Why Does Wall Street Like Realty Companies?

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Being the first day of April, our thoughts naturally turn toward the fool.   So we wondered what Robert Reffkin CEO of Compass was doing?  Turns out, he was filing Compass’s S-1 Document with the Security and Exchange Commission to take his company public.*  OK, so now who’s the fool?  Reffkin or those who will be investing in his company? 

Ask a realtor, if they think investing in real estate companies is a good idea.  And not as a GameStop lark but as an actual investment.  Would they invest their hard-earned commissions on a real estate broker?     

Full disclosure; I have been lucky enough to have worked for two different companies that went public.  In both instances, the companies created products and owned their own proprietary technology.  Real estate companies have no products, create nothing and develop no assets.  Yet they survive because they are protected by an incredibly unique industry dedicated to maintaining their status quo.  Case in point, how is today’s 6% listing any different from what it was in 1974?  

The revenue numbers of real estate companies are sure impressive.  Stock market-like impressive.   In 2020, Compass had revenue of $3.7B dollars.  Nice.  They still lost $270M dollars.  Ooops.   Realogy, the industry’s largest company had revenues of $6.7B dollars.  It’d be much more impressive if they cut that number in half and let nearly $4B dollars stay in the pockets of the homeowners they took it from. 

At some point, numbers will mean something.  Compass currently sits $1.1B dollars in debt.  Half of which was spent on their website.  Even their own S-1 filing states Compass: “may not be able to achieve profitability and we may continue to incur significant losses in the future”.    So why would underwriters take this on?

Compass cites three reasons for continued losses: increased competition, agent acquisition cost and changes in fee structure.  Let’s look at each.

  • Increased competition. Not really.  Check NAR records, the number of agents has been remarkable consistent over the last 20 years.  There is no, “increased” competition.
  • Agent acquisition.  If you have to pay agents more than any other brokerage, just to have them come work for you, then how do you make those costs up—in volume?  This may come as a surprise to those on Wall Street, but real estate agents change Brokerages like many people change socks.  Outside of a few pyramid schemes, there is no such thing as Broker loyalty.  What is hot and trendy today could be gone tomorrow and that is not usually what investors are looking for. 
  • Fee structure change.  Duh!  What underwriter looks at the traditional real estate brokerage business model and declares it sound?  What if people who sell their homes said, “I am not paying for the Buyer’s agent anymore. If they can afford this house, they can afford their own damn agent”.  Agents who list homes hear this nearly every day.  Yet somehow no one on Wall Street thinks this is a problem.

If you spend any time reading Reffkin, you’d think he was curing Cancer.  But shouldn’t Wall Street analyze these companies for what they really are?  Person A wants to sell. Person B wants to buy.  Person C butts in-between.  Compass, Realogy, Zillow, Berkshire Hathaway, Redfin, buttinsky’s all.  Sales 101, wedge yourself to be in the middle. 

But, Wall Street demands continued growth.  So how do real estate companies grow from the middle? Their revenue comes from homeowners.  And if the homeowners say NO, then what?  Clicks? 

The free market will eventually tell the industry what it will allow.  The days of the 6% listing will be gone soon.  Also soon gone; tons of agents.  With the glory days of the franchise winding down, agent retirements are inevitable.     This is actually a good thing.  The U.S. Department of Labor defines the workforce needed to annually maintain 6-7 million realty transactions to be around 250,000 realtors.  

This begs another question: why would fund managers be high on an industry that carries a workforce equal to 5X the number of people needed.   Why be high on an industry that “requires” unnecessary bloat only for the dues money it can rake in?   Would the real estate industry, as we know it, exist if it weren’t for mandatory participation requirements NAR demands?   Despite all it’s bluster, NAR is an obstructionist organization.  They don’t want change.  So, why would people want to invest in that? 

Sure, it’s super easy, and fun, to pick on Compass.  But, 8 of 10 of the largest real estate companies are now public.  And, that’s the April Fool’s Day joke that really isn’t. 

 

 

 

*Company IPO set for April 1st.  (Not a joke) As of this morning they reduced their anticipated price and decreased the number of shares to be sold.  Red Flag.

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