDA” numbers, which exclude stock-based compensation (SBC) costs. Many large U.S. tech companies now include SBC costs in their numbers, which is the generally accepted part of GAAP (generally accepted accounting principles). It’s also necessary to do this for an apples-to-apples comparison to international property portals.

Zillow’s 2016 Adjusted EBITDA is $144.8 million. Once we include SBC costs of $106 million, that drops down to $37.9 million. If we then include the negative impact of the $130 million litigation settlement with News Corp, we arrive safely in negative territory. But for comparison purposes, we’re going to stick with an EBITDA of $37.9 million; the litigation settlement was truly a one-off.

With 2016 revenues of $846 million and EBITDA of $37.9 million, Zillow has an EBITDA margin of 4.5% (far less than its reported 17% using Adjusted EBITDA numbers). As you can see below, that margin is well-below international peers.

Zillow claims that it can reach 40% EBITDA margins “at scale,” which is on par with its international peers. I suspect that number is using Adjusted EBITDA figures, which would not be an apples-to-apples comparison with the peers above.

I highly doubt that Zillow can go from an EBITDA margin of 4.5%
to an EBITDA margin of 40%. 

Zillow is projecting 2017’s revenues to crack $1 billion with Adjusted EBITDA of around $200 million. Assuming stock-based compensation costs of $110 million, that implies an EBITDA of $90 million and EBITDA margins of 8.7% -- nearly double 2016’s levels.

The chart below shows Zillow’s Adjusted EBITDA and EBITDA margins over the past 4 quarters. There was a big jump into profitability in the third quarter of 2016, which has subsequently levelled off in the fourth quarter.

A $200 million Adjusted EBITDA in 2017 looks pretty similar to extending the last two quarters out for the entire fiscal year (the blue line in the chart above), with around $50 million of Adjusted EBITDA per quarter. That implies a relatively flat trajectory when it comes to earnings (in other words, expenses will track higher with revenues).

But does it scale?

I’m interested in understanding how well the Zillow business model scales. When I think about scaling, I think hockey stick curves where revenue grows at a faster pace than expenses. Making more money by spending the same amount – that’s scaling. (For more on scaling in real estate, see Purplebricks results show promising trends written by yours truly.) 

The chart below shows historical revenue and expense growth. In 2016, revenue and expenses both grew at 31%. I’ve forecasted 2017 below based on Zillow’s revenue and Adjusted EBITDA guidance, which implies revenue growth of 23% and expense growth of 13%.

If Zillow can pull that off, it shows the business model has the ability to scale. But judging its historical numbers only, the graph is pretty clear – it’s not scaling; expense growth is keeping pace with revenue growth.

If we look at the previous seven quarters, we see another story of revenue growth. There is no accelerating upward trajectory; in fact, growth is slowing down. 

Going macro

I find it helpful to look at revenue potential from a macro level. How much more room is there to grow revenues in the U.S. market?

Let’s look at the average monthly revenue per advertiser (ARPA). The chart below highlights Zillow compared to international peers and suggests a nice uptick in ARPA, placing Zillow in the middle of the international pack. But it also suggests incremental, rather than exponential, room for growth.

Zillow is again middle of the pack when it comes to revenue per employee. This suggests a limited ability for Zillow to monetize on a radically different expense base (in other words, it probably can’t extract much more revenue without adding more expensive headcount).

At a high level, 2016’s results have moved Zillow up in the pack when it comes to overall monetization relative to population size. In the chart below, REA Group, Domain, and Trade Me Property all operate in a vendor-funded market (meaning home sellers pay for marketing costs, not agents). So Zillow is again middle of the pack for peers in the remaining markets. 

At a macro level and compared to its international peers, there is little to suggest that Zillow can achieve an outsize revenue growth going forward. 

Zillow and the U.S. market

To wrap up, there are a few observations that stand out from Zillow’s results and the overall international analysis:

• We can’t use Zillow’s “Adjusted EBITDA” numbers; it doesn’t paint an accurate picture of the business.
• 2017 is the year when Zillow can prove its business model scales. There is very little in the data above to suggest that revenue growth can materially outstrip expense growth.
• Zillow can and will be profitable, but it will be from relatively low margins on a large base. It will be difficult to reach its intended 40% Adjusted EBITDA margins, let alone anything close to that when you include stock-based compensation costs.

Key insights from a global property portal analysis

I'm big fan of data and an even bigger fan of data visualizations. I track a lot of data on the major property portals around the world. Today, we're going to look at three key insights from that analysis.

If you follow my writing you've seen this first chart before. It shows a financial comparison of the major property portals. This time around, the major change is an effort to present a true apples-to-apples comparison by normalizing EBITDA -- by using generally accepted accounting principles and including share-based compensation as a true cost.

Source: annual reports, company presentation and analyst coverage. All information based on the last full year's results (2015 or 2016).

This has the immediate effect of worsening Zillow Group's 2015 financial results, and making it the only major portal to lose money. But it also leads to the first insight...

Insight #1: Zillow Group is at a turning point

Stock-based compensation (SBC) is the practice of compensating employees with stock instead of cash. According to generally accepted accounting principles, or GAAP, this form of compensation should be included as a cost. But when Zillow Group reports earnings, it does so as "Adjusted EBITDA," which is non-GAAP, and does not include stock-based compensation as a cost. Large technology companies like Amazon and Facebook now admit stock compensation is a normal cost. For a true apples-to-apples financial comparison, we need to include these costs.

The issue is that Zillow Group issues a lot of stock to compensate its employees! Over $105 million in 2015 alone, or 16% of its total revenue. Compared to peers around the globe, that's a big number we can't ignore.

Source: annual reports and company presentations.

We should also consider Zillow's latest quarterly returns for more recent trends. In the chart below you will see its reported EBITDA numbers excluding and including share-based compensation (SBC). It's the difference between profitability and unprofitability.

Source: Zillow Group's quarterly results.

The last three quarters show a promising trend of profitability! Even when including stock-based compensation costs -- which forms a more accurate picture of financial health -- Zillow is finally managing to turn a profit.

In its last full financial year, 2015, Zillow was growing on-par with its global peers (as per below).

Source: annual reports, company presentations and analyst coverage. All information based on the last full year's results (2015 or 2016).

But if the last three quarters are anything to go by (as per below), we can expect Zillow to pull ahead of the pack in a very meaningful way when it reports its 2016 full-year financial results.

Source: Zillow Group's quarterly results.

The signs are promising for Zillow. Revenue growth is accelerating and it's demonstrating an ability to turn a profit, even when including share-based compensation costs. It's at a turning point and should be watched closely.

Before we leave Zillow for our next insight, it's worth throwing in the following chart on board of director composition.  I believe diversity is fundamentally important.

Source: company annual reports and investor web sites.

Why so blue, Zillow?

Insight #2: REA Group is a true global leader

I often speak about REA Group being a global leader, but the data below shows just how much they're blowing everyone else out of the water. Let's start with the average revenue per advertiser (ARPA) below.

Source: annual reports, company presentations and analyst coverage. All information based on the last full year's results (2015 or 2016).

This shows just how effectively REA Group is able to monetize its advertiser audience in Australia. But it's not just the absolute ARPA number that is impressive, but the annual growth.

First we're going to look at ARPA growth rates among its global peers. The other major players around the world are growing nicely, with a promising uptick for Zillow Group.

Source: annual reports, company presentations and analyst coverage. All information based on the last full year's results (2015 or 2016).

But it's not until you add REA Group to the mix that you realise how astronomical its growth is compared to global peers. Not only is ARPA significantly larger, but it's growing at a faster pace.

Source: annual reports, company presentations and analyst coverage. All information based on the last full year's results (2015 or 2016).

REA Group generates more profit than any other property portal in the world. It's worth a quick shout-out to Rightmove, though, for being an incredibly efficient operation and having the highest profit margin of the major portals. Revenue per employee illustrates this perfectly.

Source: annual results and company presentations. Trade Me Property and Zoopla are educated guesses based on available information and the broad nature of the larger groups.

Insight #3: Property portals are not winner-takes-all

With a clear leading portal in each market, there exists enough room and marketing spend for a viable #2 player to emerge. I've opted to look at total population below because the data is easily available. It's much more difficult to find an accurate number of transactions in each market.

Source: annual results, company presentations and Google. Axel Springer includes Germany, France and Belgium. SeLoger is not broken out separately for France, which would likely result in a much higher number.

REA Group and Domain are the #1 and #2 property portals in Australia, and Rightmove and Zoopla are the #1 and #2 portals in the U.K. The top portals are able to monetize between 1.8 and 2.3 times higher than the runner-up portal in each market. This is reflective of both absolute revenues as well as ARPA.

It's worth noting that Australia and New Zealand (Trade Me Property) operate in a "vendor funded" market, meaning that home sellers -- and not real estate agents -- pay for advertising on the portals.

2017 is going to be an interesting year in the property portal world. Will Zillow Group successfully turn the corner of profitability? Will REA Group's momentum in Australia continue? And how will the #2 players in each market grow?