Description

DOUG is a luxury residential real estate brokerage. It is a beneficiary of higher income people buying and selling homes. Core markets are NYC (39% FY22 rev), its suburbs (~15%) and South Florida (24%). In recent years, Elliman has entered markets where wealthy people are moving, often for lower taxes. The Douglas Elliman brand facilitates entering new markets, as most luxury homebuyers recognize the brand, and established local agents see an opportunity to grow their business with DOUG.

DOUG has struggled with the rest of the industry over the last year, as inventory dried up amid rising rates. The idea is compelling today because 1) nearly half its market cap ($1.46/sh) in net cash, 2) volume is showing early signs of stabilizing, and 3) there is potential for buybacks at the end of 2023 as the 2yr anniversary of spinoff is reached.

At current price, DOUG is a bet on luxury housing not being a complete long-term disaster. Any real recovery would likely result in valuation >2x current price.

Business model

Elliman earns most of its revenue from existing home brokerage commissions, but also markets new properties on behalf of developers. Development is decent standalone, but is also a strategic enticement to attract leading agents to Elliman.

Industry pricing has remained stable, typically ~2.7% per side of a real estate transaction, or ~5.5% total. Agents keep ~75% of commissions.

Value proposition

There are three constituents in Elliman’s business. Agents, buyers and sellers. Value proposition is straightforward for all.

1. Value to agents is being associated with a luxury brand. Most sellers prefer to list with a known brokerage to generate maximum exposure for their property. Agents are more likely to win listings as part of a premium firm. Elliman also provides services such as marketing support. In certain cases, development mandates are also valuable enticements.

2. Sellers prefer to list with an established agency that has a network and platform to promote their property as widely as possible and market in the best light. As a leading luxury brokerage, DOUG is one of a handful of companies that satisfies this need.

3. Agency matters less to a buyer, but at high end, established agents often have access to off-market listings that home purchasers might otherwise be unaware of.

Competition

Real estate brokerage is a competitive business. Agents can easily leave for a competitor willing to offer more attractive commission splits, and top agents sometimes leave to start their own business. The competitive environment has historically been stable. However, the brokerage industry faced disruption in the last decade, as Compass (COMP) raised a reported $2 billion in venture funding and used its cash to invest in technology and buy agents with attractive transfer packages. With a slower economy and investors less willing to fund losses, COMP no longer offers incentives, which could create opportunities for Elliman to gain share going forward. 

The environment may be improving, but DOUG’s strong balance sheet should sustain it through any cycle. As a regional brokerage, Elliman is smaller than national peers Compass and Anywhere (formerly Realogy), but is comparably sized in the markets it participates.  

Risks

Cost control. Despite a steep decline in transactions and revenue over the last year, overhead has increased. This is partly due to entering new markets, but also indicates inflexible cost structure and poor management. CFO has suggested cost cuts are forthcoming, but there are not many specifics. In this low margin business, poor cost control is a valid concern.

Geographic concentration. With >50% of revenue from the tri-state area, if you are bearish on the local economy, don’t own DOUG. This concentration has come down from >70% in 2018, and will continue to decline as they enter new markets.

Prices decline and volume does not recover. It is possible that the last decade-plus of record low rates created a real estate bubble that will take many years to normalize. If it leads to a permanently depressed market, Elliman will struggle. 

Management structure/communication. The business was spun out of Vector Group, which is publicly traded and sells private label tobacco. Most senior executives have the same role at both companies. The CEO of Douglas Elliman Realty is solely focused on that business, but it appears DOUG CEO Howard Lorber is the final decision maker. I have not seen this setup before, and it justifiably gives pause to some investors. While they host conference calls, they are sparsely attended and only one analyst covers DOUG.

Agency model becomes obsolete. This is a common concern among investors. I view it as unlikely. Transactions in this space are infrequent and important, so most people prefer to hire an agent to guide them in buying or selling a home. The cost to the buyer is hidden, as they do not pay an explicit fee, and the seller needs to feel confident they can achieve within ~5.5% of what an agent could, plus be willing to handle the major administrative hassle of selling a property in order to justify selling without an agent. In most cases, this does not make sense.

Valuation

Given limited history and cyclicality, valuing the business is tricky. I looked at HOUS historical EBITDA margins and multiples, using as a proxy for DOUG. Elliman has a much better balance sheet and operates in higher quality markets. Its geographic concentration could be viewed as a risk or strength, but HOUS should be a decent comp.

Looking at HOUS historical performance, EBITDA margins are typically >5% and range from -10% to +8%. 

EBITDA multiples are ~9x, ranging from 6x to 18x.

Assuming 10x EBIT for DOUG (vs 10x EBITDA @ HOUS), with a 3% EBIT margin results in ~$5.25/sh. Inversely, 10x multiple and 3% margins at current price implies ~$500m normalized revenue. Seems overly bearish considering DOUG is entering new markets, and there are early signs of inventory recovery in Manhattan during the last quarter.

Catalyst

• Rates stabilize. Higher rates have increased the cost of homebuying, but volatility has had a greater impact on Elliman, as uncertainty around “normal” has created a gap between buyers and sellers and reduced available inventory. Wherever rates ultimately settle, once there is greater consensus, volume should improve, benefitting DOUG.

• 2yr spinoff anniversary 12/30/23. Douglas Elliman was spun off from Vector on 12/30/21. After 2yrs they should be outside the window of share repurchase triggering a taxable event. Management has indicated that at current share price, they are open to more aggressive capital returns after the window opens.

• Competition abates. Sentiment could improve if there are signs that Elliman is gaining share from peers under greater financial stress.