Description

Redfin Corp (Ticker: RDFN)

Summary / Intro

In my accompanying ABNB write-up, I noted at the top my increasing preference for prioritizing great businesses with a strong degree of “obviousness” in their vision, and a “big idea” angle that represents effectively unlimited upside over the long-term (not literally “unlimited”, but enough upside that its measured with an “x”, not a “%”). As I referenced there, we can do all the number-crunching and valuation work we want, but at the end of the day, good things happen to good companies run by good managers and bad things happen to bad companies run by bad managers. 

RDFN is another one of those companies that checks a lot of boxes along these lines. Mountains of analysis can confirm a view that doesn’t require all that much analysis to see and understand - the process of buying/selling residential real estate is incredibly inefficient and “outdated” relative to all the resources and services and capabilities at our disposal today. The prevalent services we use (i.e. real estate brokers) are also incredibly expensive relative to the value they provide (especially with so much data available for free at our fingertips), and, despite a tremendous influx of technology - the great deflator - into our lives, that cost has not really gotten any cheaper.

Certainly, there are several companies attacking this in some shape, manner, or form. In researching the space, I kept coming back to the same thing - RDFN’s been pursuing the same vision for the entirety of their history, while everyone else has taken a roundabout road to effectively now trying to replicate RDFN’s vision. I believe the reason for that is simple - industries with tremendous inertia and old systems and methods and incentive schemes that are difficult to uproot ultimately requires an ambitious approach to disrupt instead of a series of half-measures that nibble at the periphery. In the case of real estate, that means that nibbling at the periphery while still supporting the incumbent system of independent contractor broker/agent arrangements with high fees doesn’t really get you anywhere and you need to take control of the transaction to really change things. Of course, nibbling at the periphery usually costs less and is more attractive to strict number-crunchers. It’s also short-sighted. 

Ultimately, what this comes down to is I think RDFN has the right vision and I think they have one of the best leaders out there trying to execute that vision. I’ll go so far as to say that RDFN’s vision is quite “obvious” as the way things “should” be. There are few managers I’d rather bet on and few opportunities and visions I view as obvious as RDFN. Relative to the tremendous upside available, I view the opportunity to get involved today (certainly following the pullback over the last few weeks) as quite compelling. While the future of real estate may be opaque, as a great company with a great leader, I think RDFN is likely to have great things happen to it.

What They Do

Redfin provides residential real estate services, which ultimately boils down to 3 categories of offerings:

1) Residential real estate brokerage with a non-traditional model - Redfin utilizes a Zillow-like, property-information-rich web site and mobile app to acquire, and communicate with, customers (#3 in monthly uniques after Zillow.com and Realtor.com). Unlike Zillow (even with recent events at Zillow), Redfin is a full-blown real estate brokerage, employing its own agents, but with real estate agents as salaried employees, not independent contractors. Employee agents are compensated primarily on customer satisfaction, not commission volume, so the goal is to drive a great experience all around, vs. jamming a sale through by any means necessary (it also encourages teamwork vs. a mercenary-like culture). 

While “technology” is an incredibly overused buzzword in the real estate brokerage world these days, Redfin truly has pervasive technology, with the salaried agent model more-or-less guaranteeing the pervasiveness of the technology in day-to-day operations. This includes all software tools (both front- and back-end) being developed in-house. 

What Redfin is most “obviously” known for is its industry-low fees. Redfin represents sellers for a 1.0-1.5% listing fee (vs. 2-3% industry average) and rebates buyers back a portion of the implied commission coming from their end (also ~1.0-1.5%).

2) iBuying - Redfin (like ZG and OPEN) provide real estate market liquidity for sellers by offering fast-close cash offers. These offers are at somewhat of a discount to “fair value”, with the goal being to resell inventory at small profit within 90 days. 

3) Ancillary services - somewhat of a blanket term for the multiple add-ons that all follow the same idea. This includes mortgage origination (mortgages, refis, and HELOCs, which it subsequently sells) and title / escrow / closing services. 

Core Strengths of the Business

Disruptive Model – RDFN uses salaried employees with customer satisfaction-tied bonuses, instead of commission-splits with independent contractors. Combined with a technology-centric model, RDFN is able to ensure much higher efficiency and quality of service (information sharing, automation and ease of search/discovery, scheduling, documentation, etc.), while also charging lower fees than the industry (by a wide margin), for a better experience. RDFN is more comparable to a very-high-performing agent team (e.g., with consistent best practices, etc.) than a given brokerage, but at a much larger scale and with greater resources.

Customer-centricity – RDFN is governed by improving home buyer and seller costs and experience. The vast majority of the brokerage industry is focused on the agent experience more so than the customer experience, which provides a meaningful opportunity and a very easy path toward service/offering expansion in ways that competitors can’t (e.g., enabling no-broker sales). This isn’t some eye-roll “we put our customers first” throwaway comment. As noted below, the traditional resi real estate industry is largely geared toward making life easier for agents, not consumers, which presents practical, structural issues where anything that would be good for the consumer (and thus drive more service demand) must also be “kosher” with a brokerage’s agents in order to get implemented. Given the traditional agent compensation structure, it's actually really hard to provide value to a consumer without taking something out of an agent’s pocket. This is not a problem that RDFN has. RDFN’s 1% fee is the most glaring example of this. Such fees are simply not feasible in a traditional model, but you can bet that consumers love it. 

Massive Opportunity Vulnerable to Disruption – resi real estate transactions and related services are largely wrote and commodity (i.e., ripe for automation), a terrible experience for buyers/sellers (i.e., ripe for a fresh approach), still heavily people-intensive (read: inefficient and difficult to scale), heavily fractured (largest mortgage originators only hold ~5% share; largest brokerage has mid-teens share), but massive economically (>$100B in collective fees from broker sales commissions/fees, mortgage originations, and title insurance annually). With the biggest challenge for most parties being customer acquisition (given it’s a fairly commodity marketplace), RDFN is well-positioned to capitalize at the expense of incumbent legacy players. 

How they make money

Brokerage service fees – As referenced above, RDFN charges sellers a 1.0-1.5% commission, with the range dependent on several factors specific to every situation (geo/location, home type, condition, etc.), which is far lower than the industry average of ~2.5-3.0% (“advertised” rates are typically 5-6%, split between brokers for buyer and seller, so every “transaction side” gets ~2.5%; RLGY and RMAX report avg commission rates in the 2.25-2.50% range, which foots with the 5% industry average). 

Also, It’s important to recognize that the buyer side of the commission is still going to be a factor; sellers can do what they want, but RDFN encourages sellers to offer the typical 2.5-3.0% for the buy-side of the deal, otherwise it will be hard to get prospective buyers (because no other agents will want to play ball). Thus, the discount is not 1.5% vs. 6%, but rather 1.5% vs. the typical sell-side commission and the total commission will be in the 4% range. 

For buyers, RDFN aims to be in the same range as the seller’s commission, but does so by way of a rebate to the buyer. So under the assumption that the sale price includes an implicit 3% commission pass-through to the buyer, RDFN aims to return something in the range of one-third to one-half of that implied pass-through via a cash rebate to the buyer. Given average sale prices in the US, this is several thousand dollars, which is pretty meaningful. 

RDFN’s avg 2019 take rate (i.e., commission-related rev divided by notional home value transacted) was ~1.78%, which has trended upward over the last few year (1.61% in 2016), so they make a bit more on buy-side representation.

This buckets accounts for >100% of RDFN’s GM (~>90% of non-iBuying revs) and carries a GM% of ~30%, ~2-3x that of a typical brokerage

Partner Program Referrals – ~5% of non-iBuying revs; effectively a commission split with deals referred to RDFN’s partner network of vetted agents in situations where RDFN is not staffed to handle a given lead (e.g., peak season or under-scaled markets). Likely runs at ~100% GM%

Property sales – aka “iBuying”; literally “flipping” houses, typically within 90 days of purchase, though at paper-thin margins (currently breakeven-ish). Longer-term, will likely include more meaningful contribution from high-margin add-ons (e.g., mortgage and title insurance). Currently >30% of rev

Mortgage originations and related fees – fees associated with originating mortgages and (potentially) gains on the subsequent sale of the loan. Currently LSD% of rev and just achieved positive GM% levels

Title and closing services – fees associated with title and closing services; slightly smaller than the mortgage origination business

Key Competitors

Core resi brokerage - RLGY, RMAX, EXPI, Keller Williams, and a plethora of other real estate brokerage outfits and independent agents

iBuying - Opendoor is the “original” in the space, along with ZG, OfferPad, and Knock as other players in the space

Mortgage originators - ZG, AFH and a host of others known to be among the largest mortgage originators (Quicken Loans, United Wholesale Mortgage, Fairway Independent Mortgage, WFC, and JPM, among others)

Real estate eyeballs - ZG and Realtor.com

The key thing to remember is that real estate services are largely commodity and wrote and thus largely dependent on scale and customer acquisition capability. Among resi brokers, no one has anything close to RDFN’s customer acquisition costs. Certainly ZG has “cheaper” customer acq, but ZG themselves (despite becoming an actual brokerage) is still not exactly 1-to-1 comparable to RDFN, while other brokers advertising on ZG are all obviously paying for that privilege and competing with each other. As far as brokers go, RDFN stands alone. 

Key Management

CEO Glenn Kelman – joined in the early days (2006) as CEO, right when they got venture money and all the founders checked out. He built the company. Owns just under 2% and is the main man here. Super smart, very down to earth, and checks all the “soft” boxes (all about the long-game, doesn’t pay himself all that much, doesn’t really sell stock, etc.). Responsible for RDFN’s culture, which drives how the company operates.

CFO Chris Nielsen – CFO since 2013; Not Kelman, but involved and seems pretty solid. Was at Zappos (as CFO) prior to RDFN

CTO Bridget Frey – Been CTO since 2015 and at RDFN since 2014. Pre-IPO employee; owns 10 bps 

VP Marketing Lisa Tayor – first marketing hire at RDFN (2009) and runs marketing 

President of Real Estate Ops Scott Nagel – Been at RDFN since 2007 in basically the same role. Long-time employee who basically runs ops; owns 8 bps

Valuation / Outlook

Lots of room on revenue - There is >$100B in GM available from among fees associated with real estate brokerage, mortgage origination, and title insurance. That’s a big number by itself in what amounts to an incredibly fractured space (given that agents are independent contractors and not really tied to the brokerage house that they “belong to”) and where RDFN currently holds <1% market share. Further, RDFN currently derives virtually immaterial GM from the latter categories, which are incredibly ripe for disruption (for those who haven’t had the pleasure - refinancing my mortgage this past summer was slightly less painful than obtaining my original mortgage, the process for both of which is slightly ahead of hearing nails on a blackboard WHILE getting a colonoscopy - and my process was incredibly straightforward relative to others). Meaningful advantages on customer acquisition, cost, and experience make the case for meaningful share gain over time quite compelling.

Margins could go meaningfully higher - Quite simply, the business is incredibly sub-scale. RDFN is chasing a very big idea and investing accordingly. They are profitable in early, well-scaled markets and were FCF-positive for the first time in 2020. The big numbers for me are the huge GM% advantage they have vs. traditional brokers and the meaningful advantages on customers acq. That’s a great recipe for substantially superior magins to current industry behemoths (RLGY has EBITDA% right around 10%). 

Valuation is reasonable - Given 1) low GM% generally speaking (not relative to its industry, but to other industries); and 2) the rapidly shrinking GM% due to the gross accounting for iBuying, I look at EV/GM in the absence of a scaled level of profit. Given the company’s rapid growth and their compelling long-term compounded growth prospects, 15x 2022 GM is quite reasonable to me for a multiple years of revenue compounding at >25%. For the sake of comparison, ZG trades at 12.5x 2022 GM, OPEN at 19x, and EXPI at 29x

Catalyst

Continued share gains in core resi brokerage services (including hiring more agents - they have more demand than agents to serve it)

Scaling iBuying

Scaling mortgage origination services

Scaling title/escrow/other services