Description

Investment Summary

• Business model
• EXPI is a cloud-based residential real estate brokerage firm that has grown from 850 agents in 2015 to more than 80,000 in 2022. In terms of transactions, it is the third largest brokerage firm in the US with more than 500k closed in 2022.
• The company is disrupting the industry based on three main pillars: 1) Agent-centric culture, 2) Power of incentives and 3) Cloud-based model.
• Competitive advantages
• Switching costs
• There is a lot of churn in the industry. Acquiring agents is not as hard as retaining them. The revenue share is an important source of income for agents within eXp
• Scale advantage
• eXp can leverage its scale to offer the best tools and perks for its agents at the lowest price
• Network effect
• Incentives attract a specific type of mindset. The best performers come to EXPI. Building and retaining the best talent implies better training (most are mentors) and practices for agents within the platform, which in turn improves the agents’ skills and the business
• Return on capital employed
• EBIT margins ~3%
• ROCE: triple digit
• ROCE ex Goodwill: triple digit
• Growth
• Growing organic revenues at 15% plus
• Growing organic EBITDA at 30% plus
• Capital allocation
• Opportunistic acquisitions to improve the quality of service offered to agents
• No debt and generating free cash flow
• Opportunistic shareholder distributions through buybacks and dividends
• Management team
• Founder-led business
• Agent-centric corporate culture and a strong focus on the alignment of incentives
• Risks
• Real estate cycle and macroeconomic risks
• Pressure on commission rates
• Ibuying
• Other cloud-based residential real estate brokerage firms
• Valuation
• Trading at 24x FCFF 2024
• Clear market leader, gaining share and growing at high teens

Business model

EXPI is a cloud-based residential real estate brokerage firm that has grown from 850 agents in 2015 to more than 80,000 in 2022. In terms of transactions, it is the third largest brokerage firm in the US with more than 500k closed in 2022. The company is disrupting the industry based on three main pillars: 1) Agent-centric culture, 2) Power of incentives and 3) Cloud-based model.

Real estate brokerage firms generally take a cut (60% - 40%) on commissions generated by their independent contractors or agents. Although agents work on their own and real estate is done in the field, brokerage firms provide the following to the agents:

• Brokerage license: On top of the agent license, you need a state brokerage license. To get it you need to have an agent license and demonstrate several years of experience.
• Legal responsibility: The brokerage firms take all the potential legal liability in each transaction.
• Services: Accounting, tax, back office to process transactions, CRM, training, physical office, etc.
• Brand: It is not the same to work for a well-known real estate broker than independently. They don’t provide leads. You can share leads with other agents for a share of the commission but that is completely separate from the brokerage firm.

Traditional brokerage firms have been brick-and-mortar establishments where agents have an office, learn and congregate. Real estate, however, is done in the field. Many agents operate from home and the value of a traditional brokerage has been eroding. Technology is enabling agents to work remotely and focus on their core job, closing deals. EXPI is a fully cloud-based brokerage firm. At EXPI, there are no physical brick-and-mortar offices. But through a virtual world powered by Virbela (acquired in 2018) and other tools, they cover their accounting, back office, tax, CRM and training needs.

Also, the traditional model is not flexible at all. They break up countries into regions or “market-centers” to individuals looking to open an office. So if you are a licensed agent in Georgia and your brokerage firm assigns you the Atlanta market, you cannot close deals in North Georgia. Let alone another state where you are licensed. EXPI is one independent brokerage with no territories, regions, or franchise locations. Agents have the opportunity to expand their business or attract agents from any area regardless of borders, even internationally.

On top of that, in the traditional model, agents are not aligned with the brokerage firm. Agents work on their own, for their own commission. This has two main negative effects. Agents do not actively contribute to grow the brokerage firm, since they do not have any incentive and they do not have a retirement plan in place. There is a saying in real estate “real estate agents don’t retire, they expire”.

At the core of EXPI’s value proposition is its compensation model, which works as follows:

• Commission split: 80/20 with a cap of US$ 16,000. After the cap is reached (when total gross commissions reach US$ 80,000, which implies total transaction value of US$ 3.2 mm or close to 11 deals), 100% of commissions go to the agent. The agent has to pay:
• Monthly fee of US$ 85 for CRM, back office, training, etc.
• Broker fee of US$ 25 per transaction
• Risk fee of US$ 40 per transaction that caps at US$ 500
• Revenue share: Agents can receive compensation for bringing other agents to EXPI. When an agent “sponsors” another agent, that agent then is rewarded with a percentage of that new agent’s commission in perpetuity. That percentage is based on revenue (gross commissions) of the agent sponsored. So that compensation does not come out of any agent commissions. It comes from EXPI or the “broker cut”. It works on a seven-level model. Meaning that agents not only earn this share percentage of the agents they sponsor, but also that of the agents they sponsor down seven levels total. Each level offers a different amount. There is a total cap of US$ 8,000 that an agent can earn per “sponsored” agent. The revenue share is paid monthly in cash.
• Agent equity program: Agents can decide to receive 5% of commissions earned from each completed residential real estate transaction in the form of common stock at a 10% discount. Previously the discount was at 20%.
• Agent growth incentive program: Agents that cap ($80,000 gross commission income) and pay an additional $5,000 in capped transaction fees (20 transactions at $250/transaction) each year are eligible to become ICON agents. As an ICON agent, eXp Realty gives you back the $16,000 that you paid in for your cap in the form of EXPI stock at its current price. Awards typically vest after performance benchmarks are reached and three years of subsequent service is provided to EXPI.     
• Equity: Agents receive stock directly when they close their first sale each year (US$ 200 in stock), when a sponsored agent closes its first sale (US$ 400 in stock) and when they hit the annual cap (US$ 400 in stock). All stock awards vest after three years of subsequent service is provided to EXPI.      

All in all, the combination of agent-focused approach, fair and transparent compensation model, alignment of incentives to grow the business through revenue-share program and the flexibility of being online is rewarded with an NPS of 73, which is well above industry peers.

Financials

• Revenue: Total commissions from transactions closed. If one agent closes a transaction, selling a property valued at US$ 1 mm and generates a 2.5% fee, revenues for EXPI will be US$ 25,000. Revenues do not include any of the fees that brokers have to pay to EXPI. Those are recorded as “less” cost of sales.
• Cost of sales: Commissions and other agent-related costs. Commissions to agents and brokers under the revenue sharing plan are included as part of commissions and other agent-related costs. Does not include D&A. Fees that brokers have to pay to EXPI are deducted from cost of sales.
• G&A: Include costs related to wages, including stock compensation, and other general overhead expenses. It represents 6% of revenues and has been scaling down from 11% of revenues in 2018.
• S&M: Not meaningful at all. Currently 0.3% of revenues.

Unit economics

Competitive advantages

EXPI has done what Hamilton Helmer defined as “counter-positioning” in 7 Powers: "A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business." All current models with a huge physical network are at a clear disadvantage against EXPI. On top of that, most of the players will have to adapt their incentives, build a tech platform, remove territory split, etc.

On top of this “first-mover advantage”, EXPI has the following competitive advantages:

• Switching costs:
• There is a lot of churn in the industry. Acquiring agents is not as hard as retaining them. The revenue share income is an important source of income for many agents. If they leave, they lose their “passive” income as well. Also, awards for ICON agents, typically vest after three years of subsequent service is provided to EXPI. This strategy, (although an inferior one), made Keller Williams very successful. Although instead of revenue share, they had “profit share”.
• Also, as you grow the business, the valuation grows as well, making equity incentives even more attractive. This is hard to replicate for copycats.
• Network effect??: Incentives attract a specific type of mindset. The best performers come to EXPI. Building and retaining the best talent implies better training (most are mentors) and practices for agents within the platform, which in turn improves the agents ‘skills and the business.
• Scale advantage:
• eXp Realty gives all agents first-class websites and CRM through kvCORE a third party tool that usually costs agents thousands per year.
• Health insurance. From an agent: “The next huge one for me, especially for my family, was health insurance. EXPI offers health insurance through Clear Water. There's not a ton of brokerages out there that are offering health insurance. As a brokerage they've come together discounted a huge amount of health plans and give them to you and your family for a big discounted price. I have a beautiful wife and two great kids and I want them to be protected and that is something that is super important to me.”
• High quality training: If you attract the best agents you also have the best mentors, which attracts new agents that want to get trained by the best. Mentor program is set up to support agents who have not sold 3 or more transactions in the last 12 months. The eXpand Mentor program assigns a LOCAL mentor to the agent. Most of the time, this means having someone in your exact market or within around 50 miles of you.
• As they get bigger, brand will get more and more recognized which helps agents to get more transactions

EXPI vs Keller Williams: KW is a franchise model. It breaks up countries into regions, which sell franchises or “Market-centers” to individuals looking to open an office. EXPI is one independent brokerage. with no territories, regions, or franchise locations. Agents and brokers have the opportunity to expand their business or attract agents from any area regardless of borders.  Both share a similar philosophy of putting the real estate agent’s needs first. Both companies offer agents additional income opportunities although KW, is profit share vs revenue share. It is less transparent and overall split is 70/30. On average, compensation at KW is way lower vs EXPI for same amount of transaction volume. Actually, 40% of new agents on EXPI are coming from KW. Also, if you are taking agents from KW, profit share income goes to zero and erodes switching costs in the business.

EXPI vs Redfin/Compass: Compass and Redfin are similar to the traditional brokerage but with some benefits beyond the traditional brokerages. Each have technological advantages that the traditional brokerages don’t have. Redfin has its website. It is somewhat unique in that it hires all of its agents rather than having independent contractors.

EXPI vs Fathom/Real Brokerage: Both have lower growth, are burning cash, and are at competitive disadvantages as second movers. Fathom is a fine fit for the real estate agent who sells 1-2 houses a year and doesn’t want anything other than a place to process transactions. Unlike eXp, Fathom charges a flat fee of $450 per transaction for the first 12 transactions and $99/transaction after that. There are no other fees, costs, or expenses. This is unequivocally a cheaper option than eXp or anyone else. Fathom also does not offer the monthly recurring revenue that eXp does because there are no associated fees with Fathom.

Growth

The business has grown revenues at 90% CAGR since 2018 and 126% since 2017. They will end 2021 with 70k agents are currently at 50,000 agents which is just 6% of licensed agents in the US. They believe they can get to 250,000 in the next five years. Also there is the international opportunity. By the end of 2021 they will be present in 20 countries. They plan to be in 100 countries and reach 500,000 agents in 10 years. 

Valuation

It is a US$ 2 bn business with net cash. They said that they can grow agents to 250k. Assuming they get to 140k (Keller Williams has 170k) we get US$ 10 bn in revenues by 2026. At 8% gross margin is easily achievable in US. International will be higher but using 10% and assuming SG&A scales down to 6% of revenues, we get 2.5% FCF margin. US$ 230 mm in FCF by 2026 at 22x is US$ 5.3 bn. However, this valuation does not take into account the massive opportunity of ancillary services, which they are already building through its JV with Kind Lending.

Risks

• EXPI has improved the traditional model being agent-centric but has not really focused on the final customers, which is the actual buyer/seller of the property.
• “Agents” only focused on recruiting other agents…?
• Ibuying
• Pressure on commission rates. Agents providing less value in the transaction.

Catalyst

- Better than expected agent growth 

- Ancillary services 

- Real Estate market improvement