2 Key Learnings from a Purplebricks Retrospective

/
 
 

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

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

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

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

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

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

 
 

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

 
 

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

 
 

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

 
 
 

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

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

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

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

The Race to Cut Costs

/
 
 

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

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

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

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

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

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

 
 

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

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

 
 

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

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

 
 

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

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

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

 
 

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

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

 
 

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

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

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

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

/
 
 

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

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

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

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

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

 
 

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

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

 
 

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

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

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

Slowdown: The Velocity of Brokerage Revenue Decline

/
 
 

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

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

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

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

 
 

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

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

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

 
 

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

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

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

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

 
 

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

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

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

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

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

Further Cuts on Compass' Path to Profitability

/
 
 

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

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

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

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

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

 
 

Compass ended the quarter with $355 million in cash.

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

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

 
 

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

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

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

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

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

 
 

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

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

 
 

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

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

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

One Year Later: Zillow Offers & Opendoor

/
 
 

Last week Opendoor announced that it lost nearly $1 billion during the third quarter of the year — the result of selling too many homes at a loss.

Why it matters: Exactly one year ago Zillow faced a similar situation with its iBuyer business, Zillow Offers — and subsequently shut it down.

  • The cause and effect in each case is similar, with nearly identical financial implications, but the paths forward differ.

Dig deeper: Opendoor’s net loss of $928 million for the quarter is more than double Zillow Offer’s net loss of $422 million in Q3 of last year.

  • It’s a matter of scale: Opendoor sold more than twice as many homes as Zillow (8,520 vs 3,032).

  • The net loss also includes significant inventory write-downs: $573 million for Opendoor and $304 million for Zillow.

 
 

On a per home basis, each company incurred similar losses.

  • The write-down per home in inventory is nearly identical, showing that both companies were guilty of “unintentionally purchasing homes at higher prices than current estimates of future selling prices.”

 
 

Zillow’s decision to shut down Zillow Offers in Q3 2021 likely protected the company from at least a billion dollars of additional loses.

  • It also returned the company to profitability (on an adjusted EBITDA basis) and removed the uncertainty of wild profitability swings.

  • Meanwhile, Opendoor will endure at least six months of unprecedented financial losses.

 
 

(Adjusted EBITDA excludes inventory write-downs, stock-based compensation, and property financing expenses.)

What to watch: Opendoor is making significant changes to reduce its risk in response to the volatile real estate market.

  • It is buying significantly fewer homes, and making lower offers on the homes it does purchase.

  • The company launched a new, asset-light marketplace to connect buyers and sellers, without Opendoor actually purchasing the home (more on this in a future analysis and my upcoming webinar).

  • Opendoor also quietly shut down its entire mortgage operation, Opendoor Home Loans.

Key learnings: It is very challenging for an iBuyer to respond to sudden market volatility, especially changes in home price appreciation.

  • At the desired scale iBuyers want to operate at, the results of downward pricing pressure can be financially catastrophic.

  • Asset-light — not buying the actual house — is taking more prominence in the evolution of the iBuyer business model (and is a key component of the Power Buyer model).

The bottom line: In retrospect, Zillow’s decision to shut down Zillow Offers was the right call: it prevented additional loses, preserved the core business, and positively refocused the company.

  • But while Zillow Offers folded, Opendoor has no choice but to continue on in a challenging and volatile market — making adjustments to its business model as it goes.

Predators and Prey

/
 
 

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

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

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

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

 
 

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

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

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

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

 
 

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

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

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

 
 

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

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

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

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

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

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

Behind the Scenes: Writing a 361-Word Article

/
 
 


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

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

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

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

  • What else should I know about this situation?

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

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

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

 
 

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

 
 

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

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

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

 
 

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

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

 
 

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

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

 
 

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

 
 

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

 
 

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

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

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

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

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

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

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

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

 
 

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

 
 

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

 
 

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

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

 
 

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

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

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

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

2021 is an Outlier, Not a Benchmark

/
 
 

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

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

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

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

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

 
 

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

 
 

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

 
 

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

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

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

 
 

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

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

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

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

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

The Real Estate Portal + Mortgage Conundrum

/
 
 

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

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

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

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

 
 

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

 
 

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

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

 
 

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

 
 

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

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

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

 
 

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

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

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

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

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

For First Time, Opendoor Selling Homes for a Loss

/
 
 

Opendoor's buy-to-sale premium -- the difference between the purchase and resale price of its homes -- has reached a record, negative low.

Why it matters: For the first time in its existence, Opendoor is entering territory, where, in aggregate, it is selling homes for less than their purchase price.

  • This certainly puts the company (and business model) under pressure, and is reminiscent of the situation faced by Zillow last year.

Go back: Opendoor outperformed Zillow during the dark days of 2021 (when Zillow Offers imploded); its buy-to-sale premium never dipped below zero percent.

 
 

But 2022 is different; transposing Zillow's performance in 2021 to Opendoor in 2022 shows a similar deterioration in the buy-to-sale premium.

  • Even Opendoor's pricing operation can't keep up with the rapidly changing market (or perhaps this was a calculated risk Opendoor was willing to take).

 
 

(I've estimated a negative two percent buy-to-sale premium in September, but it's still too early to know where the month will land.)

While Opendoor's buy-to-sale premium is approaching the same negative levels that sunk Zillow last year, it doesn't mean the result will be the same.

  • Zillow experienced a system-wide iBuying failure, and exited because it was unwilling to accept the risks to its entire business going forward.

  • Opendoor, built from the ground up as an iBuyer and willing to accept those same risks, is vigorously managing the current situation.

Opendoor's buy-to-list premium, a leading indicator of future profitability, appears more optimized than Zillow's in 2021; the distribution is less concentrated with more potential resale upside.

  • It would be fair to say Opendoor's pricing operation is more nuanced and sophisticated.

 
 

Opendoor is also leveraging aggressive price cuts.

  • The initial buy-to-list premium (blue line) represents new houses listed in a current month, while the current buy-to-list premium (pink line) includes houses listed in previous months.

  • The difference is price cuts; Opendoor cutting the initial listing price down to the current listing price -- which it is doing energetically across its markets.

 
 

Some perspective: Opendoor is selling around 2,000 houses per month with an average sale price of $400,000. A buy-to-sale loss of two percent amounts to a $16 million loss.

  • Yes, and: Opendoor is racking up other expenses, including $3,500 buyer agent commission bonuses and seller concessions, to previously unseen levels.

  • The result is going to be a pretty tough Q3.

The bottom line: This is market whiplash -- just six months ago I was talking about how Opendoor was going to make record profits from home price appreciation.

  • You can't have highs without the lows -- this is the nature of iBuying, and now is Opendoor's chance to prove its model works during a significant downturn.

Thank you to my friends at Datadoor.io, Yipit Data, and Max Mitchell for their help with data for this analysis. "In God we trust; all others bring data."

Opendoor's Buyer Agent Commission Advantage

/

Even in a cooling market, Opendoor's buyer agent commissions -- the fee paid to a buyer's agent when a house is sold -- remain significantly lower than market averages.

Why it matters: Leveraging its powers of scale, Opendoor is pushing down buyer agent commissions in order to reduce its expenses -- a trend that began in early 2020.

  • Opendoor's buyer agent commissions range from 0.5 to 1 percent lower than the market average (typically, but not always, three percent).

  • At scale, this could save the company over $50 million in commission fees annually.

Dig deeper: The data above, collected from Datadoor.io, looks at over 9,000 listings in Opendoor's 20 largest markets as of September 2, 2022.

  • There were also 226 listings with buyer agent commissions above three percent -- typically on houses that are struggling to sell.

 
 

The bottom line: Opendoor is deftly turning the buyer agent commission into a competitive advantage to optimize its business model.

Opendoor Doubles Its Ad Spend

/
 
 

Opendoor's advertising spend has skyrocketed this year, higher during the first six months of 2022 than ALL of last year.

Why it matters: Even in a slowing market, Opendoor's foot is firmly on the accelerator, growing the business and educating consumers at a scale never seen before.

  • In addition to key partnerships, Opendoor is taking its message of a quick, instant sale directly to consumers in a big way.

Opendoor's increased advertising spend is driving an increase in home purchases; it's already purchased nearly twice as many homes in the first six months of 2022 compared to the same time last year.

 
 

Opendoor is becoming a real estate advertising juggernaut as it strives to become a leading consumer brand.

  • Compared to the same time last year, Zillow spent $12 million less on advertising (largely due to its exit from iBuying), while Opendoor's ad spend surged $71 million.

  • At its current rate, Opendoor could eclipse Zillow's ad spend in 2022.

 
 

The bottom line: At a time when other real estate companies are slowing down and cutting expenses, Opendoor is accelerating.

  • It's notable that Opendoor hasn't enacted layoffs, isn't unilaterally cancelling purchase contracts, and has increased its advertising spend.

  • With a strong balance sheet, Opendoor is taking a long-term view of the business and enthusiastically investing now for future growth.

Deeper Cuts Announced as Compass' Cash Burn Continues

/
 
 

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

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

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

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

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

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

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

 
 

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

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

 
 

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

 
 

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

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

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

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

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

Zillow Home Loans Continues Its Unprofitable Run

/
 
 

Like much of the industry, Zillow's mortgage operation, which includes Zillow Home Loans, has seen a steep decline in revenue and continues to burn cash.

Why it matters: Attaching mortgage is a key component of Zillow's "Housing Super App" and future growth strategy; the longer it falters, the less likely Zillow is to achieve its long-term aspirations.

  • Zillow's 2025 goal includes an additional $800 million in revenue from adjacent services -- primarily mortgage.

 
 

Dig deeper: Zillow's mortgage segment, which includes its mortgage lead gen marketplace and in-house lender Zillow Home Loans, is consistently unprofitable.

  • In the first half of 2022, Zillow spent $1.85 for every $1 in mortgage revenue.

  • That's a $65 million loss in the first half of 2022, and a combined loss of $180 million since 2017.

 
 

Context: The entire mortgage industry is getting hammered this year, with dropping leads, loan volumes, and revenue.

The bottom line: Zillow Home Loans' path to profitability remains long, arduous, expensive, and uncertain.

The Zillow & Opendoor Partnership

/
 
 

Last week, former rivals Opendoor and Zillow announced a partnership to provide Opendoor's instant cash offers to Zillow's audience.

Why it matters: This is a big move for both companies. It reaffirms the continued relevancy of iBuying, gets Zillow back into the seller lead game, and gets Opendoor access to its largest customer acquisition channel yet.

But, why: It's a match made in lead gen heaven.

 
 

This partnership gives Zillow the ability to generate and monetize high-quality seller leads (consumers that are considering selling their home), something it lost when Zillow Offers was shut down last year.

  • Historically, Zillow was only able to convert 10 percent of sellers who requested an instant offer; the other 90 percent are high-quality seller leads.

  • Those leads are worth their weight in gold and can be monetized through Zillow's premier agent network (yes, I've been talking about this since 2018).

For Opendoor, this partnership represents an incredible -- and perhaps the industry's largest -- source of customer leads.

  • It extends Opendoor's ecosystem partnership strategy, which includes deals with Redfin, realtor.com, and eight of the top ten homebuilders.

  • The potential benefit to Opendoor is economic: lower customer acquisition costs, which were around $5,500 during the most recent quarter.

 
 

Perhaps most important, a Zillow Advisor will be the first point of contact for consumers requesting an instant cash offer.

  • This effectively cements Zillow's powerful position at the top of the funnel with continued, full access to the customer.

  • A Zillow Advisor will be able to discuss an instant cash offer alongside a traditional sale (seller lead), in addition to Zillow Home Loans.

Without the opportunity to upsell adjacencies, Opendoor becomes a fulfillment engine, similar to its other industry partnerships, focused on the core iBuyer transaction (buy, fix, sell).

The bottom line: This deal is both a confirmation of the relevancy of iBuying, and a continuation of that relevancy through Zillow's promotion of instant offers across its massive platform.

  • It puts Zillow back in the potentially-lucrative seller leads business, and gives Opendoor access to millions of potential customers. Win-win.

For more on iBuyers, portals, and the major shifts across the industry, check out my keynote presentation, 2022 WTF, from Inman Connect Las Vegas.

Building a Better Mousetrap: Zillow vs. Opendoor

/
 
 

Opendoor made over two million offers to curious homeowners in 2021, exponentially more than ever before.

Why it matters: This highlights the growing potential of Opendoor's "top of the funnel" customer appeal -- which is beginning to rival Zillow.

  • Opendoor and Zillow are both in the game of attracting consumers and converting them to monetizable customers.

Dig deeper: Of the 2.1 million offers Opendoor made in 2021, it only purchased 1.8 percent, or around 37,000, of those houses.

  • Based on the company's numbers, of those 2.1M offers, five percent, or 105k, represented unique "real sellers." Of those, 35 percent sold to Opendoor.

  • That purchase rate has decreased over time as Opendoor has ramped up the number of offers it makes while automating the offer process.

 
 

A low purchase rate does raise questions of product/market fit.

  • Based on the total offers sent out, a very small number of consumers are deciding to sell their home to Opendoor.

  • But of "serious sellers," one in three ain't bad.

Yes, but: Hundreds of thousands of consumers are actively deciding to visit Opendoor to request an offer.

  • Even if Opendoor doesn't buy the house, the company still touches a homeowner during their home buying/selling journey, creating an opportunity to cross-sell adjacent services (brokerage, mortgage, leads to agents).

  • And, as we'll see below, overall customer conversion is on par with Zillow.

Zillow's powerful top of the funnel customer acquisition tool is its web site, which generated an estimated 21M leads in 2021.

  • Of those, 1.4M were "real buyers" and 26 percent of them (360k) ended up transacting with a Zillow Premier Agent.

  • That results in an overall conversion rate of 1.7 percent, exceedingly similar to Opendoor's 1.8 percent.

 
 

Zillow's dominance at the top and bottom of the funnel is clear: 10x larger than Opendoor.

  • But surprisingly, Zillow, the decades-old industry heavyweight, is only 10x larger than Opendoor, which has made notable gains.

  • There are variations in conversion rates throughout the funnel, but overall efficacy is nearly identical.

Remember: Zillow is optimized around home buyers, while Opendoor is optimized around home sellers.

The bottom line: With similar conversion rates, neither company has built a better mousetrap, but Zillow's mousetrap is exponentially larger.

  • In terms of customer reach and the sheer quantity of leads generated, Zillow has a huge advantage.

  • But with its ongoing national expansion, heavy advertising investment, and automation of the offer process, Opendoor is making significant gains -- and the growing power of its top of the funnel customer acquisition can't be ignored.

A note on data: The last time Zillow reported the number of leads generated annually was 17M in 2016. My assumption of 21M leads in 2021 is a well-informed estimate.

Opendoor's Buy-to-List Premium Falls Back to Earth

/
 
 

After reaching record levels earlier this year, Opendoor's buy-to-list premium (the difference between the purchase price and current listing price of a home) has fallen dramatically -- a reflection of a rapidly changing market.

Why it matters: The buy-to-list premium is the best leading indicator of iBuyer profitability -- and while it has dropped, Opendoor appears to be deftly riding a dynamic market.

  • As of June 16th, Opendoor's median buy-to-list premium across 2,700 listings was 7.3 percent -- down from a record 17 percent in March.

Opendoor's home sale prices, as measured by the buy-to-sale premium, lags the market by a few months, and, for the time being, remains in very healthy territory.

  • In fact, Q2 is going to be another record quarter for Opendoor, with average buy-to-sale premiums over 10 percent according to YipitData.

 
 

A dropping buy-to-list premium is not the end of the world for Opendoor; it's not overpaying for houses or losing money on their resale.

  • Opendoor's buy-to-list distribution curve is significantly better than Zillow's was last year, when Zillow was, on average, losing money on each house resold.

 
 

The bottom line: The heady days of record home price appreciation -- the most significant driver of iBuyer profitability -- appear to be coming to a close (for now).

  • A buy-to-list premium of 7 percent is still healthy (and on par with the entirety of 2018 and 2019) -- but anything much lower, for longer, could present challenges.

eXp's Business Model Advantage

/
 
 

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

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

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

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

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

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

 
 

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

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

Brokerage Slowdown Begins

/
 
 

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

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

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

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

 
 

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

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

 
 

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