Compass Nears Profitability as it Outperforms Incumbent Peers

It's earnings season, which means press releases with huge numbers and big percentage gains, but light on helpful context. Compass posted big numbers; its quarterly growth is generally in line with its peers, while its record revenue is the result of continuous incremental outperformance.

Pandemic-Fueled Revenue Leap

Compass experienced a significant increase in revenue this past quarter -- a seasonal uplift fueled by a hot housing market. Compass has a history of large Q2 revenue jumps (delayed by a quarter in 2020 due to the pandemic).

When it comes to a global pandemic and real estate, a rising tide lifts all boats. Many of Compass' publicly-listed peers, including Realogy, eXp Realty, and Redfin, also experienced record breaking revenue growth. The quarterly growth rates follow a similar pattern.

They key is that Compass (and eXp) are outperforming their peers by a few percentage points each quarter -- the highs are higher and the lows not as low. That compounding effect adds up over time, and has resulted in Compass finally surpassing Realogy's brokerage revenue in Q2 2021: $1.95 billion vs. $1.77 billion.

Approaching Profitability (?!)

Compass also announced a net loss of only $7 million -- a huge improvement over past quarterly losses. The improvement was driven by Compass increasing its revenues and gross profit (by a lot) without a corresponding increase in expenses.

Future profitability hinges on more of the same: a favorable real estate market with a high volume of transactions, without a proportionate increase in expenses.

Strategic Implications

Like eXp Realty, Compass' revenue has increased exponentially over the past two years, driven by incredibly favorable market conditions that have benefited all real estate brokerages -- but some more than others.

Huge industry incumbents like Realogy have benefitted the least, while upstarts Compass and eXp have grown the most. Even tech-enabled Redfin, with so much going for it, pales in comparison to its peers.

The hot real estate market has fueled strong growth across the industry. Compass' growth is noteworthy, and demonstrates that while the industry moves slowly, some players move faster than others.

iBuyers: Paying Above Market and Reselling For More Upside

With unprecedented demand and constrained supply, house prices are rising across the U.S. Consequently, the iBuyers -- led by Opendoor, Zillow, and Offerpad -- are paying record-high, above market values for the homes they’re purchasing from homeowners. But they're also reselling them for more money than ever before.

Purchase Price-to-AVM

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

Historically, iBuyers paid a point or two below “market value.” My previous research study, conducted in 2019, found a median Purchase Price-to-AVM of 98.6 percent for Opendoor and Zillow. But things have radically changed in 2021; the number is well over 100 percent, with Opendoor paying a median of 107.7 percent in Q2 2021.

To be fair, most of the market is paying above "market value" in the housing frenzy of 2021. And for iBuyers, this trend has accelerated over the past six months, led by Opendoor. As a newly-listed public company, Opendoor needs to demonstrate strong revenue growth, and the only way to do that is by buying and selling more houses.

This shift -- and Opendoor’s strategy -- is clearly visible when analyzing its Purchase Price-to-AVM distribution compared to Zillow. In 2020, both companies were nearly identical, with a median Purchase Price-to-AVM of around 98 percent.

But in the first half of 2021, Opendoor materially shifted to the right, paying, on average, significantly higher prices for houses.

Over the past 18 months, Opendoor has clearly shifted to paying more for homes, with a much looser price distribution than the past.

The above chart can be interpreted a number of ways: houses are getting more expensive (they are), Opendoor is paying more for houses (it is), and pricing is becoming harder to predict with an AVM. But there also appears to be a shift from the tight pricing discipline of 2020 to a free-for-all, acquire at any cost strategy.

The trends adhere to the fundamental principles of supply and demand: with housing in short supply, iBuyers need to increase the quality of their offers. But this doesn't negatively affect their margins; in fact, iBuyers are reselling homes for more money than ever before.

Rising Price Appreciation

Once an iBuyer purchases a house, they quickly spruce it up and resell it -- ideally for more than they bought it for. This difference, the spread between the purchase and resale price, is price appreciation.

In 2021, the median price appreciation for iBuyer transactions is 8.1 percent -- a record high -- up from 4.7 percent in 2020 and 3.3 percent for Opendoor and Zillow in 2019. And it continues to climb, with Opendoor hitting 9.2 percent in May 2021.

Combined with 2021's 40 percent increase in the median value of homes purchased by iBuyers, price appreciation approaching 10 percent is financially significant.

Consider: median price appreciation of 3.3 percent on a $250k home in 2019 is $8,250, compared to 9.2 percent (Opendoor's price appreciation in May 2021) on a $350k home, which is $32,000.

And the results vary by market. An analysis of 262 iBuyer transactions in Phoenix during May and June shows a median price appreciation of 11.5 percent, or $39,000, after a median of just nine days on the market (total hold time is about two months).

It's no wonder that iBuyers are happy to pay more for houses and abandon their tight price discipline; they're more than making up for it on the resale.

A Note on Data Sources

The data above is primarily sourced from national public property records, with some data from the Phoenix MLS. Price appreciation is calculated by taking the percentage difference between sale price to purchase price for matched properties, and then taking the median value of those transactions. It is based on over 20,000 transactions between January 2020 and May 2021. Thanks to my good friend Suhel Mangera for his assistance crunching the data.

For more, zavvie's recent Seller Preferences Report does a good job of tracking iBuyer offer quality, fees, concessions, and other data that's relevant for consumers.

iBuyers Are Back: Purchase Volumes and Prices Soar to Record Highs

After a brief interlude last year, iBuyers are back in a big way. The iBuyers have bought more houses, at higher prices, in Q2 2021 than in any other quarter. Opendoor purchased more houses in the past three months than in all of 2020.

For anyone concerned that the iBuyer model wouldn't be popular in a seller's market, the evidence shows that it is resonating with consumers more than ever, and market conditions are in fact fueling its growth.

$350k is the new $250k

iBuyers are paying more for houses than ever before. The median purchase price of a home bought by Opendoor, Zillow, and Offerpad climbed to $350k in May, up from a steady-state median of $250k for the past several years (the iBuyer "sweet spot").

The iBuyers are still generally purchasing the same types of houses, they're just worth a lot more (+40%) due to the hot housing market. The median iBuyer purchase price closely tracks that of the overall U.S. market.

A more granular analysis shows dramatic shifts in price distribution. In the past 18 months, the percentage of homes purchased by iBuyers under $250k has plummeted from 55 to 13 percent, while the percentage of homes purchased for more than $500k has jumped from 3 to 24 percent.

This is a significant shift in the underlying economics of iBuying that affects revenues, gross profit, financing, inventory value, and more. For example, in Q1 2020 Opendoor sold around 5,000 homes. At an average of $250k each, that's around $1.2 billion in revenue. But at an average of $350k, revenue would be $1.7 billion -- a 40 percent increase driven by home values alone, and not volume.

The iBuyers will have blow-out quarters with record revenues, driven by high purchase and sale volumes and the rise in home values. iBuying is back in a big way.

A Note on Data Sources

The data above is sourced from national public property records. There is a timing delay, which means the June numbers may be slightly high or low. But the difference shouldn't take away from the major narrative of record volumes for the quarter.

Opendoor's Mortgage Attach Rate Jumps, But At What Cost?

A key component of the long-term profitability of iBuyers is their ability to attach adjacent services such as mortgage and title insurance. Opendoor's mortgage attach rate in Arizona has recently shifted dramatically -- up from around two percent during the past 18 months, to nine percent in April and a record 12 percent in May.

While the improvement is significant, there are a few points worth clarifying:

• While the percentage is high, the raw numbers are low. May's numbers equate to about 19 transactions where Opendoor sold a home and attached its Opendoor Home Loans product.

• Attach rates and loan numbers in other markets remain low (roughly two percent attach in Texas). In May, there were five transactions attached to Opendoor Home Loans outside of Arizona.

• As context, a 12 percent mortgage attach rate is an improvement, but still well-below industry averages and the Power Buyers.

The Cost of Gaining Market Share

Opendoor is making impressive gains in Arizona, but what's driving the momentum? It appears to come down to financial incentives: Opendoor is offering an additional two percent discount to buyers that use Opendoor Home Loans. As of writing, this promotion appears to be live in the Phoenix and Atlanta markets.

Opendoor offered the following table to prospective buyers (and their agents), showing the savings when using Opendoor Home Loans.

The challenge with these discounts is that Opendoor is giving away all of its margin to gain market share. In its investor presentation, Opendoor states a target margin of $5k on home loans -- which instantly disappears with a two percent back promotion.

Opendoor's rising mortgage attach rate in Arizona appears to be the result of significant financial incentives, or a "let's throw money at the problem" strategy.

Strategic Implications

There are two sides to Opendoor's "Throw Money At It" strategy. On the one hand, Opendoor effectively has unlimited access to capital, and is leveraging that competitive advantage by competing where it can win.

On the other hand, throwing money at the problem is a relatively unsophisticated, brute-force approach to gain traction and demonstrate top-line growth -- but at what cost? How valuable is a service if you need to pay people to use it?

Losing money on the core iBuyer transaction with hopes of making money on the mortgage (which is also losing money), doesn't balance out. Two loss leaders don't make a profit. For any company attempting to generate profits from adjacent services, and there are a lot, mortgage remains hard; it is no panacea for profitability.

The Rise of Power Buyers

Following the rise of iBuyers during the past decade, 2021 has seen the emergence and rapid growth of Power Buyers -- companies empowering buyers with services like cash offers, bridge financing, and trade in programs. Like iBuyers, these companies are transaction-focused, but most critically, target buyers instead of sellers.

Power Buyers leverage their balance sheets to purchase homes on behalf of their customers (turning offers into all-cash offers, or as part of a trade in program).

The focus on buyers is achieving a high product/market fit: Orchard and Homeward saw 150%+ growth in 2020 and over 300%+ growth into 2021. With high demand for housing and low supply, buyers need products to stand out from the crowd. Cash offers and trade in programs are providing that advantage.

The Mortgage Advantage

Financial products aimed at home buyers give Power Buyers industry-leading mortgage attach rates. That is in stark contrast to the major iBuyers, who have struggled to attach mortgage.

When it comes to attaching mortgage, it appears to be more effective to target buyers earlier in the process. Which is why the iBuyers are evolving their model to offer cash offer and trade in programs (ex: Opendoor's cash-backed offer).

The shifting landscape is causing disruptors and incumbents to adjust their strategies. Many companies are responding to this shift in consumer demand by launching their own instant offer, cash offer, and trade in programs.

Digging Deeper into Power Buyers

There's a lot more to unpack in the world of Power Buyers. My latest free report goes into this topic in detail, and the following video provides a crisp overview.

The Impact of Compass' Declining Stock Price on Agents

Compass' stock price has declined significantly since its IPO; it was the worst performing stock among its real estate peers over the past three months. And while stock prices certainly fluctuate, the decline has a significant, real world impact for the Compass agents that participated in its agent equity program.

A Bumpy IPO

Compass' stock has had a rough ride since its IPO on April 1, 2021. The company originally planned to price its shares between $23 and $26, valuing the company at $10 billion. With muted demand from investors, it revised down to $18 a share with a valuation of just over $7 billion for the IPO.

Compass Stock Price

Compass' stock has generally declined since its debut as a public company. It's currently trading at around $13.30 per share with a market cap of $5.2 billion -- significantly less than its last private valuation of $6.4 billion set by investors in July 2019.

Unlike any of its public real estate peers, Compass is worth less today than it was two years ago -- an outlier in the high-flying world of real estate tech stocks.

The Agent Equity Dilemma

Compass' stock price is especially relevant to agents that participated in its agent equity program, which allows agents to convert a portion of their commission into company shares. Compass agents invested $70 million into this program during 2018 and 2019 (the 2020 figure is unknown).

Any shares issued after July 2019 were valued at the company's valuation at that time: $6.4 billion or $154.26 per share ($15.42 per share after accounting for a stock split).

The point is that Compass stock is worth less today than it was in 2019, meaning agents that invested into the agent equity program since then have lost money on their investment (even accounting for a 10 percent company match).

Strategic Implications

Compass' growth story is impressive, and building a multi-billion dollar business is a noteworthy achievement. There are many individuals and organizations that made lot of money from the Compass IPO. But it's not a linear, upward trajectory to riches, and there are definitely winners and losers.

Stock option programs sound good on paper, but the reality varies. The post-IPO performance of Compass' stock highlights the primary issue with stock as a recruiting tool: it only pays if the stock goes up.

The 2021 Emerging Models in Real Estate Report

2021 Emerging Models in Real Estate Report from Mike DelPrete

Download a PDF of the
2021 Emerging Models in Real Estate Report

iBuyers Beginning to Target the Northeast Market

The Northeast is the major population center of the U.S., but has remained untouched by disruptive new models in real estate -- until now. Opendoor, Zillow, Offerpad, RedfinNow, and Orchard are establishing the first footholds in this potentially lucrative market. Traditional agents and brokers have had years to prepare -- are they ready?

The strongest iBuyer markets are centered in the West, Southwest, and South -- basically everywhere except the Northeast and Midwest. These markets, with older housing stock and longer winters, are more difficult to crack.

Major iBuyer Markets

But it's no secret the iBuyers (and other models) plan to enter the Northeast. Opendoor's investor presentation clearly laid out the playbook and plan of attack, which includes expansion into the Midwest and Northeast corridor.

Opendoor's Target Markets

Based on a pair of recent job postings, it appears that Opendoor is starting in Washington D.C., Virginia, and Maryland -- a market that RedfinNow and "Power Buyer" Orchard also entered earlier this year.

In early 2021, RedfinNow was the first iBuyer to launch in Boston. Meanwhile, Offerpad is expanding through the Midwest, recently announcing a launch in Columbus. This sits alongside Zillow Offers' presence in Cincinnati, a market launched in 2020.

Strategic Implications

Traditional real estate agents located in the Northeast and Midwest have had years to watch and learn. Billion-dollar disruptors are coming, featuring new models like instant offers, cash offers, and buy before you sell programs.

The Northeast accounts for 17 percent of the U.S. population, and local realtors can be zero percent forgiven for ignoring the coming disruption. Change is happening (slowly) and smart agents are adapting to that change. No market is immune. What's your plan? (Hint: Compete Where You Can Win).

Offerpad and Its More Profitable Flavor of iBuying

The Offerpad story presents the clearest signal yet that iBuying can become profitable. Its latest Q1 2021 numbers show a business only losing $230 per home bought and sold -- a breathtaking achievement compared to losses of tens of thousands of dollars per home at Opendoor and Zillow.

All up, on a GAAP basis, Offerpad's Q1 net loss was just $233k, compared to $58 million for Zillow Offers and $270 million for Opendoor. Staggering differences.

Background

Following Opendoor, Offerpad was the second iBuyer to launch in the middle of the last decade. In terms of size, it was eclipsed by Opendoor but has maintained parity with Zillow, buying and selling more than 4,000 homes per year.

Offerpad's version of iBuying stands out because it is losing radically less money than its peers. Offerpad's overall net loss per home is significantly lower than Zillow and Opendoor -- $5,400 compared to Opendoor's $29,000 in 2020. And it's overall net loss in 2020 was $23 million, twelve times smaller than Opendoor's $286 million.

Comparing Unit Economics

Financially, there are two possible explanations for this difference: either Offerpad is generating more revenue, or it is incurring less expense, per home bought and sold.

On the first point, the evidence suggests nearly identical revenue generation at Offerpad and Opendoor, as measured by gross margins (this accounts for purchase price, sale price, renovations, and ancillary services).

Both companies are tracking above Zillow, with all iBuyers seeing significant gross margin gains in Q1 2021 due to higher home price appreciation in the current market (and Opendoor is almost certainly benefiting from withholding new listings in 2020).

Offerpad and Opendoor have very similar direct costs as well (as measured by selling costs, holding costs, and interest expense in the charts below). The primary difference appears to be in each company's indirect expenses.

The unit economics between the two companies are nearly identical. But as a percentage of revenue, Offerpad's indirect expenses were 5.5 percent in 2020, compared to Opendoor's 14.6 percent (and Zillow's 17.5 percent). This is the key difference driving profitability.

Indirect Expenses

Each company has three main expense lines:

• Sales, marketing and operating

• General and administrative

• Technology and development

Sales, marketing and operating generally scales with volume; it includes selling costs, holding costs, and other costs directly involved in the transaction. General and administrative consists of corporate overhead like executive and admin salaries and rent, while technology and development includes all tech costs, including headcount.

The iBuyers have vastly different approaches to their technology investment; Opendoor is spending about eight times more on technology and development than Offerpad (and both companies are dwarfed by Zillow -- but given Zillow's wider technology ecosystem, I'm going to focus on an Opendoor comparison).

Since 2018, Opendoor has invested over $150 million into technology, compared to just over $20 million at Offerpad.

Offerpad's General and Administrative (G&A) expense -- think of it as general corporate overhead -- is also well below its peers. Again, Opendoor is outspending Offerpad by a factor of eight.

The differences in investment aren't explained by volume. In 2019, Opendoor sold about 4x the houses as Offerpad, but its overhead and tech costs were about 7x higher. In 2020, Opendoor sold about 2x the houses as Offerpad, and its overhead and tech costs were about 8x higher (a trend that continues into 2021).

Certainly each company has slight variations on how it accounts for expenses, but the overall narrative is clear: In aggregate and on a per unit basis, Offerpad is spending a fraction of what Opendoor is on technology and corporate overhead, resulting in significantly lower indirect costs.

The Impact of Technology

How does Opendoor's $150 million technology investment compare to Offerpad's $20 million? Looking at the bottom line, the results show a negligible difference and no competitive operating advantage.

I would expect technology development to allow iBuyers to more accurately price homes, improve operational efficiency, or reduce expenses -- but Offerpad and Opendoor have nearly identical unit economics and direct selling costs (Opendoor's gross margin advantage is being driven by home price appreciation, which is a gravy train that won't last forever).

Two Teams, Two Approaches

Offerpad and Opendoor are illustrating two different approaches to iBuying specifically, and venture-fueled disruption more generally.

Each company raised radically different amounts of venture capital before becoming public companies. At $1.3 billion, Opendoor had nearly 10x the capital to grow the business compared to Offerpad. The amount of capital raised is a direct result of differing growth mindsets, and has enabled two different growth strategies.

A look at each company's management team is illuminating. Nearly half of Offerpad's team come from a real estate background, including a co-founder (not pictured) that also co-founded single family rental behemoth Invitation Homes.

Contrast this with Opendoor, where not one single person listed has a real estate background. It appears that all of its executives come from venture-funded technology businesses.

The end result is two completely different teams with completely different approaches -- one centered in real estate, and the other centered in technology.

Strategic Implications

Offerpad's latest financials strongly suggest that a less venture-funded, less tech-enabled, more real estate focused, and less breakneck version of iBuying can be (almost) profitable.

And while Offerpad is nearly profitable on a small scale, perhaps it also suggests that Opendoor and Zillow can become profitable on a large scale -- not at 4,000, but at 40,000 houses per year -- once sales volumes catch up with overhead expenses.

Finally, the Offerpad story raises questions around the true value of technology in real estate. Like Compass' massive investment in technology (and WeWork before it), Opendoor is over-investing in tech with little to show for it on the bottom line. Technology helps create a great story, but at the end of the day, real estate is still...real estate.

Compete Where You Can Win

In the fast moving world of real estate, it’s never been more important to define a crisp and effective strategy. A portion of my work consists of strategic consulting for a range of real estate tech businesses. That experience has taught me a lot, and I can sum up what I believe to be the single most important concept in strategy: Compete where you can win.

A three minute video of me talking about "Compete Where You Can Win."

Find Your Sustainable Competitive Advantage

All of my strategy work — from multi-billion dollar organizations to scrappy start-ups — starts with a somewhat cliche business school phrase: sustainable competitive advantage. This is what sets a company apart from others; the collection of unique attributes that allow an organization to outperform its competition.

In the world of real estate tech, Zillow has its massive consumer audience, Compass has its deep pockets, Keller Williams has its scale, and Realogy has its brands.

Clearly identifying a sustainable competitive advantage — a company’s strengths — is an important first step in an effective strategy. The critical second step is leveraging that competitive advantage directly against a competitor’s weakness or a market opportunity — competing where it can win.

Case Study: Compass

Perhaps the best case study is Compass. Its competitive advantage was capital ($1.5 billion in VC funding), which it used to gobble up market share.

The competitive weakness that Compass exploited was a traditional brokerage’s inability to compete on capital. Competitors couldn’t match Compass’ commission splits, signing bonuses, or marketing support. Unlike its competitors, Compass didn’t need to worry about being profitable, and the company leaned heavily into this strategy to recruit agents and grow its market share. Compass played a game that it, and it alone, could win.

Compete Where You Can Win

What truly sets yourself or your business apart from others? What can you offer that no one else can, and how can you leverage it against your competitor's weak points? It’s senseless to go up against your competitors where they are strongest (although many still try).

Anyone in real estate, from disruptor to incumbent, behemoth to startup, tech company to individual agent, can effectively compete in today's quickly changing market. It all comes down to being smart about understanding your strengths and competing where you can win.

Zillow, Power Buyers, and the Challenge of Attaching Mortgage

In 2018, Zillow set itself lofty goals when it entered the mortgage business. Three years later, Zillow's actual performance is far, far below its predictions, highlighting how difficult the mortgage space is, not just for Zillow, but for every real estate tech company targeting mortgage as a lever for growth.

Setting High Expectations

Zillow's 2018 Annual Report, released after Mr. Barton assumed the CEO role, clearly set out the company's 3–5 year goals in mortgage:

Mortgages Segment

• Zillow Home Loans achieves a 33 percent attach rate to Zillow Offers, up from zero in 2018.

• Zillow Home Loans originates more than 3,000 loans per month, up from nearly 4,000 MLOA loan originations in all of 2018.

The 33 percent attach rate to Zillow Offers is down from the lofty 75 percent attach rate quoted earlier by Mr. Rascoff in Zillow's 2018 second quarter earnings call:

"So for anybody who is wondering why we just bought a mortgage lender, just to hit some of those numbers again, at a mere 10,000 homes sold a month from Zillow Offers, a 75% attach rate gets to over $800 million a year of revenue opportunity for mortgage origination.”

Three years and over 10,000 homes bought and sold later, the reality is a mortgage attach rate to Zillow Offers of less than 1 percent.

(Zillow and Opendoor's attach rate is based on the markets where the service is live.)

Zillow's goal of originating 3,000 loans per month, or 36,000 in a year, remains highly aspirational. Loan originations actually took a step backwards in 2019 before rebounding in 2020 due to the pandemic and record low interest rates -- but are still less than 20 percent of Zillow's original goal.

It's worth noting that proportionally, Zillow's purchase volume (versus refinance) has steadily declined from 97 percent in 2018 to 31 percent in 2020 (and down to 10 percent in Q1 2021). The growth in Zillow Home Loans is being fueled by refi.

The Rise of Power Buyers

Ironically, Zillow is attaching more mortgages to Opendoor-owned homes than it is to Zillow-owned homes. Just let that sink in.

This bizarre fact underscores how difficult it is to attach mortgage to an iBuyer home for sale; most prospective buyers are already pre-approved. It's too late in the buyer journey to introduce and attach a new financing option.

Which is why the smart money is on companies -- I call them Power Buyers -- focused exclusively on attracting buyers earlier in the process with products like cash offer and buy before you sell. Examples include Homeward, Orchard, and Knock, and initiatives like Opendoor's Cash Offer and Zillow's video tease of it helping a Zillow Offers seller secure financing for their next purchase.

There are a multitude of companies attempting to sell mortgage and other adjacent services to their customers in an effort to increase profits. For the time being, the Power Buyers are in the lead with mortgage attach rates approaching 80%, with the iBuyers pivoting their models to catch up. Zillow's experience shows that it's a long, slow road, requiring big investment, patience, and a smart, consumer-first approach.

Compass Agents: You Are The Customer

As a newly public company, Compass faces a challenge to reach profitability. Its latest numbers reveal a noticeable drop in agent commission splits, a reminder that Compass’ path to profitability lies directly through -- and may come at the expense of -- its own agents.

Compass incurred losses of $212 million in its first quarter as a public company, compared to the $270 million it lost in all of 2020. Meanwhile, Compass’ peers managed to turn a profit during some of their best quarters ever.

The $212 million loss includes a one-time expense of $149 million of stock based compensation. Looking at Adjusted EBITDA, where each company backs out various expenses to provide a more favorable accounting of the business, still reveals significant losses -- compared to the healthy profits at eXp and Realogy.

The data reveals a brokerage continuing to lose money, especially compared to its peers, during a booming real estate market. But now that Compass is public, the spotlight is turning towards profitability and leading to an obvious source of additional profit: its agents.

The Agent is the Customer

In the first quarter of 2021, Compass’ agents generated $1.1 billion in revenue and were paid $900 million in commissions (including stock). But the effective agent commission split of 80.8 percent is a noticeable drop from the past year. While its brokerage peers paid proportionally more money to their agents, Compass paid less.

In its public filings, Compass attributes this “favorable decrease” (their words, not mine) to “the change in mix of the commission arrangements we have with our agents” and “changes in geographic mix.” The agent economics are changing in Compass' favor, and Compass is retaining more of the commission.

This dynamic is not unique to Compass, but it highlights the natural tension between brokerage and agent when less money being paid to agents is seen as “favorable” and “an improvement.”

For Compass, a reduction of its effective agent commission -- through a combination of changes in commission arrangements, geographic mix, and increasing technology fees -- of just 3 percent results in immediate profitability.

It's highly unlikely that Compass will drop its agent commissions 3 percent and survive as a business. Agents would simply pack up and leave. But the gap isn't too far and, combined with rising technology fees, represents the fastest path to sustained profitability.

Compass' effective agent commission drop in Q1 2021 is the largest seen in two years. It may be an outlier or it may be the start of a trend, but it remains a key metric to watch going forward. And if you're a real estate agent, this is a gentle reminder to never forget that you are the customer.

A note on data: When calculating Compass' effective agent commission splits, I've included stock-based compensation. For Q1 2021, I've backed out the one-time acceleration of stock-based compensation expense of $41.7 million in connection with the IPO.

Zillow and realtor.com Battle for Traffic and Revenue Growth

According to the latest company results, it appears that Zillow's longstanding traffic lead over realtor.com is diminishing. In an industry where metrics like this move slowly if at all, it's fascinating. But it's also insignificant in terms of competitive advantage and revenue uplift -- and may simply be an artifact of pandemic browsing patterns -- but it does reveal a deeper truth around portal monetization.

Zillow's traffic advantage hasn't changed in years -- consistently hovering at three times the average monthly visitors compared to realtor.com. However, beginning in Q1 2020, that lead begins to erode.

The timing suggests that this is likely a result of the pandemic. Perhaps Zillow has less upside, while realtor.com is benefiting from more consumers willing to visit multiple sites to see all available inventory in a high-demand, low-supply market.

A Corresponding Revenue Uplift

Across the board, the increase in portal traffic has resulted in an increase in revenues. Like Zillow, realtor.com experienced an unprecedented pandemic bump in lead gen revenues -- the first time in years.

But in this case, a rising tide lifts all boats. Both companies experienced a proportionally identical increase in lead gen revenue; Zillow's revenue lead remains unchanged at 2.5 times higher than realtor.com.

The data above is an apples-to-apples comparison of each company's lead gen business: Zillow's premier agent vs. realtor.com's "real estate" revenues.

Strategic Implications

As I outlined in a recent analysis on challenger portals, there is a non-linear correlation between market share (traffic) and value (in this case, revenue). Time and again, it's "winner take most" for the #1 portal.

What I find fascinating is that despite all of the activity of the major portals, the monetization ratio has remained constant. Like the speed of light, there's an immutable law of portal monetization at play with an upper limit, unchanged despite:

• realtor.com's $210 million acquisition of Opcity

• A new CEO and senior management team at realtor.com

• Zillow launching Zillow Flex and qualifying leads

And it's not just the U.S. In Australia, the top two portals have a similarly static monetization ratio despite years of intense investment and competition.

At its extreme, this suggests a sort of monetization nihilism -- that nothing matters. Product improvements, senior management changes, business model shifts, global pandemics, and nine-figure acquisitions are, in the end, meaningless in terms of portals outperforming each other. There's a premium for being #1, and it just doesn't change.

What Zillow's Results Reveal About Its Momentum Towards Zillow 2.0

The coverage of Zillow's latest results is fantastically uninspiring. Lots of big numbers, devoid of context. But when the dots are connected they reveal a rich story about the business's evolution to Zillow 2.0.

Perhaps most impressively, Zillow just had its third consecutive profitable quarter! For a business that's basically operated at a net loss since inception, this is a noteworthy achievement.

The move towards profitability is driven by Zillow's premier agent program -- the engine room of the company -- which is firing on all cylinders and back to impressive growth (fueled by record-breaking demand during the pandemic).

On an absolute revenue basis, Zillow's premier agent program has set a succession of all-time record quarters for the past 12 months. Zillow is generating more money from its premier agent program than ever before, which is especially noteworthy after the program ground to a halt in early 2019.

Zillow's iBuyer business is back to growth mode, purchasing and selling houses at pre-pandemic levels, and still operating at a loss. But the net loss per home has dropped to its lowest level yet, a reflection of improving economics at scale.

Last week I looked at the Ecosystem Disruption in Mortgage, and how global leaders Zillow and REA Group have spent hundreds of millions of dollars expanding into mortgage through the acquisition of broker-heavy, 20 year old traditional businesses -- and not technology companies.

Zillow's mortgage business continues to grow, but it is being driven by refinancing (90%), and not new purchase (10%), business. To fully believe the one-stop-shop Zillow 2.0 narrative, new purchase volumes should grow in the future.

But while overall mortgage revenues increased, the business remains unprofitable. This is another sign that mortgage is hard, difficult to scale profitably, and tough to "reinvent" with technology. Like the Zillow Offers business, Zillow Mortgage appears to be another high revenue, low margin operation.

The evidence reveals a business -- in my humble opinion -- that is still in the early innings of reinventing real estate. Zillow is clearly benefiting from the current red-hot real estate market, with its premier agent program leading the charge and funding the evolution to Zillow 2.0.

But the promise of new, adjacent services is still an aspirational goal. The various pieces are being built, but still need to be assembled in a credible way that reinvents the transaction at a meaningful scale. Momentum is on its side, and Zillow's evolution continues.

Portal Wars: CoStar vs. Zillow, Boomin vs. Rightmove

Across the globe, there are efforts underway to unseat leading real estate portals. In the U.S., commercial real estate behemoth CoStar has spent over $400 million to acquire residential listing portals Homes.com and Homesnap. And in the U.K., start-up Boomin is raising an additional £25 million to directly compete with Rightmove.

The primary value a real estate portal provides its customers is exposure to the most potential homebuyers and homesellers. In the U.S., Zillow's traffic lead over CoStar's recent acquisitions is astronomical.

Homeowners want to advertise their biggest asset in the one place buyers will definitely look. Zillow is that place: From a traffic standpoint, Zillow has a reach 23 times larger than Homes.com, making it exponentially more effective and valuable.

Attempting to directly compete with market-leading real estate portals is an incredibly difficult proposition, with success unlikely. The unique challenges include:

• Incremental gains in market share don't equate to incremental gains in value.

• Getting listings is the easy part. Building traffic is hard.

• Product differentiation means little. The main value to users is reach.

The CoStar Strategy

CoStar doesn't need to unseat Zillow to build a valuable business. Zillow's customers are real estate agents -- premier agents -- that pay Zillow for leads. However, Zillow only works with about five percent of real estate agents in the U.S., leaving a large addressable market for CoStar to tap into.

The narrative that CoStar is attempting to compete directly with Zillow is simply that: a story designed to rile up agents and generate buzz. The actual battle isn't about consumer eyeballs; it's about a real estate agent's wallet.

Strategic Implications

The challenger portals are succeeding with the easy bit: securing listings. Traffic is the hard part.

Through the years, the top portals have maintained their lead against billion-dollar, multinational media organizations (Zillow vs. realtor.com, IS24 vs. Immoweb), industry-backed, publicly listed upstarts (OnTheMarket vs. Rightmove), private-equity backed #2's (Zoopla vs. Rightmove), and publicly listed competitors (Domain vs. REA Group). Hundreds of millions of dollars have been thrown against the top portals for years with no effect on their dominant position whatsoever.

Past evidence shows that it is exceedingly unlikely that this new batch of challengers will dethrone the top portals. The smart challengers understand this game and how it’s played; not trying to overtake the leaders, but instead building a viable business on its own merits.

A Deeper Dive

Check out the articles below to dive deeper into the massive advantages that incumbent portals possess and the challenges around trying to disrupt them.

• Millions More Buyers: A Real Estate Portal’s Competitive Advantage

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

• Why investing in OnTheMarket is a horrible idea

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

Ecosystem Disruption in Mortgage Looking Exceedingly Traditional

Last month, Australia's #1 real estate portal, REA Group, announced the $244M acquisition of mortgage broking business Mortgage Choice. This is the latest move by global leaders Zillow and REA Group to spend hundreds of millions of dollars expanding into mortgage through the acquisition of broker-heavy, 20 year old traditional mortgage businesses -- and not technology companies.

Real estate portals are moving closer to the transaction, and there is a battle brewing in adjacent services. For portals, it's a path towards revenue growth and a seamless customer experience. For new models like iBuying, it's the only path to profitability.

But: mortgage is hard. The underlying economics demonstrate how difficult it is for portals to grow these businesses. Financial services is still a small segment of REA Group's entire business, representing less than three percent of total revenue. It is, however, profitable, with margins just under 40 percent. But overall revenue growth has stalled and moved backwards since the acquisition of Smartline.

By comparison, Zillow's mortgages segment (which includes Mortech and its mortgage lead gen business, in addition to the Mortgage Lenders of America broking business), has seen strong revenue growth but is much, much less profitable.

Zillow acquired Mortgage Lenders of America (MLOA) in June 2018, which was followed by a modest revenue uplift. However, it appears the driver of FY20 growth was the pandemic and record low mortgage rates in the U.S.

Zillow's mortgage business was unprofitable leading up to the MLOA acquisition, and subsequently became much more unprofitable. It wasn't until the massive growth during the pandemic that the segment eked out a profit.

The evidence suggests an underlying business that is expensive to run and difficult to make profitable. Getting adjacent services right and running a successful mortgage broking business -- and in REA Group's case, growing it -- is hard work.

For all the money being invested in this space and the hype around a digital ecosystem, it's noteworthy that the real estate portals see their path to growth via traditional brick-and-mortar brokerage businesses, and not high-flying, scalable tech solutions. Mortgage is not an industry that can be disrupted with technology alone.

iBuyer Purchases Recover to Pre-Pandemic Levels

The pandemic of 2020 brought iBuying to a grinding and dramatic halt. The major iBuyers -- Zillow, Opendoor, and Offerpad -- have slowly recovered, with total purchases in Q1 2021 finally rising to the levels of the same period last year.

A few additional observations on the above data:

• While Opendoor has matched its year-over-year purchase volumes, Q1 2020 was itself an outlier, with significant slowdown in purchases from Q4 2019.

• On average, Opendoor is still 35 percent below its high-flying 2019 peak.

• Offerpad, soon to go public via a SPAC, is a respectable third player, with purchase volumes of about half of the leaders.

Before the pandemic, Opendoor was the clear category leader, purchasing over twice as many houses per month as Zillow. The lockdown was the great equalizer; both companies dropped to near zero, and recovered at the same pace throughout 2020. However, in the first quarter of 2021, Opendoor again pulled ahead while Zillow took its foot off the accelerator.

From a sales perspective, all iBuyers are still well-below their pre-pandemic highs. Opendoor sold 55 percent fewer houses in Q1 2021 than the same period a year ago. This is attributable to timing; as the iBuyers purchase more houses and rebuild their inventories, sales will follow.

Individually, the top six iBuyer markets are mirroring the gradual recovery. Phoenix and Atlanta remain the largest markets by volume by a wide margin.

The iBuyers are down but not out. Recovery continues at pace; the business model is certainly here to stay, but not without its recovery challenges.

Inside the Compass IPO

Inside the Compass IPO from Mike DelPrete

Download a PDF of Inside the Compass IPO

The Compass Valuation Quandary

Compass' recent debut as a public company was a mixed bag. Of considerable note is the current valuation: $6.65 billion, compared to $6.4 billion when it last raised capital two years ago. The tiny gain brings up interesting questions: Why has Compass' valuation not increased more, and how does it compare to its peers?

Compass has a massive valuation, on par with Redfin and dwarfing Realogy. This analysis isn't about the valuation itself, but rather changes in value over time. Often, trends and momentum reveal more than absolute figures.

Between July 2019 and April 2021, many real estate and real estate tech stocks have seen massive gains, even traditional incumbents like Realogy and RE/MAX. However, Compass stands out with a tiny 4 percent gain in valuation over the past two years -- two years which has seen massive growth at the company across all metrics.

Compass has positioned itself on the cutting edge of real estate tech, promising to revolutionize the industry through unprecedented investments in technology. However, the company valuation has hardly budged in two years. Why the disparity?

The valuation discrepancy -- especially compared to its peers -- stands out loud and clear. Investors either significantly over-valued the company in its previous fundraising rounds, or are pessimistic about its growth prospects going forward.

Research note: Company valuations from July 2019 are taken from GCA Advisors research, and for 2021 are from April 8th. All valuations are a like-for-like "equity value." Opendoor's 2019 valuation is from March, the remainder from July 2019.

America's Next Top Real Estate Model: Tracking the Growth of eXp, Redfin, and Compass

Compass, eXp Realty, and Redfin are three of the largest, fastest-growing brokerages in the U.S. Each operates a traditional brokerage business model and leverages technology as a key competitive differentiator. A deeper look at the rapid rise of each reveals a trio of insightful growth stories — which may very well shape the future of America’s real estate landscape.

The changes to the top 20 U.S. brokerages by transaction count are striking (data courtesy the Real Trends 500). In 2018, the top two brokerages (Realogy and Berkshire Hathaway HomeServices) dwarf the competition; no other brokerage comes close. Fast forward to 2020, and eXp Realty is within striking distance of the top two, followed closely by Compass.

Each business has experienced wildly different growth trajectories. Compare Redfin’s slow and steady growth to the exponential hockey stick curves of Compass and, most impressively, eXp Realty.

The engine room of each company’s growth is driven by agents (as I like to say, agents sell houses, not technology). The corresponding agent count at each company closely mirrors overall transaction count growth. Redfin has far, far fewer agents than its peers, but its agents are exponentially more efficient.

Since 2018, Compass and eXp have grown agent count and transaction volume exponentially, which -- at this scale -- is unheard of, and why each company is so disruptive in the industry.

Reviewing the interesting similarities and key differences between the three companies reveals their different target markets, represented by average sales price. Compass is clearly in the luxury band, while Redfin caters to high priced homes and eXp is closer to the national average home value.

In the end, Compass and eXp are quite similar: fast-growing real estate brokerages fueled by unprecedented agent growth. Both companies leverage cash (or the promise of cash via stock options and/or multi-level marketing) to recruit, and lean on technology as a differentiator.

In 2018, it could have been possible to ignore the companies or dismiss their efforts to grow. But in 2021 they've become too big to ignore, and are cementing -- and growing -- their leadership position in the future of real estate.