A Bet on Redfin is a Bet on Calmer Waters in the Housing Market
Redfin is making some bodacious bets on the future of the real estate market. Its time for a check-in on those bets.

Redfin’s mission is to redefine real estate in the consumer’s favor. One way they do this is by hiring Real Estate agents as employees and paying them a flat salary instead of a commission percentage per home transaction. In doing this Redfin is able to cap the amount the agent gets per sale, letting the buyer and seller of the home keep more money. The agents lose, the consumer wins.

Because of this setup Redfin has higher upfront overhead. They pay their agents regardless of whether those agents bring in any deals or not. The bet Redfin is making, (and the bet you’re making if you invest in Redfin) is:

The number of deals coming in will be enough to cover agent salaries.

That sounds obvious, but now think about the current situation: In March and April we had a shock to the real estate system where the shutdowns stopped virtually everything in its tracks.

That means all of a sudden Redfin was severely losing its bet. To compensate, it started furloughing and laying off its employees.

What happened next? Real Estate came roaring back.

That was the exact worst timing for Redfin because they needed all hands on deck to service the demand.

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Remember, the way the bet works, if Redfin can do enough transactions to cover agent salaries, it wins. And every transaction after covering its agent’s salaries is profit. The way Redfin hits home runs is by achieving scale. The market we’ve been in the last couple of months is the ideal situation for Redfin to prove its value proposition EXCEPT for the fact that Redfin JUST laid off and furloughed employees in March, so they didn’t have enough people to meet the huge upswing in demand in May, June, July, and August.

The thing biting them in the butt right now is that their business model is not very flexible. They need to have the right amount of agents to meet the market demand. The less predictable the market demand, the more Redfin looks silly compared to normal brokerages.

That’s the trade off of being so purpose focused- Redfin is predicting a transition towards lower real estate transaction fees, and the steadier that transition, the better. They could be right, and yet if they aren’t nimble enough to meet demand where it’s at, then they will overpay employees when demand is low and under-deliver their service when demand is high.

If you’re rooting for Redfin, you want less volatility in the housing market, because the business model doesn’t react as fast to swift changes in demand as traditional brokerages.

To me, I think it’s a safe bet that what we saw in March was abnormal, and that going forward Redfin will continue to take market share because the housing market won’t continue to be so volatile. But now you know what you’re getting yourself into.

A bet on Redfin is a bet on calmer waters in the housing market.
Eric Pelnik's avatar
how would you compare them against $Z ?
Michael McGuiness's avatar
I'm not super familiar with this space, but I thought this write-up of Zillow on VIC made some good points: https://www.valueinvestorsclub.com/idea/ZILLOW_GROUP_INC/6400943706 .... I thought this point was particularly interesting: "Despite being a relative late mover in entering the i-Buying space Zillow’s early trajectory has been remarkable and they are fundamentally advantaged over their competitors. Anyone else seeking to profitably acquire and resell homes is going to have significant customer acquisition costs, whereas Zillow given their position as the de facto starting place for 70%+ of US online real estate browsing will be able to leverage the existing traffic to its website to garner demand for this new service for free (or close to it)."
Nathan Worden's avatar
@eric Redfin is a bet on the cost structure of the residential real estate industry going down, Zillow is a bet on iBuying.

Redfin has salaried agents rather than third party agents. Redfin is trying to change the industry, whereas Zillow just generates a ton of leads that they then try and sell to real estate agents.

Investing in Zillow is more of a bet on iBuying, which I believe Zillow has an advantage in. In my opinion they saw how Opendoor was trying to flip homes at scale and they copied them and ate their lunch because of their enormous traffic.

(Anecdotally I have a tenant who worked at Opendoor and he was laid off at the beginning of the year. So I have some proximity bias. Opendoor is likely doing pretty well, but Zillow is a big problem for them).

Redfin is also in the iBuying game with their RedfinNow service. If I had to guess, I'd say Zillow will win close to 3/4ths of the iBuying market, and Redfin, Opendoor, Knock, Offerpad, etc. will fight for the rest.

I personally think the industry will move towards lower agent commissions, so I root for Redfin, but I own both $Z and $RDFN. I own about 1 share of $Z for every 5 shares of $RDFN . So that shows you my conviction level between the two.
Nathan Worden's avatar
@eric update on Opendoor: Chamath is on CNBC talking about Opendoor as a SPAC target and says that they are 4.4x larger than the next closest competitor. I would assume that competitor is Zillow. I am surprised Opendoor is doing that well.

Opendoor 2019 revenue was $4.7 billion, 2023 estimated revenue is $9.8 billion.

If Opendoor is able to achieve 4% marketshare in the new markets they can expand into in the US, it could do $50 billion in revenue.