[RDFN – Redfin] Business Model Analysis and Growth Constraints

[I am currently writing up a somewhat brief companion piece on Zillow.  It will be posted next week.]  

Like healthcare and education, real estate is a massive market plagued by inefficiency, protected by incumbent interests, and resistant to reform.  If you’ve ever bought or sold a home, then you have no doubt been struck by the oddity that in a fragmented landscape staffed by 2mn licensed agents and 86k real estate brokerages, fee structures seem obstinately uniform and inflated.  It takes little incremental effort and expertise to sell a $1mn house than it does a $500k house, and yet the agent will receive twice the fees in the former case, as commissions are based on a percentage of the home sale.  A buyer’s agent is financially motivated to maximize the price that the buyer pays.  Redfin’s business model doesn’t change any part of that fundamental structure.  It still recognizes most of its revenue as a take rate on the proceeds of a home sale.  But, by integrating labor and technology to deliver a comparable service at lower prices the company at least makes a small dent in the $80bn of annual commissions garnered by agents and brokers.

In a typical residential real estate transaction intermediated by agents, the seller is charged a ~5%-6% commission that is split between the buying and selling agent.  The agent, typically an independent contractor, will split the commission with his sponsoring brokerage, typically ~60/40 in the agent’s favor.  If it is part of a franchise operation, like ReMax, the brokerage will in turn kick up some part of its commission share plus monthly franchisee fees to the franchisor.  Redfin, on the other hand, charges 1% in most areas (and 1.5% in others) as the selling agent, and refunds a portion of the 2.5% it receives as the buying agent to the buyer. [A home seller rep’ed by Redfin still pays the buying agent the standard 2.5%-3%, so the seller’s all-in savings comes to 1%-2%].¹

Like other real estate brokers, Redfin has access to all the homes listed for sale in its markets’ Multiple Listing Services (or MLS’s, private databases on which licensed brokers share information on listed properties and offer compensation for brokers who can deliver a buyer…hence the splitting of commissions), but traditional real estate brokers with offline roots don’t operate websites with nearly the sophistication or reach of Redfin’s.  Visit the sites of leading brokers and broker franchisors like HomeServices of America (owned by Berkshire), Realogy (brokerage franchisor with brands that include Century 21 and Coldwell Banker), RE/MAX, Douglas Elliman, Keller Williams, etc. and prepare to travel back in time to an age of “About Us” landing pages, stultified maps with jerky zoom-in/outs, and mapless listings.  Those firms have effectively outsourced online lead gen to Zillow, Facebook, etc., and still heavily rely on client referrals and personal networks.

Zillow is not a broker in its own right and so has historically relied on intermediaries like ListHub for MLS data.  It has managed to secure “hundreds” of direct MLS feeds – in 2015, following an acrimonious spat², ListHub and Zillow terminated their feed agreement, forcing Zillow was ink deals directly with MLSs in piecemeal fashion – but the completeness of those the listings and the speed with which Zillow obtains them, varies widely by MLS.  In San Diego, for instance, out of the 250 data fields in an MLS listing, Zillow only gets 50.  Also, it appears that most of Zillow’s listings are still sourced from agent syndicates, brokers, and third party feeds³, rendering it a step removed from the swift and comprehensive access that Redfin, as a licensed broker, is privileged to.  Practically, what this means is that Redfin can remove claimed inventory and post new MLS homes on its own site within minutes, enabling it to notify customers about newly listed homes 3 to 18 hours faster than other real estate listing portals.  And its detailed MLS data yields more accurate automated home valuation estimates to boot: according to an “independent” SSRS study commissioned by Redfin, 64% of the listings for which Redfin provided a public estimate sold within 3% of that estimate vs. 29% for Zillow and 16% for homes.com.

Given that nearly all prospective buyers start their searches online and nearly 90% end up purchasing their homes through an agent or broker, integrating a well-trafficked web portal with an efficient brokerage operation is a salient point of differentiation.  Unlike either traditional brokers who don’t have a viable online presence to acquire their customers or aggregators who can’t fully monetize their visitors, Redfin is positioned at both the front and back ends of the funnel to efficiently capture and convert prospects.  Visiting redfin.com, you’ll notice that the names and brands of third-party listing agents⁴ who list on the site are obscured and your engagement is directed to Redfin buyside agents at various points.  So if you’ve ever house shopped on Zillow, you might recall typing your contact information into an agent card and having that agent email or call you back to coordinate a visit.  Redfin, rather than force third party agents and prospects into a game of phone tag and risk conversion slippage, simply offers a menu of visiting dates and times.  You can schedule a home tour just as you would a restaurant reservation on OpenTable, and upon doing so, are given the option to connect with a Redfin buyside agent (and are, in fact, forced to declare whether you are already working with an agent before booking a visit).

If instead you choose to “Start an Offer” on a listing, your contact details, along with your offer price and payment means (mortgage or cash), are sent directly to a Redfin agent.  If a prospective buyer schedules a tour at one home but neither signs up for tours at similar homes in the area nor subscribes to online alerts for new homes in her price range, Redfin will direct these signs of waning interest to one of its buying agents, who can give that prospect extra attention.

Besides owning both the gateway and the transaction, Redfin benefits from a second point of integration, at the brokerage level.  Unlike most brokers’ agents, who work as independent contractors compensated predominantly on a commission exclusively tied to the value of the home sale, Redfin’s agents are full-fledged employees who enjoy base salaries, benefits, training, and expense reimbursements.  Redfin agents are plugged into the company’s lead gen engine and so don’t have to dedicate valuable time prospecting for leads.  They are supported by a centralized support staff that responds to online inquiries, beautifies listed properties, and prepares closing documents, leaving agents more time to develop clients and provide a superior level of service, which improves the odds that a lead will convert to a buyer.  The average Redfin agent completes 3x the transactions of a typical brokerage agent and is paid more than twice the industry median ($90k/year vs. $40k)⁵.  That goes a long way toward explaining why Redfin’s 73% agent retention rate – with most of the churn occurring within the first 6 months – exceeds the industry median of 58%.  A traditional broker operating without the benefit of Redfin’s infrastructure is left crudely toggling commission splits to retain agents (as was demonstrated in late 2016 when NRT – the non-franchised part of Realogy, operating under the Coldwell Banker, Corcoran, Sotheby’s International, ZipRealty, and Citi Habitats brands – was forced, after years of losing market share, to more generously share the commission pie).