Purplebricks’ Market Share Ceiling

Purplebricks’ H1 2020 financial results highlight a business whose growth has clearly plateaued and reached maturity in the U.K. The company appears to have reached peak efficiency, putting a ceiling on its future growth prospects.

Financials: Profitable, But No Longer Growing

Purplebricks’ revenue growth in the U.K. has effectively stopped. Total revenue is down from the same six month period last year, and the overall growth picture has gone from growth in 2018 to a plateau in 2019 and 2020.

Purplebricks’ U.K. business is still profitable, which is becoming a rarity in the world of real estate tech brokerages. Other high-flying overseas disruptors, like Redfin, Compass, and Opendoor — which have raised billions of dollars and are grabbing market share from traditional incumbents — are all unprofitable.

The fundamentals of the Purplebricks business model are sound, with demonstrated profitability, but it has clearly hit a glass ceiling in terms of market share. Its number of customers, as measured by "instructions to sell," has remained flat over the past two and a half years.

Purplebricks remains a business that scales linearly based on money (marketing costs to acquire customers) and people (local property experts to service those customers).

Marketing ROI

One key to the Purplebricks business model is efficient marketing spend at scale. On a positive note, its marketing return on investment (ROI) has bounced back up in the most recent six months. Each £1 invested in marketing returned £3.8 in revenue.

By way of comparison, Redfin had a marketing ROI of 9.8x in 2018 and 5.9x in the first nine months of 2019 — significantly higher than Purplebricks. This is a reflection of the value of Redfin’s popular consumer portal; having tens of millions of visitors browsing listings helps the brokerage acquire customers at a relatively low cost. (Last week I wrote about the difficulty — and incredible competitive advantage — in building a large consumer audience.)

Overall customer acquisition cost (CAC) has also remained relatively flat, at around £375 per customer. This number really hasn’t changed much in over three years. The small fluctuations suggest a business model that has reached peak efficiency for customer acquisition — again highlighting a limiting factor in growing market share.

Gross Margins

Purplebricks is a business with a novel operating model. It has managed to change how traditional estate agents are compensated, with a structure more similar to Uber than a traditional real estate brokerage. As a result, its gross margins, 64 percent, are top of the industry. (For more on this, check out Inside Compass — Part 5: Endgame.)

Industry Average: REAL Trends U.S. reporting, Redfin: Brokerage Services Only, Compass: author's estimates.

Lessons Learned

I continue to use Purplebricks as a case study of successful disruption in my university course on real estate tech. Going from an idea to the largest estate agent by market share in the U.K., with a profitable business model (in the U.K., at least), is impressive and worthy of study.

In the U.K., Purplebricks succeeded where every other hybrid agency failed: by scaling. While its competitors slowly went out of business while failing to demonstrate a path to profitability, Purplebricks — partially through sheer force of will and spending power — managed to scale to the point of profitability.

But while Purplebricks managed to cross that first chasm, it never really made it over the next one: becoming a platform. The business still scales linearly based on marketing spend and people; I've yet to see evidence to support a credible path to double-digit market share. In the U.K., this may be as big as the business can get — a high-water mark for the hybrid agency model.

A Real Estate Portal's Path to Market Power (A Zillow Case Study)

Zillow’s drive to dominance in the greater New York City real estate market — via rental listings on StreetEasy and its hyper-local Hamptons portal Out East — reveals the path to market power of real estate portals around the world.

The Path to Market Power

All real estate portals follow a simple formula for national domination: acquire listings, build consumer traffic, and monetize. Comparatively, the first step is easy, the second hard, and the third inevitable.

Building a huge consumer audience and achieving traffic dominance — which can take a decade — is the critical step. After that step comes power: The power to monetize, the power to push out competition, and the power to force adoption of your platform by recalcitrant customers.

(Upstart portals, such as OnTheMarket in the U.K. and Bomero in Sweden, don’t seem to fully recognize the difficulty of building traffic dominance — frequently believing that “if you build it, they will come.” The importance of acquiring listings is overstated while that of building traffic understated.)

Battleground New York

Zillow acquired StreetEasy, New York City's leading real estate portal, in 2013. Four years later, it announced it would begin charging for rental listings: $3 per listing per day. The rationale was that it would enable StreetEasy to "continue to fuel innovation, technology and resources to support a robust rental marketplace,” but it was also the inevitable outcome of achieving listing and traffic dominance in the market.

The pricing change caused a drop in listings — by some accounts, more than half — but StreetEasy still had the most listings and, more importantly, traffic dominance. This dominance allowed StreetEasy to announce a fee increase of 50 percent to $4.50 per listing per day in 2018. And again a year later, in 2019, StreetEasy announced a fee increase to $6 per listing per day.

There’s a fantastic, self-correcting system at play here — call it a free market — where the platform keeps increasing its prices and its customers keep paying, as long as there’s a positive return on investment. While price rises never feel good, it's hard to argue with, or effectively replace, the advertising reach a portal provides.

Monetization Strategies

Real estate portals around the world employ differing monetization strategies. Outside of the U.S., portals act as the de facto multiple listing service (a national database of all properties for sale) and monetize on a pay per listing basis. Within the U.S., Zillow has adopted both pay per listing (StreetEasy rentals) and, where a multiple listing service is already in place, pay per lead (Premier Agent).

Both strategies have their advantages. In some countries, the average revenue per listing can be thousands of dollars, while the price of a lead can range between $50-$100. The U.S. portals, Zillow and realtor.com, are pushing out a new, success-based fee structure in favor of pay per lead (read my analysis here).

Out East

While the battle for rental listings is well-advanced in New York City, the struggle is at an earlier stage for Zillow’s hyper-local portal in the Hamptons, Out East. Launched in 2018, Out East is in the early stages in the path to market power: acquiring listings and building traffic.

A group of local brokers launched a competing portal, HamptonsRE.com, to challenge the dominance of Zillow and Out East. While not seriously threatened (HamptonsRE.com only has 1,800 listings vs. 2,500 at Out East), it is a critical time in the path to market dominance.

Zillow’s recent decision to move from a pay per listing subscription to a free model for agents is a step backwards in its monetization journey. But it is only a tactical retreat designed to give Zillow a long-term, strategic advantage. Any by allowing agents to post new listings directly — for free — Zillow's move effectively circumvents the brokerages and handicaps their portal.

Key Takeaways

Viewed through a strategic lens, the moves and countermoves in the New York market highlight a number of key takeaways:

• Traffic is king. Once traffic dominance is achieved, there’s really no stopping a portal from moving down the monetization path at will.

• Play the long game. In the Hamptons, Zillow’s power gives it the ability to turn off an existing revenue stream in order to solidify its market position for the long term, with the inevitable monetization coming later.

• Consumer first. An interesting observation: when brokers band together to launch a competing portal, they rarely talk about the consumer. To wit: "The impetus for the site was to create something that’s owned by the brokers." These are companies launching products that are good for themselves, not consumers.

Mike DelPrete: 2019 in Review

Amazing things happen when you combine a thirst for knowledge with an industry hungry for change. In 2019 I published a massive amount of original, evidence-based research in real estate tech -- and worked with a growing, receptive group of industry executives, mainstream media, investors and founders.

I'm grateful for the opportunities the year has brought me and for the personal connections created. I've made many friends (and antagonized a few people I'm sure). I truly value the intellectual challenge of what I do, and enjoy being at the nexus of the massive changes occurring across the real estate industry.

My 2019 Highlights

Three Major Reports

I released the industry-leading, 160+ slide iBuyer Report, a 35-page strategic analysis of Compass, and a comprehensive research study of iBuyer offer quality.

Keynote Presentations

I delivered a number of "wildly insightful and incisive" presentations, from conference keynotes to intimate executive retreats. Check out iBuying Disrupted: Battle of the Behemoths from Inman Connect.

Media Coverage

My research and analysis was covered in the Wall Street Journal, New York Times, Bloomberg, Curbed, the Australian Financial Review, and others. Plus I was on NPR's Marketplace, twice.

Strategy Consulting

I worked with a select group of companies around the world, helping them understand the changes occurring in real estate, crafting growth strategies, and connecting them with partners, investors, and investments.

Real Estate Tech 101

I had the pleasure of ushering the largest group of students yet through my class on real estate tech at the University of Colorado Boulder.

Looking Ahead

Last year a reader said I was "the most reliable source for data-driven, strategic insights in the industry." That's my North Star. I'm looking forward to harnessing my curiosity, creativity, and industry connections in the year ahead to do my best work yet. Thanks for supporting my work -- 2020 should be a blast!

Property Portal Pricing Is Irrational (A Case Study)

I’m selling my house in New Zealand. As part of the process, I'm advertising the property on the major property portals as well as Facebook and Google. It's a perfect opportunity to evaluate the pricing and performance of the various advertising channels, and reveal -- in a real world scenario -- how irrational the system can be.

Background

In New Zealand there is no MLS system that has all properties for sale. That job falls to the real estate portals, and the business model of those portals is pay-to-list. New Zealand (in addition to Australia) is also a vendor-funded marketplace, meaning the homeowner pays the advertising costs, not the real estate agent. And for this transaction, I'm using a Tall Poppy real estate agent, the company where I’m an independent director.

Cost per Channel

When listing my house, I was presented with several advertising options. Trade Me (where I used to work) is the leading real estate portal and realestate.co.nz is the #2 portal. Facebook and the Google Display Network (GDN) are alternative advertising options, and in the world of real estate portal strategy, I’m curious to evaluate their effectiveness (i.e. are they truly competition to the portals?).

There is a significant cost difference between the #1 and #2 portal; Trade Me is over five times more expensive, but is it five times as effective?

Clicks to Listing

The easiest measure of advertising effectiveness are clicks to the property listing. In this case, as is the case with many real estate portals around the world, the top portal is absolutely dominant. At the time of analysis, Trade Me generated over 10 times the clicks to my property listing than the runner-up portal -- 3,100 vs. 300.

(It's worth noting that the Tall Poppy web site generated more clicks for my listing than the #2 portal, reinforcing the continued importance of a real estate agent's web presence to advertising listings.)

Cost per Click

To measure the overall cost effectiveness of the advertising options we review the cost per click.

Trade Me, the top portal, is not only the most effective but also the most cost effective -- by a wide margin. While Trade Me is over ten times more effective than the runner-up portal, it is only 5.5 times more expensive.

Assigning a value per click of $0.30 (the blended average), Trade Me delivered $936 of value for $549, while the runner-up portal only delivered $89 of value for $99 -- a negative return on investment.

It turns out that Facebook is a legitimate advertising channel, but it doesn’t come close to replacing the portals as the primary advertising channel -- in terms of clicks and cost effectiveness. GDN is simply not cost effective.

Findings

Real estate, and real estate advertising, is a non-rational system. Decisions are made based on emotions, not facts. And this transfers to the world of real estate portals and pricing strategies.

A portal's pricing doesn’t always align with its effectiveness. There are more systems at play that influence -- and restrict -- a portal’s pricing strategy, namely the risk of alienating customers by aggressively raising fees, and pressure from competitors.

For the time being, the top portal in each market -- Zillow, Rightmove, REA Group, ImmoScout, Trade Me -- commands a dominant position. Being the place where "everyone goes to search for property," even with alternate options, most often yields exponentially more effective results than the competition.

Do iBuyers Like Opendoor and Zillow Make Fair Market Offers?

This research study addresses a fundamental question in real estate: Do iBuyers like Opendoor and Zillow make fair market offers on the homes they purchase? This has been a point of contention since the iBuyer business model launched, with opponents claiming that iBuyers purchase houses at well below market value, while iBuyers claim they provide consumers fair market offers.

To provide a definitive answer, this comprehensive study is both deep -- reviewing over 20,000 iBuyer transactions -- and broad -- utilizing multiple methodologies to draw insights from the data. The evidence suggests a clear answer to an often confusing question.

Methodology and data

This study uses three methodologies to establish an evidence-based view of iBuyer offers relative to market value:

1. Purchase Price-to-AVM

2. Price Appreciation

3. Rejected Offer vs. Market Sale

The data consists of over 20,000 iBuyer transactions conducted in 2018 and 2019 where an iBuyer purchased and then resold a property. The transaction data is sourced from public records, which are the legally required disclosures on any property transaction. Multiple sources were used to establish consistency, and thanks go to Remine and ATTOM Data for making their unique expertise and data sets available.

The data used is not merely a sample; it is comprehensive, covering over 95 percent of relevant iBuyer transactions. The study includes over 60 different legal buying entities that iBuyers use to purchase homes. While all major iBuyers were tracked, this analysis focuses on the leading two: Opendoor and Zillow, which account for 86 percent of total iBuyer volume.

Method #1: Purchase Price-to-AVM

Purchase Price-to-AVM is a straightforward comparison of the price an iBuyer pays for a house and what an AVM (automated valuation model) determines a house is worth at the time of purchase. This study uses the First American AVM.

A review of the transactions undertaken by Opendoor and Zillow between January and September 2019 reveal a median Purchase Price-to-AVM of 98.6 percent, or $3,800 on a $270,000 home.

(For those interested, transactions in 2018 reveal similar results +/- 0.1 percent. I am focusing on 2019 because in a rapidly changing industry, the most recent transactions best reflect the current practices of each business. Zillow was in start-up mode in 2018.)

The Purchase Price-to-AVM also varies by market, with consumers getting offers closest to AVM in the three Florida markets of Tampa, Orlando, and Jacksonville.

While an AVM is not a definitive proxy for true market value, like a Zestimate, it is a data point and does provide helpful context in determining the fair market value of a house. The outliers are most likely problems with the AVM, rather than an iBuyer purposely over- or under-paying for a house by a significant margin.

Method #2: Price Appreciation

Price appreciation is the difference between what an iBuyer buys and subsequently resells a house for. Each of these “flips” occurs within a short time frame (typically 90 days). The difference between these two numbers reveals clues around the market value for a house.

A review of the transactions where Zillow and Opendoor purchased and then resold a house in 2019 reveals a median price appreciation of 3.3 percent, or $8,900 on a $270,000 house.

In 2019, the average annual home price growth is 3.8 percent, according to Black Knight. Assuming an average holding period of 90 days, that’s 0.9 percent of price appreciation that naturally occurs in the market. Subtracting this from the 3.3 percent median price appreciation leaves 2.4 percent associated with the purchase and resale of the house.

The remaining 2.4 percent price appreciation delta is not solely a discount to market value; it must also account for the improvements made to each home. It’s reasonable for iBuyers to command a premium on the houses they own and resell, in the same way a certified pre-owned car commands a premium. These houses have been through a rigorous repair process with new carpets and paint, and refurbished up to a generally high standard.

Zillow’s per home renovation and repair costs are $12,000 (source: Zillow’s third quarter 2019 shareholder letter). Opendoor’s average average repair cost is between 2–2.5 percent of a home’s value. In each case, a significant amount of money is being invested into each home before resale, which should theoretically and practically lead to a higher home resale value.

Therefore, if we subtract the price appreciation that naturally occurs in the market (0.9 percent) and assume that half of the remaining price appreciation delta is a relative discount to market value when an iBuyer purchases a house, and the other half reflects a resale premium, the actual discount to market value is 1.2 percent (half of 2.4 percent), or $3,200 -- very similar to the 1.4 percent discount derived from the Purchase Price-to-AVM methodology above.

Price appreciation over time

Price appreciation is a fluid metric, and is changing over time and by market. On a yearly basis, the median price appreciation delta has dropped from 5.2 percent in 2018 to 3.3 percent in 2019. And it’s not simply a factor of iBuyers moving into more expensive markets; in absolute dollar value, the median price appreciation dropped from $12,300 in 2018 to $8,500 in 2019.

The trend continues in 2019. On a monthly basis, median price appreciation has dropped a full percentage point between January and September of 2019.

The resulting trend is clear: iBuyers are making less and less money on the “flip” of a house.

There are a number of reasons for this trend. The iBuyers have always publicly stated that they aim to offer consumers a fair deal, with no desire to buy low and sell high. The iBuyers are attempting to make offers as close to market value as possible, and are improving over time.

The change also reflects increased competition in the space. With Zillow launching its home-buying program in 2018, competition is heating up in a major way. Both Opendoor and Zillow are attempting to grab market share as fast as possible, and one way to do that is by offering more attractive offers to consumers. 

Median price appreciation varies by market, and could be an artifact of overall market appreciation, iBuyer market maturity, or local competitive pressures.

Method #3: Rejected Offer vs. Market Sale

Many consumers request an iBuyer offer, but not all accept it. Of those that request an offer, reject it, and then go on to sell their home traditionally, it is possible to track the difference between the original iBuyer offer and the eventual sale price.

A recent Zillow study looked at 3,200 homes where a seller declined a Zillow Offer and then went on to sell traditionally within 120 days. On average, Zillow was offering 99.8 percent of the eventual sale price -- an implied discount of 0.2 percent.

The Zillow statistic has not been verified by an independent third-party and its comprehensiveness is unclear. Even so, it is a useful data point in this analysis. Opendoor declined to discuss its metric for this study.

Summary of evidence

The evidence in this research study strongly suggests that iBuyers are offering close to fair market value for the homes they purchase. Multiple methodologies based on independent, third-party data suggest a discount to market value of around 1.3 percent -- or $3,500 on a $270,000 house.

It is important to remember that this is the median. In any statistical study, there will be outliers, examples of homes where the discount to market value is higher or lower.

Total cost to the consumer

Whether iBuyers make fair market offers on houses is a different question than if iBuyers make fair offers to consumers. To answer the latter question -- which is not the focus of this study -- all of the associated costs and fees need to be included.

The average iBuyer fee is around 7.5 percent -- 1.5 percent higher than a typical real estate commission. However, the average holding costs for three months (which can range from 1–2.5 percent of a home’s value) shift from the consumer to the iBuyer, making the true cost difference negligible.

Which leaves the discount to market of 1.3 percent, or $3,500 on a $270,000 house, as the primary monetary difference between an iBuyer and a traditional market sale. Ultimately, it is up to consumers to decide whether that discount -- in exchange for convenience, speed, and certainty -- is worth it.

Strategic implications for the industry

So what is revealed about a business that buys and resells houses, but doesn’t make money on the flip? Buying houses is a means to an end. But what is the end, and how will iBuyers make money?

The answer is that it’s not about the house, it’s about the transaction. And iBuyers can make money through ancillary services like mortgage and title, and in Zillow’s case, seller leads. This should concern any mortgage and title incumbent; iBuyers are your new competition. And to maximize consumer adoption of these new services, iBuyers must control the transaction, and the expert advisor in the transaction: the real estate agent.

The results of this study -- that iBuyers are buying homes at close to market value -- is seemingly positive for consumers. But long term, to fulfill their strategies and build a viable business that makes money, iBuyers will need to operate walled gardens under their control: Sell to an iBuyer, buy an iBuyer home, finance with an iBuyer Mortgage, and use an iBuyer Agent. And this exclusive, closed ecosystem will likely have a significant impact on the real estate industry going forward.

Download this research study as a lovely, nine-page PDF.

Transparency And Deception In Real Estate Tech Fundraising

Transparency is the cornerstone of any successful, trustworthy business. But not all real estate tech companies practice transparency; the most egregious example occurs in fundraising. The lines between raising equity and securing debt have been blurred, and numbers are being inflated in an effort to mislead the public. If a business model relies on deception, it’s a bad business model.

Equity vs. Debt

A company raises equity and secures debt.

When a company raises equity funding, it sells investors stock in exchange for capital; investors are buying part of the company at an agreed-upon valuation. When a company secures debt, it is granted a line of credit to access funds when needed, or is given a loan -- both of which need to be paid back, with interest.

With the rise of iBuyers and similar models that involve a strong financial component, such as purchasing homes directly from homeowners, debt requirements are skyrocketing. Many real estate tech companies, some of which are barely a year old, are securing hundreds of millions of dollars in debt.

Debt is not equity

As far back as I can recall, when a company announced that it had raised money, it was talking about equity investment. An investor had reviewed the business pitch, decided the model and the team were winners, and invested money into the venture in exchange for stock.

At some point, things changed. When raising money, it is becoming increasingly common for real estate tech companies to combine equity and debt together into a larger, more impressive sounding number.

Because companies are using debt to finance the purchase of homes, the amounts are absurdly large. In fact, the companies that combine equity and debt are, on average, artificially inflating the amounts raised by 11 times!

This is a deceptive practice meant to trick the public into thinking a company has raised more money than it actually has, and is bigger and more successful than someone may otherwise think.

Debt is not equity. If I get a $500,000 mortgage to purchase a new home, have I “raised $500k to reinvent the home buying process for my family,” or have I simply secured a loan (which must be repaid)?

Best (and worst) practices

Some companies unapologetically combine equity and debt numbers and refuse to reveal the breakdown. Others combine equity and debt as a headline number, but eventually reveal the breakdown later in a press release. Artificially inflating the headline number is still deceptive, but at least they’re not brazenly hiding the truth.

The best practice -- and the most transparent -- is talking about equity as equity, debt as debt, and not inflating the headline number by combining the two.

Transparency in action

Full credit to the two biggest iBuyers, Opendoor and Zillow, for providing full transparency around capital raises. As a public company, Zillow really has no choice other than to play by the rules. Opendoor, as a private company, is not forced to offer the same level of disclosure, but nonetheless chooses to in a commendable effort of transparency.

Ribbon and Knock are two of the worst offenders, with the following big-money, attention-grabbing headlines: “One-year-old Ribbon raises $225M to remove the biggest stress of home buying,” and “Knock Raises $400M To Simplify Home Buying.” Unfortunately, each raise includes massive amounts of debt and neither company reveals the actual numbers (in Knock’s case, public filings later revealed the equity component was $26 million).

EasyKnock, Nested, Flyhomes, Homeward, and Perch are all guilty of combining equity and debt into large headline numbers, and then go on to clarify the figures in the body of the announcement -- but the damage has already been done.

Offerpad used to break out equity and debt, but is now combining both into a large, headline figure and not providing the details. Like the others, the results are impressive headlines that confuse and mislead the public -- especially when compared against peers, like Opendoor, that aren’t inflating their numbers.

Comparing apples and oranges

The issue becomes clear when making comparisons -- often while someone is attempting to make a decision. Whether it’s a prospective customer, a potential employee, or a curious journalist, misleading headlines create unfair and inaccurate comparisons.

For instance, if one compares the headline numbers from Opendoor’s $300 million raise with Knock’s $400 million raise, Knock may appear to be the fundraising winner. However, in reality, Opendoor raised over ten times the amount of equity than Knock: $300 million vs. $26 million! And in total, Opendoor is even further ahead.

Getting noticed

I imagine a number of companies -- many of them run by friends and colleagues -- undertake this practice to appear larger than they actually are. But I also imagine that in real estate, a factor even more important than fundraising prowess is trust. And trust comes through transparency. If your business model relies on deception, it’s a bad business model.

Do Compass and Opendoor Have A WeWork Problem?

On its path to a now-delayed IPO, SoftBank-backed WeWork’s valuation has fallen from $47 billion to somewhere between $10 billion and $15 billion. This precipitous drop appears to be a collective repudiation of not only WeWork’s business model and SoftBank’s valuation philosophy, but of the inverted economics of big money unicorns without a path to profitability.

WeWork’s valuation challenges highlight the potential issues that SoftBank’s other real estate investments—namely Compass and Opendoor—may face in their march towards IPO.

Strong growth, fueled by capital

WeWork shares a number of traits with Compass, a real estate brokerage, and Opendoor, an iBuyer: They all deal in real estate, have raised massive amounts of capital from SoftBank at multibillion dollar valuations, and are growing incredibly fast. All three are unprofitable, pay most of their revenues away as a cost of sale, struggle with their identity as a tech company, and, in the case of Compass, have a profitable, publicly traded rival that is valued far less.

Compass’ business model is fueled by capital. It has raised more than $1.5 billion, which it is using  to acquire brokerages and recruit agents at an unprecedented scale. It is turning dollars into agents, which in turn generate revenue.

Opendoor has raised over $1 billion—more than 10 times its nearest competitor—and has used that capital to fuel a rapid national expansion (in addition to launching a mortgage venture and acquiring a title company). Opendoor is on track to purchase around 17,000 homes in 2019.

When a company raises such large sums of capital, there is only one possible exit: an IPO. The other path—an acquisition by another company—is priced out of the equation due to the massive valuations involved; other companies can’t afford the transaction. Case in point: Compass’ $6.4 billion valuation is on par with Zillow and nearly four times higher than Redfin.

When selling my company years ago, a trusted advisor told me that a business is worth what someone else is willing to pay for it. SoftBank is certainly guilty of testing the upper bounds of private company valuations, and the WeWork episode makes it clear that what SoftBank is willing to pay for a company is quite different than anyone else.

Justifying a sky-high valuation

Both WeWork and Compass have profitable, publicly traded rivals that are valued far less (IWG for WeWork and Realogy for Compass). In the case of WeWork, “IWG has substantially more square footage and more customers, and has actually made a profit—yet its market cap is just 8% of what SoftBank’s latest funding round thinks WeWork is worth,” according to Recode.

The Wall Street Journal examines why WeWork is struggling to sell its story to investors, and sums up the narrative as follows:

• WeWork’s revenue is growing fast, but so are its expenses.

• WeWork’s operating losses are keeping pace with its revenues.

• WeWork is raising increasingly large sums—but has yet to announce a profit.

• And a profitable, publicly traded rival is valued at far less.

In 2018 (the last full year where complete information is available), Compass’ publicly traded rival, Realogy, had 42 times the number of transactions, 11 times the sales volume, seven times the revenue—and actually made a profit!—but an enterprise valuation on par with Compass.

WeWork, Compass and Opendoor have valuations that are pegged to their impressive growth rates, but when that growth is dependent on having and spending vast sums of money in an unsustainable manner, it’s difficult to justify.

Impact on Compass and Opendoor

If the pressure from the public markets continues to push for profitability, it may accelerate (or force) a change in the operating economics at Compass and Opendoor, which up until now have fueled their massive growth with massive expenditures.

A drive to increase revenue could lead Opendoor to raise its fees, or Compass to reduce its generous commission splits with agents; either move would severely limit growth. Reducing expenses would come in the form of office consolidation (Compass has over 250 offices across the U.S.), ratcheting down employee perks, or even staff layoffs.

(Uber, another one of SoftBank’s investments, recently announced a round of layoffs from its product and engineering teams: 435 people, or 8%of its entire workforce, were let go. This comes just a few months after Uber, whose stock is down over 20% since IPO, announced that it was cutting 400 employees from its marketing division.)

Stock options

Those most impacted at WeWork, Compass and Opendoor may end up being employees and contractors that have stock options. Compass, in particular, has used this as a key tool for agent recruitment and retention, and a dropping valuation would make those options worth a small fraction of what was initially promised.

In addition to stock options granted to induce agents to join Compass, those agents can also invest a portion of their commissions into the company. As of November 2018, more than 1,000 Compass agents had invested over $20 million into stock options.

And while Compass’ valuation isn’t dropping—it recently increased from $4.4 billion to $6.4 billion—the rate of increase is slowing.

Compass is not WeWork, and nor is Opendoor. But to succeed, all three businesses require an unprecedented amount of capital and a willingness to buy into a vision that is driven more by words than numbers and where the long-term validity of the business model is easier to assert than to prove.

The current WeWork fiasco (and to be clear, we’re talking about a 70% to 80% drop in value simply as a result of opening the books and being honest about the business) shows that valuations can’t keep rising unchecked by the realities of basic economic principles—and that investor patience does have a limit.

After U.S. Flop, Real Estate Brokerage Purplebricks Faces Mounting Headwinds In The U.K.

Tech-driven real estate brokerage Purplebricks released its 2019 results last week. After a failed U.S. expansion, the core U.K. business is still growing and remains profitable, but is facing headwinds in a soft property market. The results highlight the critical importance of scale and customer acquisition costs, and offer a reminder that tech-enabled platforms continue to command a rising percentage of the real estate transaction.

Profitable, but mounting headwinds

Purplebricks’ impressive growth in the U.K. market continues, albeit at a slowing pace. Overall instructions (or instructions to list) are up again, but only 9% compared to the previous year.

At this scale, the trend is unsurprising. As I said last year in this Financial Times article, “Real estate is very fragmented, there are relatively low barriers to entry to get into the business of selling houses, the products are undifferentiated and there’s no customer loyalty. That leads to natural fragmentation.”

Meanwhile, Purplebricks’ finances for the U.K. operation -- while up for the entire year -- have taken a hit in the most recent six months (December to April, 2019).

The decline is driven by a drop in revenue. Compared to the first six months of Purplebricks’ financial year, marketing expenses remained steady while revenue dropped £6.5 million. With a soft property market in the U.K., at least partially driven by the uncertainty around Brexit, it is becoming more difficult and expensive for Purplebricks to acquire customers.

For the first time in its history, Purplebricks customer acquisition cost (or cost per instruction) has increased from the previous year. The trend of increased economics of scale has taken a pause -- perhaps temporary, perhaps not.

Overall marketing ROI (defined as how much revenue each £ in marketing buys) -- while still nicely positive -- is down in the most recent six months.

A financial bloodbath in new markets

Purplebricks announced its departure from the Australian and U.S. markets earlier this year. At the time, international expansion was a key driver in Purplebricks’ stock price and investor optimism. But the latest results reveal what a financial bloodbath the moves were.

In 2019, Purplebricks lost nearly £19 million in Australia and £34 million in the U.S. A large part of this expenditure was expensive marketing. The reasons for the failure in international markets are complex, and range from not picking the right markets to ineffective marketing.

Gross margins and the platform play

A key highlight in Purplebricks’ results are a reminder of the market power it possesses, and more specifically, its high gross margins. A company’s gross margin is the amount of revenue it retains after paying its cost of sales, which for Purplebricks, are payments to its local property experts (aka agents).

In the U.S., average brokerage gross margins are around 15%. The outliers are Redfin and Purplebricks, whose novel operating models enable a standardized process with corresponding efficiency and economic gains for the company.

Purplebricks’ gross margins in the U.K. increased to 63%, up from 58% in the previous year. In other words, for each £899 listing, the agent keeps around $333 while Purplebricks retains £566 of the fee.

And in the U.S., Realtor.com’s $210 million acquisition of Opcity and Zillow’s new flex pricing product follow the trend, with both charging real estate agents around a 30% referral fee when a transaction closes. These are all examples of the core economics of real estate changing, with technology platforms commanding a higher percentage of the transaction.

Purplebricks’ continued -- albeit slowing -- growth in the U.K. highlights the importance of customer acquisition costs in the new world of hybrid and online brokers. Having fantastic technology and a great team will only get you so far; at the end of the day, massive advertising expenditures are required to reach scale, and then, profitability.

How serious are Zillow and Redfin about iBuying?

In the past year, two of the U.S.'s leading portals, Zillow and Redfin, have launched iBuyer businesses. Zillow's entry was, in part, a response to an existential threat to its business model, and much of the value it may derive is not from buying and selling houses at all, but by generating valuable seller leads (watch my video presentation). Which begs the question: How serious is Zillow about being an iBuyer?

Opendoor's 3x advantage

The best way to compare seriousness is actual market traction and purchase volumes -- putting your money where your mouth is.

In the first seven months of 2019, Opendoor continues to be the clear leader in the iBuyer space as measured by home purchase volume. Opendoor has purchased nearly 10,000 homes, around three times the volume of Zillow.

On average, Opendoor is purchasing around 1,400 homes per month (as an aside, a recent Opendoor commercial stated the company buys a home every 34 minutes -- or around 1,300 per month). Again, this number is about three times the volume of Zillow for the first seven months of 2019.

However, Opendoor's volume advantage is eroding over time as Zillow's activity accelerates. In January, Opendoor purchased 4.7x the volume of Zillow, but that is down to 2.4x in July. Zillow is closing the gap (especially in the last three months).

The magic number in all of this appears to be 3x: year-to-date in 2019, Opendoor is about 3x ahead of Zillow in terms of home purchases. But Zillow is catching up.

Available firepower to purchase homes

Another way to judge a company's level of seriousness about iBuying is how much debt it has available to purchase homes. Each of the major iBuyers has secured massive amounts of debt, but some have secured more than others.

Once again, the magic 3x number appears: Opendoor has three times the debt available to purchase homes compared to Zillow. So it is no surprise that it is purchasing three times the volume of homes.

What about Redfin?

Readers may notice Redfin in distant fourth place in many of the charts, which, again, is an indicator of seriousness about iBuying.

Opendoor has 30x the debt available and has purchased nearly 40x the homes compared to Redfin in 2019. On average, Opendoor is purchasing around 1,400 homes per month, compared to Redfin's 36 homes per month. Redfin is an iBuyer in the same way I'm a basketball player. Both statements are technically true, but neither of us are anywhere close to the big leagues.

Differing strategies and motivations

Opendoor's entire business model revolves around buying and selling as many homes as possible. At scale, it becomes a powerful business. Zillow, on the other hand, may want to moderate its home purchases to achieve a scale where it maximizes seller leads. As I've said before, Zillow has the potential to make more money with less risk by monetizing seller leads.

Zillow's purchase rate (the amount of homes it buys compared to the total number of offer requests it receives) has consistently hovered around 2 percent.

Zillow is expanding fast to catch up to Opendoor, but it may have different motivations in doing so. Zillow's buying activity in Phoenix, for example, has plateaued since January of 2019. Is it taking a well-earned breather, or is 100 homes a month all it wants (or needs) to buy?

The evidence suggests that Zillow is serious about being an iBuyer and a major player in the space. But its motivations, and the question of why it wants to be an iBuyer, may differ significantly from other iBuyers.

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Check out the part of my Inman Connect presentation where I talk about Zillow's pivot to iBuying, and the value of seller leads.

Is Compass no longer valued as a technology company?

A few weeks ago, Compass announced its latest funding round: $370 million at a $6.4 billion valuation, bringing its total funding to over $1.5 billion. This provides new answers to a familiar question: Is Compass being valued as a tech company or a traditional brokerage?

Turning dollars into agents

The chart below shows Compass' recent funding rounds and its growing agent count. As I said during my recent Inman Connect presentation, "Compass is turning dollars into agents."

During Compass' recent funding announcement, it stated that revenue is 250 percent in the second quarter compared to Q2 2018 (or up 150 percent). The highlighted columns represent those two time periods. Compass' agent count in August 2018 was around 4,500, compared to 13,000 in August of 2019. Overall agent count is up 190 percent while revenue is up 150 percent.

Using that growth figure for the full year, which is generous but fair, Compass' 2019 revenue would be around $2.25 billion. A $6.4 billion valuation would imply a revenue multiple of 2.8x -- a significant drop from previous years. While agent count is up 190 percent and revenue is up 150 percent, valuation is up only 45 percent.

Tech company or brokerage valuation

One of the key questions I explored in my deep dive analysis of Compass is whether it is being valued as a technology company or a brokerage. At the time, it was clearly being valued as a technology company, with a revenue multiple of 4.9x -- well above traditional brokerages and much closer aligned to Zillow.

The updated chart below shows revenue multiples based on projected 2019 revenues and stock prices as of July 1, 2019. Zillow still leads the pack, while Compass is on the leading edge of the next rung of traditional and tech-enabled brokerages. On a revenue multiple basis — and compared to 2018 — Compass is being valued less as a technology company and more as a traditional or tech-enabled brokerage.

(Revenue multiples are just one way to benchmark company valuations. Even using other methods, such as a gross margin multiple, the story is the same: When using the same valuation methodology, Compass' valuation multiple is significantly lower than it was last year.)

Slowing growth?

Revenue multiples are generally based on future growth rates. One could argue that as Compass gets larger and its growth rate slows, its revenue multiple will naturally fall. However, Compass' growth in 2019 appears to be the same as it was in 2018: 150 percent. Compass' lower revenue multiple does not appear to be tied to a slowing growth rate.

Compass continues its impressive growth. Topping $2 billion in revenue would be quite an achievement, and its $6.4 billion valuation is massive. However, as the company approaches an IPO, it's worth noting the lower valuation multiple.

It would appear that investors are less bullish on the company. Either Compass' growth is expected to slow dramatically in future years, or the company is being valued more as a traditional brokerage and less as a high-flying technology company.

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Check out my epic, five-part Compass analysis into an easy to read whitepaper. Now you can read all 35 pages in one document, print it out, and easily share with colleagues. Download the free PDF and enjoy!

Realtor.com’s slow descent to irrelevancy

With the rise of iBuyers as a powerful new starting point in the consumer journey, realtor.com is yielding the strategic advantage to arch-rival Zillow. Lacking an iBuyer strategy for the past year, realtor.com has fallen further behind in terms of delivering value to consumers and agents. Multiple options to enter the space are available, but the clock is ticking for realtor.com to execute strongly and maintain relevance in a rapidly evolving industry.

Power at the top of the funnel

One of the topics I discussed in my recent Inman Connect presentation was the power companies have at the start of the consumer journey. Real estate portals around the world derive and maintain their dominant positions because they are a consumer's first stop in the home buying and selling process.

In the days before the internet, real estate agents were the starting point. With the launch of Zillow and its Zestimate, portals became the popular starting point for consumers. Opendoor and iBuyers shifted the dynamic by offering instant offers on homes, attracting consumers. Today, a number of iBuyer aggregators and real estate agents are fighting to attract consumers by incorporating instant offer services. I explain further in the quick video clip below.

In some markets, up to 40 percent of serious home sellers are requesting an instant offer before listing their home! Instant offers are becoming the new Zestimate -- the new, natural starting point for determining a home’s value. And because of this, they are also an existential threat to portals.

The value of seller leads

The iBuyer business model generates a ton of high-intent seller leads: consumers who are interested in moving and request an offer, but don’t sell their home to an iBuyer. In the last three months alone, Zillow generated 69,000 offer requests but only bought 1,500 homes. The remaining leads can be distributed to real estate agents -- a valuable source of new business.

Today, Zillow Offers is active in 11 markets. Once it expands to 20 markets, Zillow could generate close to 500,000 seller leads annually -- a number that will increase as its national roll-out continues.

Zillow and realtor.com’s traditional lead generation businesses are built around buyer leads. iBuying has become the holy grail of seller leads: popular with consumers, valuable to agents, and of generally high quality. Over time, these leads will become a valuable source of new business for real estate agents, and an additional revenue driver for Zillow.

Using rough estimates, it's clear that the profit potential of seller leads far outweighs that of buying and selling actual homes, with considerably less risk for Zillow.

Real estate agents partnering with Zillow receive valuable buyer and seller leads. The same partnership with realtor.com yields only buyer leads.

Strategic advantage: Zillow

Each day, Zillow continues building its sustainable competitive advantage by strengthening its leadership position in consumer’s minds as the place to go for an instant offer. Simultaneously, Zillow generates tens-of-thousands of valuable seller leads for its agent customers each month -- a service which realtor.com does not provide.

For a real estate portal’s two most important audiences -- consumers and agents -- Zillow is highly differentiated while realtor.com lags behind.

Realtor.com needs to provide an iBuyer service -- but does not need to buy and sell houses directly -- to compete with Zillow. The logical entry point is a partnership with a national iBuyer (and that iBuyer, by the way, needs an inexpensive source of leads just as much as realtor.com needs an iBuyer service).

Until realtor.com unveils a coherent iBuyer strategy, it will remain at a growing disadvantage to Zillow, and risks further irrelevancy in the evolving battle for consumer eyeballs.

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Check out my entire Inman Connect presentation, "iBuying Disrupted: Battle of the Behemoths."

My "iBuying Disrupted" Presentation

"Only Mike would start a 9 a.m. presentation talking about EBITDA and GAAP financials." – Anonymous Zillow executive

Two weeks ago I had the pleasure of speaking at Inman Connect Las Vegas -- one of the world's premier real estate conferences. My talk, "iBuying Disrupted: Battle of the Behemoths," was followed on stage by Rich Barton, CEO of Zillow, Glenn Kelman, CEO of Redfin, and Eric Wu, CEO of Opendoor. What a lineup!

Watch the video

At the Inman Connect Las Vegas 2019 conference, Mike DelPrete, an entrepreneur, analyst and real estate industry strategic adviser, took to the stage to explain the seismic shifts shaking up the residential real estate market.

Some of my favorite lines from the presentation:

“There’s a new competitive advantage in town: sustained unprofitability.”

"Red is the new black."

"Agents are the ultimate iBuyer aggregator."

“iBuying is the new Zestimate."

“Companies and agents that win will be the those that empower consumers to make the choice that’s right for them.”

In addition to the video of my presentation, you can also download a copy of my my presentation slides. I'd love to hear your feedback!

Inside Compass — Part 5: Endgame

A big hairy audacious goal (BHAG) is a phrase, coined by author Jim Collins in his book Built to Last, meant to convey a company’s visionary “moonshot” goal, often bordering on the unachievable. Think of SpaceX’s aim to make humanity multiplanetary or Google’s goal of organizing the world’s information. These are BIG goals and exponential ideas, without a hint of incrementalism. And big ideas have a tendency to attract big investment.

In real estate, optimizing the commission split and generating revenue by selling mortgages are what brokerages have been doing for years. Going down that path is an old, incremental game plan, which is why it’s unlikely to be Compass’ destination. Investors didn’t pump over $1 billion of venture capital into Compass to build “just another brokerage.”

Compass clearly has big ideas and big goals. But what exactly is its big hairy audacious goal?

More than a brokerage

To justify its massive valuation and satisfy its investors, Compass must become more than a brokerage. Having raised over $1.1 billion at a hefty $4.4 billion valuation, Compass is already richly valued as a tech company rather than a traditional real estate brokerage.

When a company raises venture capital, especially at the scale Compass has, investors expect a significant return on their investment. When SoftBank invested in Uber in 2018, it was valued at $48 billion with expectations of a $100 billion IPO (as of June 2019, Uber is worth around $75 billion).

As a late-stage, private company almost certainly heading towards an IPO, investors likely have similar expectations for Compass — call it a $10 billion valuation at IPO. Compass can’t justify this valuation as a traditional real estate brokerage. Incremental improvements are not in the cards; to achieve a meaningful outcome for owners and investors, Compass needs to embrace more radical changes to its business model, and real estate in general.

Changing the game

As we’ve seen in my previous analysis, Compass’ economics are similar to a typical brokerage. The primary revenue and expense drivers are the same: revenue generated as a percentage of the commission from real estate agents, and expenses driven by employee costs, office space, administration and technology.

To date, the models that have meaningfully shifted core brokerage economics at scale have all featured novel operating models. Redfin, with full-time, salaried agents, and Purplebricks, with a fixed-fee independent contractor network — both backed by significant lead capture and centralized support organizations — have demonstrated exponential efficiency gains.

From an economic standpoint, the efficiency gains pay off for the brokerage. Redfin operates at a gross margin of 24 percent (about double Compass), while Purplebricks U.K. enjoys gross margins over 50 percent.

compass: estimate, Industry average: real trends industry benchmark, redfin: fy2018, purplebricks: fy19 (U.k. only)

Because of their novel operating models, Redfin and Purplebricks have a great deal of direct control over their agents, allowing them to standardize processes to deliver a more uniform and efficient consumer experience.

For Compass to break out of the traditional brokerage mold and fully realize its ambitions, it needs to become more than a brokerage, and more than a technology company. It needs to become a platform. And in doing so, radically change brokerage economics and, consequentially, the role of agents.

The platform play

To become a true real estate platform, Compass first needs to become a consumer destination.

Redfin has its portal, Uber has its app, and Purplebricks (in the U.K.) has its web site. In each case, consumers go directly to the company — not an agent or driver — to start their journey, giving the platform owner unprecedented ecosystem power. The platform owner controls the lead, distributes it, and takes a healthy cut of the revenue. If an employee or contractor doesn’t perform to expectations, the company removes them. The platform owner is in complete control.

For Compass to become a consumer destination, it needs eyeballs. The most effective strategy — and likely the only possible strategy given the market dominance of Zillow — is to build consumer traffic with the draw of exclusive listings. It’s a similar strategy to Netflix and Amazon’s exclusive video content. If the Compass web portal advertises houses for sale that aren’t available anywhere else, it draws consumers to the platform.

Building exclusive content

The secret to building audience with exclusive content is scale: Compass needs significant market share for this strategy to work. Pocket listings, which are withheld from the MLS for a period of time, have been around for years, but never employed at this scale. Compass needs to advertise so much exclusive content, including coming soon listings, that consumers can’t afford to miss it.

The evidence that Compass is strongly promoting exclusive content is plainly visible on its web site. In fact, exclusive content is the primary call-to-action on Compass’ web site, starting with top billing on its site navigation.

Scrolling down the page, the first content after the search box is a section highlighting exclusive listings before they hit the market.

A few Google searches for homes for sale in San Francisco yields the following results. Not only is Compass paying top dollar for its position, but notice who it is competing and bidding against.

Compass is expending a considerable amount of resources to attract consumer eyeballs to its web site. In addition to the above, it has search engine optimized pages for exclusive properties in each market. This focus on exclusive listings currently sets Compass apart from Zillow, Redfin, Purplebricks, and most other traditional brokerages — no other company gives it this much focus (or any focus at all).

The result is a high proportion of listings that are exclusive to Compass (which includes coming soon). As of June 2019, anywhere from 12 to 27 percent of Compass listings in a market are exclusively listed on the Compass web site — a significantly high number. Across six markets, that represents over 1,800 listings, none of which are advertised on the MLS or any other portals, including Zillow.

Compass is encouraging agents and consumers to list properties as Coming Soon as an effective pre-sales tool. This agent team page touts specific benefits, such as fewer days on market and more visitors at the first open home, while this agent team highlights the benefits of increased exposure and pre-listing feedback.

Flexing its platform power

Once Compass has consumer eyeballs, what’s next? The same thing that Zillow, Redfin, and Purplebricks do: generate and control the distribution of leads to agents.

Recently we have seen more power being accrued in real estate platforms that distribute leads. Realtor.com’s $210 million acquisition of Opcity and Zillow’s new flex pricing product both charge real estate agents around a 30 percent referral fee when a transaction closes. Over time, the amount charged for a lead has consistently gone up.

Redfin and Purplebricks also control the flow of leads. Redfin distributes its leads to salaried agents, while Purplebricks pays its local property experts in the U.K. around 25 percent of a fixed listing fee. Both companies control the flow and distribution of leads to their agents, which is a necessary ingredient for a platform to fundamentally change the economics of a traditional real estate brokerage.

Endgame

It would be naive to think Compass has raised over $1.1 billion in venture capital to become just another real estate brokerage. Even adding adjacent services like mortgage doesn’t change the core economics of the broker model — bigger changes are required to justify its valuation. Compass has larger ambitions, and it’s likely that its big hairy audacious goal is to become a real estate platform. The evidence suggests the following strategy:

• Build market share (listings) through aggressive agent recruitment and acquisition.

• Once market share is high enough, encourage sellers to list exclusively on Compass for a period of time.

• Leverage exclusive content to drive consumers to the Compass portal.

• Launch a Compass platform that generates and distributes leads to agents.

• With platform power, transition the role of an agent (Redfin/Purplebricks/Uber), taking a larger cut.

Compass is a real estate disruptor on a scale never before seen in the U.S. With deep pockets and big ambitions, its impact on the real estate industry is only just being felt. Compass, its investors, and a number of well-funded peers are aiming for massive change in an industry that has resisted massive change for years. Whether its strategy succeeds or fails, the die is cast and the race is on.

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Inside Compass: A Strategic Analysis

My epic, five-part Compass analysis in one easy to read whitepaper. Download the free PDF and enjoy!

4 strategies for agents to stay relevant in the age of iBuyers

New content alert! I'm trying something new: crisp, strategic "quick hits" that offer actionable suggestions. I usually publish evidence-based industry insights, while my consulting work focuses on hands-on strategy and guidance. This is meant to bridge the gap between the two -- let me know what you think!

iBuyers are a rising force in real estate. Companies like Opendoor, Offerpad, and Zillow are collectively spending billions to offer consumers a new way to buy and sell homes. As iBuyers expand nationally, more and more real estate agents and brokers are being faced with a key strategic question: How do we stay relevant in the age of iBuyers?

As overall iBuyer activity exceeds 1,000 home purchases and sales per month in just one market -- Phoenix -- it’s a trend that can't be ignored.

I’ve conducted deep analysis on iBuyers for the past four years, culminating in the recently released iBuyer Report. Based on that background and my work in the industry, I offer four key strategies agents and brokers should consider when evaluating their response to iBuyers:

Be a trusted advisor. The role of a real estate agent has always been to help guide consumers through the home buying and selling process. An instant, cash offer on a house simply represents a new path to the same end. This doesn’t mean there isn’t a role for an agent; it’s simply another path that needs navigating. And the agent is uniquely placed to be that expert advisor.

Solicit multiple offers. As a trusted advisor who represents the home owner’s best interests, an agent is well-suited to solicit multiple offers on a home from multiple iBuyers, and to present those offers alongside a traditional market sale. The iBuyers’ online processes make it easy to receive multiple offers; the agent can do the work and provide guidance. Each major iBuyer offers partnership programs that pay a referral fee for a successful transaction.

Don’t ignore them. iBuyers are spending millions of dollars each month on direct-to-consumer advertising (TV, radio, and digital). Agents and brokers can’t (and shouldn’t) compete with that spend, and they can’t ignore the fact that consumers are being educated -- on a massive scale -- about iBuyers. Ignoring them won’t make them go away. (In the past two months alone, I’ve been quoted in the New York Times, the Wall Street Journal, and Marketplace -- all doing stories about iBuyers.)

Highlight the power of personal relationships. Real estate agents are people, and iBuyers are corporations. If you’re an agent, highlight the personal relationship you bring to the process. The power of human psychology is incredibly strong in real estate; brokers and agents should use it to their advantage.

iBuyers represent a significant shift in the real estate landscape, but it’s not a zero-sum game. Real estate agents and brokerages can employ specific strategies to stay relevant, highlight their strengths, and maintain their position as a trusted advisor in the center of the transaction.

Inside Compass — Part 4: Sustainability

Part One of this series took a detailed look at Compass’ growth strategies, while Part Two examined if Compass is a tech company, or a traditional brokerage, and Part Three looked at Compass’ $4.4 billion valuation compared to its industry peers.

Part Four of this series looks at sustainability. Can Compass keep up its aggressive — and expensive — acquisition strategy? Will agents, without whom Compass wouldn’t generate any revenue, remain happy and stay under the Compass banner? And perhaps most importantly, can the company generate a profit?

The search for profitability

Compass is not profitable. Given its massive expenditures — both to support its brokerage acquisitions and to support its growing employee base — there’s simply no way it can be making money. Nor should it be (yet).

Compass is a growth stage business, investing today for a more powerful and profitable tomorrow. The question for all growth-stage businesses is whether they can ever achieve profitability. A number of other real estate industry behemoths are also unprofitable on a GAAP basis: Zillow, Redfin, Opendoor, eXp Realty, and Purplebricks.

Compass, like all private companies, does not need to share its financials. But with the data is does make public, in addition to benchmarks against public company peers and a few educated assumptions, we can paint a rough picture of its financials. To refine my thinking for this analysis I’ve spoken to dozens of industry executives and insiders, including leaders of top brokerages, independent analysts, and current and former Compass employees and agents.

Revenue and gross margins

Compass ended 2018 with around $900 million in revenue (source: Robert Reffkin’s letter on Inman). Like its real estate brokerage peers, eXp Realty and Realogy, that number includes the full real estate commission, only a fraction of which Compass retains. A large percentage of that number is paid directly to agents (70%–90%), with a smaller percentage retained by Compass as its gross profit. This is the commission split.

According to REAL Trends, which has been tracking the residential brokerage industry for decades, the average retained revenue (gross profit) of brokerages was 14.9 percent in 2018. The sample size is 200–300 of the largest U.S. brokerages.

High producing agents typically command more favorable commission splits as high as 90/10 — with only 10 percent retained by the brokerage. There is anecdotal evidence (including a number of agents I’ve spoken to, agents that Compass attempted to recruit, and brokers that have lost agents to Compass) that in some cases Compass offers 100 percent commission splits as a recruiting incentive, either for a certain amount of time or a fixed number of deals.

This is confirmed by the Wall Street Journal, which reports, “The firm has lured top talent with some of the most generous commission splits in the business: Some agents received all the sales commission, with nothing going to Compass, on as many as eight of their first deals, according to offer letters.”

eXp Realty, another self-proclaimed tech-enabled brokerage with revenues of $500 million in 2018, has 8 percent gross margins. eXp Realty also offers favorable commission splits with a cap on fees, and is the best benchmark available for Compass. It’s likely that Compass’ gross margin is in the 10–12 percent range, and for this analysis I’ve assumed 12 percent, resulting in $108 million of gross profit in 2018.

Operating expenses

Estimating Compass’ operating expenses is more complicated. I’ve used three different methodologies in order to provide a range of data points:

• Operating expenses as a percentage of revenue

• Operating expenses as a percentage of gross profit

• Build-up approach

(Readers are encouraged to download the companion Excel file and plug in their own assumptions. It’s a choose your own profitability adventure!)

Compass has four publicly listed peers with similar business models: Realogy, eXp Realty, Redfin, and Purplebricks. Each company reports and breaks out operating expenses into various categories, including technology, marketing, and general and administrative. It’s straightforward to calculate each company’s operating expenses as a percentage of overall revenue, and as a percentage of gross profit.

On average, the four industry peers’ operating expenses are 32 percent of revenue and 113 percent of gross profit (Redfin and eXp Realty are unprofitable). Applying those same averages to Compass suggests operating expenses of between $122 million and $288 million in 2018.

The build-up approach for operating expenses focuses on known data: employee headcount and office expenses. Based on the same source of information, here’s what is known:

• Compass had 238 offices at the end of 2018

• Compass had around 1,500 employees at the end of 2018

Compass operates in expensive metro markets like New York City, San Francisco, and Seattle, so employee costs are on the high end of the spectrum. According to a review of 250 employees on Glassdoor, the average salary for a Compass employee is $72,000 per year (ranging from $60k for an office administrator to $120k for a software engineer).

That figure doesn’t include benefits; according to the U.S. Department of Labor, on average, employee benefit costs account for around 30 percent of total employee costs. That would put total employee costs at $100,000 per head (salary plus benefits), resulting in an annual staff cost of $150 million for Compass’ 1,500 employees.

For office space, several industry insiders and CEOs of top brokerages claim that 75–100 square feet of office space per agent is a reasonable benchmark. Cushman & Wakefield reports that the national average, across all industries, is 194 square feet per employee. I’ve assumed an average of 83 square feet per agent, or 3,500 square feet for each of Compass’ 238 offices.

Compass pays from the mid-$60s to mid-$70s to $80 per square foot for some of its NYC offices, and $54 per square foot for a San Diego office. I’ve assumed an all-up expense of $60 per square foot, resulting in a total annual rent cost of $50 million.

Employee and office space expense alone totals $200 million. This figure doesn’t include a number of other one-time and ongoing expenses, such as sales and marketing and office fit-outs, which would push that number even higher.

This figure is Compass’ expense run-rate, based on figures from the end of 2018, a year which Compass grew its employee count and office space incredibly fast. Taking a mid-point average (150 offices and 1,000 employees) yields an employee plus office cost expense of $132 million for 2018.

(Based on this June 12, 2019 update from Compass, there are currently 2,500 employees. Assuming 248 offices, the current employee plus office expense run-rate is $300 million per year (not including other operating expenses), up from the $200 million mentioned above.)

Based on rough industry benchmarks, Compass’ operating expenses could range anywhere between $122 million and $288 million in 2018 (quite a range). But the build-up methodology suggests it was closer to $150—$200 million.

Operating expenses of between $150 million and $200 million in 2018 are nearly double Compass’ gross profit. In other words, Compass would be spending between $1.50 and $2 for every $1 in gross profit — not including its brokerage acquisition costs (which I previously estimated to be between $220 and $240 million, paid in a combination of cash and stock).

Profitability Catch 22

In its march towards long-term, sustainable profitability, Compass faces a dilemma. Like other brokerages, its gross profit is directly tied to the commission splits it offers agents. Profitability is a Catch 22: reducing commission splits for agents increases gross profit for Compass, but makes the company a less appealing home for agents.

Compass must look elsewhere for new sources of revenue — but it’s unclear where.

Compass’ chief operating officer told the Wall Street Journal, “We’re not yet at a stage where I have a very clear monetization strategy because we haven’t really talked about it.” Its CEO said the company plans to make money through ancillary services like title, mortgage and insurance services, but it’s not clear how. “Short term profitability is something that many of the more modern companies are not as focused on,” he added.

To grow revenues, Compass needs more agents closing more deals, and — unless something radically changes — those agents will require more, not less, support staff and office space. To reduce expenses, Compass would need to trim its full-time headcount or slow the hiring of support staff, or consolidate and close a number of its offices — both of which run the risk of making Compass a less attractive brokerage partner for agents.

The options available to Compass — optimizing the commission split and generating revenue by selling mortgages — are the same available to other real estate brokerages, and in fact, what they have been doing for years. Going down that path is an old game plan, which is why it’s unlikely to be Compass’ destination. Investors didn’t pump over $1 billion of venture capital into Compass to build “just another brokerage.”

Endgame

This analysis presents a thorough look at what Compass is doing; the alluring, unanswered question is why.

The company is deploying an aggressive acquisition strategy to acquire agents and brokers to build market share, is positioning itself as a tech company, and sports a sky-high valuation based on its growth rate and future plans — but what are its future plans? How does it plan to turn the existing, unprofitable brokerage business into a mammoth of the real estate industry? This is the topic of the next and final installment of this analysis: Endgame.

Inside Compass — Part 3: Valuation

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

Valuation overview

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

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

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

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

Revenue multiples

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

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

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

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

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

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

Transaction volumes

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

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

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

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

SOURCE: SWANEPOEL MEGA 1000

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

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

Agent count

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

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

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

What about profit?

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

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

profit = net income, not “adjusted ebitda”

Peer valuation scenarios

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

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

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

A sustainable model?

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

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

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

Inside Compass — Part 2: Brokerage or Tech Company?

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

Ingredients of a tech company

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

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

• Tech staff: A technology company should employ technologists. 

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

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

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

Tech staff

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

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

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

source: compass public statements

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

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

source: linkedin, may 2019

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

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

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

Zillow

compass

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

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

Efficiency

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

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

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

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

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

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

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

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

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

source: Swanepoel Mega 1000

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

source: Swanepoel Mega 1000

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

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

Scalability

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

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

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

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

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

The valuation quandary

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

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

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

Inside Compass — Part 1: Growth Strategies

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

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

Fundraising and growth drivers

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

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

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

Source: author’s estimates from numerous company statements.

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

A New York Yankees growth strategy

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

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

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

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

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

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

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

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

Marketshare merry-go-round

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

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

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

Brokerage or technology company?

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

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

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Inside Compass: A Strategic Analysis

My epic, five-part Compass analysis in one easy to read whitepaper. Download the free PDF and enjoy!

Also check out the rest of my strategic, evidence-based analysis of Compass.

The Rise (and Fall?) of Purplebricks

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

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

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

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

Still strong in the U.K.

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

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

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

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

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

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

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

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

Strategic implications

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

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

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

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

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

iBuying is Zestimate 2.0

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

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

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

Zillow's strategic necessity

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

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

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

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

Mass-market appeal

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

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

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

Strategic implications

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

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

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

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

In other words, iBuying is the new Zestimate.