Disclaimer: The perspective and opinions of this article are based on the author’s perception. Consult with your financial adviser for any investing questions.
Compass, Inc. (COMP) | Amount Raised: $1.5B| Market Valuation: $1.049B
Real Estate Segment: Buying and Selling.
Compass went public in 2021 at a valuation of $8.22B. Today, the company is valued at $1.049B, less than the amount of money they’ve raised, so this is a huge bust for Softbank Vision Fund.
Well, nothing really. Compass has thousands of terrific agents and a sophisticated brand. The problem is it’s just a traditional business that is not poised for out-sized returns.
Compass CEO Robert Reffkin shrewdly positioned the company as a tech company that has the potential for software like returns. Investors bought it.
But just because a real estate company calls itself a tech platform, doesn’t mean the margins measure up to a SaaS like business. Unfortunately, for the late stage VC investors, they’ve learned this the hard way.
Compass is a real estate agency that seeks to super-charge independent contractor real estate agents. In return, agents split their commission. For example, the agent earns 80%, Compass earns 20%. That company split is their take-rate revenue, however, they report revenue as the gross amount of the real estate commission.
(Side note – Uber reports it’s revenue as the take-rate revenue, and it’s total bookings as gross bookings. IMO, that’s a better metric of revenue since the contractors are COGS.)
Company split is a very traditional business model, extremely competitive, and requires operational excellence to be profitable at scale.
It’s not changing the way homeowners buy and sell homes using technology, but rather enabling agents to be more successful. Unlike discounted brokers like Redfin, Compass wants their agents to charge maximum compensation for their service… positioning the agent and the brand as premium, and increasing the company take-rate amount.
Despite technology making the process of buying and selling a home far less cumbersome on real estate agents, and home values reaching record high, the company believes agents should charge 5% to 6% to sellers because that’s what’s standard.
And as long as sellers will pay, why not?
To attract agents, Compass built up a support team to build technology and leased expensive retail real estate. Additionally, the company compensates agents with the same splits or better than industry average.
This enabled Compass to grow very quickly, albeit unprofitably.
Compass used their growing revenue as a metric of market disruption to attract investors at a valuation based on it’s revenue.
Challenges with model
If you were to ask agents that are not licensed with Compass, they will tell you that there is no significant material advantage of hanging your license with Compass compared with other agencies.
Most homeowners and home-buyers choose a real estate agent based on the personal connection they have with the agent, and less with the sponsoring broker.
Thus, for the agent, they will often choose to work with a broker that maximizes their split. So if Compass is offering 80/20, the agent may prefer a different broker if they can earn 90/10, thereby effectively earning 10% more on each transaction.
Compass knows that the splits have to be competitive to attract the best agents, but in order to pursue it’s mission of having the best tech tools for agents, it requires significant overhead. This creates a challenging dynamic.
Now, if your company is valued based on revenue, great! It’s very easy to grow a real estate agency unprofitable. And you can pour money into having the best tech tools for agents.
On the other hand, if your company is valued based on net income, you’ve got a problem, and it requires savvy operators.
Lately, the market has been holding Compass accountable to profits, or lack thereof, so now it has to figure out how to do more with less.
So far, Compass has failed to achieve profitability but will likely get there by shedding overhead which it has already begun to do. This includes the technology department, which is a sign that it was never really a tech company in the first place… you don’t hear of Google letting go of top engineers.
Opportunities for Compass
At this point, it’s too late for Compass to pivot to a more disruptive real estate model like iBuyer or lease to own.
Compass has two paths to profitability.
First, they can hone-in on their existing model. Negotiate improved company splits with agents without losing them and reduce overhead. Basically, it’s constrained like any other real estate broker.
Second, is to look for new revenue sources.
They’ve already started a mortgage division, but given their track-record of running an unprofitable real estate agency, my guess is they’ll lose money on the mortgage division too. This will force them to offer above market interest rates, which isn’t really helping the agent or the borrower.
The best opportunity for new revenue sources is to license some or all of their technology to real estate agents not licensed with Compass.
This will upset Compass agents that joined to get access to the proprietary technology but becoming a software company has higher upside.
SaaS companies have extremely high gross margins, which is why you can achieve such outsized returns. Think Salesforce (CRM).
If Compass has built the best real estate technology stack in the world, they’d better be off licensing that technology rather than keeping to themselves.
Doma Holindgs Inc (DOMA) | Amount Raised: $679.6M| Market Valuation: $162M
Real Estate Segment: title insurance and real estate closing
Doma went public in August, 2021 via SPAC. It’s vision is remove the friction of title insurance and real estate closings.
The smart money early investors were able to cash-out at the time of the SPAC merger.
The late investors have been crushed. Doma opened at $8.20 per share, today it’s trading for $0.47 a share. Ouch!
Customer acquisition cost, that’s what happened.
Real estate agents often have a fraternal relationship with local title and escrow companies. So when an agent lists a home, they’ll often recommend to their client (the seller) to work with a particular title and escrow company, which almost always happens to be local.
There’s pros and cons to a local title company, but the point is, Doma was not able to untangle that current method in which title companies are selected.
Let’s be honest – buyers and sellers almost never shop around for a title company. When you’re selling a home, that’s sort of the least of your concern. If your agent recommends First American whose office is down the street, then that’s good enough.
In effort to reduce friction in the title, closing, and real estate transaction process, Doma has lost $186M last year.
Even in the best of times, when 30 year fixed rates were in the 2s, Doma was losing money. That does not bode well for the company.
It’s already aggressive right-sizing the company with aggressive layoff rounds but it’s got a long way to go.
What can it do
At this point, if you have game-changing tech, which Doma claims to have, then best possible outcome would getting acquired by a company that has a better customer acquisition flywheel.
Most companies are now seeking to bundle real estate services, mortgage, title, and homeowners insurance, in an effort to maximize revenue per customer and reduce friction in the home-buying process.
Some potential suiters could be a bank, a large real estate agency like Anywhere (Hous), non-banks like LoanDepot or Rocket Mortgage (which already owns Amrock).
As I mentioned, more and more companies seek to offer real estate, mortgage, title, and homeowners insurance.
But setting up those four companies is expensive.
Title companies are now offering Joint Ventures with mortgage companies as a compliant way for a mortgage company to set-up a title division, and collect a piece of the pie for the title insurance fee.
This is an effective way for title companies to increase market share at a lower customer acquisition cost.
Doma states its vision is “architecting the future of real estate transactions.” If that’s the vision, then I think title, escrow, and closing are just a piece of the puzzle and probably not the biggest.
If Doma is serious about their vision, then they should start a mortgage division to streamline the home-buying and refinance process, leveraging their title, escrow and closing platform. As a title company, you have access to large data set which can help a newly formed mortgage division acquire customers for less than industry average.
This will enable Doma to execute on their vision, add a potential additional stream of revenue in a mortgage operation, and acquire customers for title insurance in a more cost effective way.
Opendoor Technologies Inc. (OPEN) | Amount Raised: $1.9B| Market Valuation: $1.9B
Real Estate Segment: buying and selling
Unlike Doma or Compass, Opendoor has a disruptive business model, as it seeks to change the way people buy and sell homes.
Traditionally, homeowners and home-buyers buy from people, represented by an agent, who earns a commission for brokering the transaction.
Opendoor is seeking to change that in having homeowners sell and home-buyers buy from a company, thereby removing the agent.
This lead to the term of iBuyer.
That said, property flipping is tough, just ask Zillow.
(Side note – a client of mine sold his home to Zillow. He said they paid him 15% more than what he could have sold the home for on the open market. Crazy.)
Opendoor is relying on data to enable them to property flip profitability at scale.
So far, that has yet to happened and their stock price has been crushed.
In February, 2021, Opendoor stock traded at $34.59. Today, it’s price per share trades for $3.04.
Opendoor went public via SPAC, led by Chamath Palihapitiya who has an atrocious record with SPAC investments and is now throwing in the towel.
The SPAC deal valued Opendoor at $4.8B. It’s now trading at $1.9B.
The challenge is you need willing sellers that do not want to go with the traditional agent and open-market route.
The less Opendoor can acquire the home, the better for it’s business. The higher it pays for the home, the more challenging it is.
Opendoor speaks broadly like that we’re in a “generational shift of moving housing online” or that Opendoor’s “value proposition is resonating.”
But basically, at it’s core business, the company needs to buy homes for less than market value.
BTW – this is a tenet for pretty much all investments. Warren Buffett is looking for undervalued businesses.
So far, Opendoor has tried to buy homes at near market-value to ramp-up its operation, build its brand, and operate at slim gross margins.
The thin gross margins on the sale of the property, coupled with a sizable overhead, has led to losses, lots of losses.
Things may get worse
Thin margins may work in a bull market, but I question whether their algorithm has to accounted for a housing slowdown.
As interest rates approach 7%, it’s very likely we’ll see less demand for housing, thereby decreasing home prices.
This spells trouble for Opendoor as it has a lot of exposure at any moment in time. The company had 17,164 homes on it’s books in November, 2021.
If Opendoor cannot sell those homes quickly, it’s possible they could be looking at taking losses on each transaction. Yikes. And that doesn’t even account for a bloated overhead.
It’s been reported that Opendoor lost money on 42% of it’s sales in August.
What Opendoor can do
Opendoor has spent years and billions of dollars to get this point. They’re not just going to walk away from the business, even if it continues to lose money in the short-term.
Opendoor will likely need to get “lean and mean”, like a traditional property flipper. They’ll need to cut overhead in any way they can, be super firm on price their willing to pay, and seek to increase the margin between the price they paid for a home, and the price they sell.
Additionally, Opendoor has an opportunity to offer ancillary services to increase gross margins as well as tap into an affiliate network to serve their vast user database.
If they can move from a transactional company, to a company that’s engaged with a home-buyer through the life of homeownership, there’s a real opportunity to use the thin margins from property flipping as the “loss-leader” to building a suite of services for homeowners and home-buyers.
“SELFi started with a simple ida: to help homeowners obtain the lowest interest rates on their mortgage. That’s it.”
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