Predators and Prey

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

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

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

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

 
 

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

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

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

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

 
 

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

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

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

 
 

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

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

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

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

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

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

Behind the Scenes: Writing a 361-Word Article

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

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

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

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

  • What else should I know about this situation?

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

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

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

 
 

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

 
 

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

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

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

 
 

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

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

 
 

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

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

 
 

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

 
 

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

 
 

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

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

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

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

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

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

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

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

 
 

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

 
 

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

 
 

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

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

 
 

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

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

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

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

2021 is an Outlier, Not a Benchmark

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

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

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

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

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

 
 

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

 
 

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

 
 

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

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

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

 
 

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

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

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

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

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

The Real Estate Portal + Mortgage Conundrum

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

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

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

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

 
 

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

 
 

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

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

 
 

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

 
 

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

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

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

 
 

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

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

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

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

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

For First Time, Opendoor Selling Homes for a Loss

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

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

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

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

 
 

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

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

 
 

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

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

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

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

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

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

 
 

Opendoor is also leveraging aggressive price cuts.

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

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

 
 

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

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

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

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

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

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

Opendoor's Buyer Agent Commission Advantage

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

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

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

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

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

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

 
 

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

Opendoor Doubles Its Ad Spend

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

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

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

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

 
 

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

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

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

 
 

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

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

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

Deeper Cuts Announced as Compass' Cash Burn Continues

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

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

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

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

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

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

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

 
 

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

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

 
 

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

 
 

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

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

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

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

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

Zillow Home Loans Continues Its Unprofitable Run

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

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

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

 
 

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

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

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

 
 

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

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

The Zillow & Opendoor Partnership

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

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

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

 
 

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

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

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

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

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

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

 
 

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

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

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

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

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

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

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

Building a Better Mousetrap: Zillow vs. Opendoor

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

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

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

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

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

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

 
 

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

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

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

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

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

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

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

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

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

 
 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 
 

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

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

 
 

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

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

eXp's Business Model Advantage

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

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

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

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

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

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

 
 

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

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

Brokerage Slowdown Begins

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

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

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

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

 
 

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

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

 
 

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

The Opendoor MLS

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Tucked away in Opendoor's recent earnings call was an enlightening statement by its CEO, Eric Wu, which sheds light on its exclusive supply strategy.

Why it matters: Exclusive content is a strategy being driven by VC-funded real estate tech disruptors, with important implications for consumers and a spotty track record of success.

  • A possible endgame for Opendoor is to match exclusive supply with demand directly -- off the MLS -- through an Opendoor ecosystem.

 
 

The benefits to Opendoor are clear: avoiding agent commissions, controlling the consumer experience start to finish, and streamlining the sales process.

Opendoor is not alone in wanting to build a supply of exclusive inventory to draw consumers to its private platform.

 
 

Compass also uses exclusive content to drive consumers directly to its platform, a clear endgame for the business.

  • Compass encourages sellers to list exclusively and privately on its platform.

  • Nearly a quarter of Compass' current listings are exclusive; a homebuyer has to call a Compass agent for access.

 
 

Yes, but: This isn't new.

The rise of exclusive content in real estate risks fragmenting the search and discovery process -- with considerable implications for consumers.

  • Buyers lose easy access to a complete view of the market by being forced to visit multiple sites (or call an agent like it's 1995).

  • For sellers, it fragments and artificially reduces the number of possible buyers, which could lead to less demand and a lower price for a property.

The bottom line: There is incredible value to whoever controls the home search platform. In the U.S., that's Zillow, realtor.com, and hundreds of MLSs.

  • New platforms -- leveraging exclusive content -- are a significant threat to these incumbent platforms.

  • And so far, the benefit to consumers is questionable.

Go deeper: I've previously explored this topic in my Strategic Analysis of The Top Threat to Real Estate Portals. Spoiler alter: It's exclusive content.

This analysis looks at several case studies from around the world.

Compass' Cash Burn Problem

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Compass' latest financial results reveal a company that burned $142 million in cash during the first three months of 2022, with $476 million left in the bank.

Why it matters: Manufactured profitability metrics aside, cash is the fuel that powers all businesses.

  • Compass has a track record of significant cash burn (over $400 million in the past 15 months), with high fixed operating costs and expensive acquisitions.

 
 

There's a widening gap between Compass' gross profit (revenues after commission expense) and its operating expenses.

 
 

Compass is burning more cash and operates more unprofitably than any of its publicly-listed peers.

  • Realogy, eXp, and Douglas Elliman all have gross profits higher than their operating expenses.

 
 

Compass' cost base is significantly higher than last year; operating expenses are up 50 percent from Q1 2021 (excluding stock-based compensation).

  • But revenue growth is soft; Compass is only projecting eight percent revenue growth in Q2.

  • This is only operating expenses, and doesn't include capital expenditures and acquisitions.

 
 

Compass' cash burn over the next 12 months is highly dependent on the overall real estate market.

  • There's not a lot of margin of error; a challenging 2022 market will depress revenue and increase cash burn.

  • Specific projections aside, there is an undeniable downward trend in Compass' available cash balance, which is becoming more difficult to ignore.

 
 

What to watch: Compass is not in immediate peril, but it is approaching a critical juncture where it will either need to raise more money or reduce expenses.

  • The Compass business model relies on massive amounts of investment capital to subsidize massive financial losses.

  • It's not clear that the business can achieve breakeven on its current trajectory; its cash burn is unsustainable.

  • Compass may be forced to enact significant layoffs to recalibrate its burn rate.

Cash is king: After years of big spending, access to seemingly unlimited amounts of capital, and sustained unprofitability, the time has come for Compass to demonstrate a durable, self-sustaining business model.

A note on projections: This analysis uses the midpoint of Compass' guidance for Q2 revenue ($2.1 billion), and seasonal estimates for Q3 and Q4.

  • Gross margin is assumed to be 18 percent (Q1 2022 actual).

  • Operating expenses remain flat at Q1 2022 levels.

  • Roughly $50 million of capital expenditure and acquisition costs for the year (much lower than historical amounts; there was $190 million in 2021).

 
 

Opendoor 2022: Can't Stop, Won't Stop

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2021 was a record year for Opendoor, and 2022 may be even bigger. To date, Opendoor has exponentially increased its advertising spend and homes purchased.

Why it matters: The latest data reveals a company doubling down on growth, despite rising market uncertainty and the risks illustrated by Zillow's 2021 implosion.

Opendoor's growth, as measured by the number of homes purchased, has materially accelerated.

  • Opendoor's monthly purchase volume is running significantly ahead of last year; March was big and April looks even bigger.

  • The company purchased 2.5x as many homes in Q1 2022 compared to the same time last year.

 
 

Opendoor's advertising spend is driving the growth in transaction volumes.

  • The company doubled its advertising spend in Q1 2022 compared to last year.

  • If that spend were annualized, Opendoor would be on track to invest a record $200 million on advertising in 2022.

 
 

The increasing advertising spend is causing Opendoor's customer acquisition costs to rise compared to 2021 (as calculated by total advertising spend divided by houses acquired).

  • But customer acquisition costs are lower than Q1 2021, showing improving economies of scale.

 
 

The bottom line: 2021 was a record year for Opendoor -- and the evidence suggests 2022 may be even bigger.

  • As a public company, Opendoor needs to demonstrate growth regardless of market conditions.

  • Despite recent profitability driven by record home price appreciation, Opendoor's model only works at scale -- a scale larger than 2021.

  • Opendoor remains committed to making its model work, and in a sense, is just getting started -- by operating at a scale where things get interesting.

Zillow Flex Grows In a Cooling Market

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Zillow and realtor.com's Q1 results shine a light on two key factors: overall revenue growth is slowing in a cooling market, and Zillow's next gen lead gen business, Zillow Flex, is building momentum.

Why it matters: Zillow is going all in on next gen lead gen; it's an important evolution of the real estate portal business model, and perhaps the singularly most critical component of Zillow's future growth (Zillow 3.0: Back to Basics).

  • Revenue growth in Zillow's Premier Agent business, which includes Flex, has slowed, and is projected to remain relatively flat in the months ahead.

 
 

Zillow's plan is to double premier agent revenue by 2025.

  • It's far too early to pass judgement, but the results highlight future challenges -- and that Zillow will need to do something new to re-accelerate its business.

Comparatively, realtor.com's revenues are also flat, and its next gen lead gen business accounts for a similar amount of revenue as at Zillow (28 vs 25 percent).

 
 

But growth rates are radically different. Zillow's Flex revenues increased 200 percent from the same period last year, compared to an 18 percent increase at realtor.com.

  • Meanwhile, revenue in Zillow's traditional lead gen business dropped (!) 10 percent during the same time, compared to growth of 3 percent at realtor.com.

 
 

The evidence supports the narrative that Zillow is going all in on next gen lead gen.

  • It's extremely unlikely that Zillow will hit its 2025 targets with traditional, market-based pricing; it's all about Flex.

Yes, but: Even though traffic and lead volumes are down at the portals (22 percent lower for realtor.com), overall lead gen revenues are up (7.5 percent at realtor.com and 9 percent at Zillow).

  • The portals always win: In a slowing market, agents are paying more money for fewer leads.

The bottom line: It won't happen overnight, but the future of Zillow appears very much tied to the future of Flex.

Zillow Goes All In on Next Gen Lead Gen

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Zillow recently announced that it was moving exclusively to its success fee Flex model in two major markets, Denver and Raleigh.

Why It Matters: Zillow Flex is "Next Gen Lead Gen," featuring a 35 percent commission share and lead qualification by Zillow employees. It's the future of real estate portal lead gen -- and gets Zillow much closer to the transaction.

  • In the past, Zillow has operated Flex alongside its traditional pay per lead model; this changes that.

  • By going all in in two major markets, Zillow is signaling its intent to control more of the transaction in order to satisfy its goals of doubling its Premier Agent business by 2025.

 
 

Zillow's new strategy (Zillow 3.0: Back to Basics) has the company going back to its roots, doubling down on agent lead gen, and extracting more revenue from real estate commissions.

 
 

Winners and losers: Next gen lead gen works for the agent partners that decide to participate in the program; those agents and brokers receive millions of leads.

  • But those agents may become even more reliant on the portal as a critical business partner, giving the portal more market power.

  • Over the long term, agents not participating in these invite-only programs will receive fewer online leads, and may be at a significant competitive disadvantage in the race to acquire customers.

What to watch: How Zillow integrates mortgage (Zillow Home Loans) and ShowingTime into its renewed Flex program.

Next Gen Lead Gen is a major trend discussed in my Real Estate Portal Strategy Handbook. Check out a free preview of the report, or this article on the topic!

The Ever-Shifting Landscape of Mortgage Disruption

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Recent growth and contraction in the mortgage, iBuyer, and Power Buyer space has resulted in a reshuffling of the largest businesses aiming to disrupt the industry.

Why it matters: Mortgage is an emerging battleground in real estate, and the number of Mortgage Loan Originators (MLOs) employed by a company is an important leading indicator of that company's firepower and strategic intent in the space. Of note:

  • Opendoor has surged to #3 after acquiring RedDoor.

  • Significant layoffs at Knock and Homie have pushed Homeward into the #1 spot of emerging Power Buyers (full disclosure: I'm an advisor to Homeward).

Zillow and Knock have shed MLOs during a series of recent layoffs.

  • Zillow's MLO headcount is down 17 percent and Knock is down a massive 50 percent from December.

 
 

Better Mortgage and its employees have had a tough five months. So far, the business has lost about half -- around 600 -- of its MLOs through a series of layoffs.

 
 

Comparatively, Zillow still has significant firepower at its disposal; all eyes are on what's next for Zillow Home Loans in a post-Zillow Offers world.

 
 

Redfin and Prosperity Home Mortgage (a subsidiary of mega-broker HomeServices of America) dwarf Zillow and the others in the space, highlighting the latent power of incumbency.

  • Redfin (through Bay Equity), Prosperity, and Zillow operate more traditional mortgage businesses, while the others offer more disruptive services.

  • It's also important to differentiate between purchase and refinance business; many of the Power Buyers and iBuyers are focused on purchase.

 
 

The bottom line: Real estate tech disruptors are investing billions to build integrated brokerage and mortgage experiences.

  • Tracking MLOs over time reveals who is marshaling resources for future growth, who is making strategic retreats, and who has the most potential to effect change in the future.