Redfin Corporation's (NASDAQ:RDFN) recent IPO was a big hit with investors. The stock shot up almost 45% on its first day of trading. Here's a look at what the company does and how it compares with real estate internet pioneer Zillow Group (NASDAQ:Z) (NASDAQ:ZG).

Redfin is a web-based residential real estate brokerage company that uses the internet to find buyers and sellers for its agents to work with. Unlike traditional real estate companies, Redfin's lead agents are employees of the company and are paid a salary with benefits. Most real estate brokerages have agents who act as independent contractors and are paid strictly on commission. Revenue for the company comes from collecting commissions on deals that its Realtors close.

Redfin sale sign in front of a home.

Image source: Redfin.


Zillow's business model

Zillow Group is a technology-powered residential real estate advertising company. Unlike Redfin it does not employ local real estate agents. Instead, it looks upon real estate agents, mortgage brokers, and contractors as customers who will advertise on its various branded sites.

From a business model perspective, these two companies are very different. Redfin is an operating real estate brokerage company that is also interested in title insurance and mortgages and Zillow is primarily an advertising company. Both are using technology and consumer access to the internet to disrupt the traditional residential real estate industry.

The monthly average visitors to each company's websites is a good comparison of the relative popularity of each company among U.S. consumers.

Company 2016 MAUs 2015 MAUs 2014 MAUs
Zillow 140.1 million 123.7 million 76.7 million
Redfin 16.2 million 11.7 million 8.7 million

Monthly users are averaged over the entire year for Redfin and for the three months ended Dec. 31 for Zillow. Data source: Redfin and Zillow. Chart by the author. 

How does Redfin compete for business?

Redfin's competition is local real estate companies doing business all over America. It is currently located in over 80 different markets around the country and employed almost 800 lead agents as of the end of 2016. Like Zillow, its selling point to consumers is the ability to see home prices and pictures of homes for sale online. Unlike Zillow, it will then compete to get buyers and sellers to work with its agents.

There are three primary factors that Redfin is using to attract buyers and sellers.

  • Reduced commission. In a standard transaction of a house sale, there is a total of 6% commission with half going to the seller's agent and the other 3% to the buyer's agent. Redfin charges on average 1.5% for the listing, the seller then pays the other 3% to the buying office, constituting a saving of 1.5%. Redfin rebates buyers, in states where rebates are allowed, on average about $3,500 when the buyer uses a Redfin agent.
  • Technology to facilitate the selling or buying process. This will help agents be more productive as they will spend less time finding buyers or sellers, and technology also allows customers to monitor the transaction process online.
  • Agents that are not incentivized by a commission. Many folks will appreciate a process that lacks the traditional sales pressure, sometimes a characteristic of commissioned sales people.

Far and away the biggest lure for most consumers to use Redfin is reduced commissions. The problem with this approach is other real estate brokerage companies can fight against this by matching Redfin's offer. There is nothing magic about lowering the price of a product or service.

The big difference between Redfin and Zillow

Redfin outlines one of its core beliefs in its filing for its recent IPO.

We believe that the Internet is more efficient at connecting consumers with agents than the prospecting activities of most agents, and that this efficiency gain can benefit the consumer most when a website is operated by the brokerage representing that consumer in a purchase or sale. 

The company looks at the savings in prospecting by realtors as a means to reduce real estate agents costs and its price to customers.

Zillow is not trying to compete on price, in fact, one could argue that it has pricing power -- the ability to raise the price in the face of competition -- based on the large number of visitors to its websites each month.

Pricing power and the ability to scale the business

Redfin's key selling point is highly dependent upon price and this does not bode well for the company's pricing power. The business may also struggle to scale as it expands it will have to incur more costs hiring local real estate agents and renting office space to handle more clients.

Zillow's business should scale much more easily as it offers internet enabled self-serve ad placement through its new auction style zip code advertising product. Its dominant position in real estate web traffic also would make one believe it may have pricing power in its back pocket.

Based on these two factors Zillow wins my vote as the stock to own.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.