In this episode of Industry Focus: Energy, Motley Fool analyst Tim Beyers and host Nick Sciple take a look at Redfin (RDFN +0.00%) the tech-enabled real estate brokerage working to disrupt the real estate industry. Along with providing a brief introduction to Redfin's business, Tim and Nick discuss how the company has navigated disruptions caused by the COVID-19 pandemic, its most recent earnings report, its future growth opportunities, and more!
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This video was recorded on Nov. 12, 2020.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. On this week's episode, we'll be taking a look at Redfin, the tech-enabled real estate brokerage that's disrupting the traditional brokerage industry. Joining me to help break it all down is Motley Fool analyst Tim Beyers. Tim, welcome back on the podcast.
Tim Beyers: Thanks a lot, Nick. Good to be here.
Sciple: Great to have you back on. For folks who are longtime listeners of the podcast, you might have heard Tim and I talk about Redfin back on May 23, 2019. So, this maybe will be a little bit of an update on the company, today where it is and where it's headed. For folks who missed that first episode we did, Tim, why don't you give us a high-level overview of what Redfin is and what they do?
Beyers: Yeah, Redfin, they call themselves a technology powered real estate brokerage. What makes them different, Nick, is they handle the entirety of the real estate transaction, they don't have, say, real estate agents who are contractors and have, like, an affiliate group; which is the way the model tends to work. All the brokers are employees, the engineers who write the code, they are employees, everybody is an employee at Redfin, it's very rare for them to use partner-brokers, they do it in some areas, but they try to make that a rarity.
So, Redfin is a national brokerage. They use a lot of technology. They do a lot of virtual tours. The pandemic has been pretty interesting for them, because they've been working on things like virtual tours and a more robust mobile app for a really long time, and during this pandemic that has served them very well.
Sciple: Right. And this is a company that from the first has been a tech-enabled platform, when you have a scenario as this year has presented, where folks can't go see homes in-person, but there's been a big surge in demand, which we'll talk about a little bit later, it really sets up nicely for Redfin. Another thing is you see some of these regional migrations happening, a business that is national like Redfin is, they have that national brand that they can migrate with folks.
Beyers: Right. And this is one thing that CEO Glenn Kelman and one of the reasons I really like this business is because of him. He is a CEO who acts like a founder, he's not the founder of Redfin, but he's been around this company for a really long time, and actually helped guide them through the original 2008 crisis when Redfin was still a pretty young company, and was able to guide them through. He's a conservative manager, but he's very passionate. His employees tend to like him. I think he is somebody I would consider a conscious capitalist, he really does put the needs of his employees, of his customers first, and he tries to take a whole stakeholder approach. So, this business is, for a company that's growing fast right now, it's easy to forget that they've been around for a long time, and they've been through crises before and weathered them. So, I think this is a more resilient business than people may know.
Sciple: Right. When you talk about weathering crises, that's maybe a good transition to what's happened this year with the business, coming into the year having seen four consecutive quarters of growth. In the first quarter revenue was up 73%, but then a pandemic showed up, Tim, how did the business respond to that disruption?
Beyers: Well, I mean, initially there were furloughs and layoffs. I mean, there was an expectation early on in this, and they were very clear about it that they were going to have to cut substantially their brokers. And at one point they basically shut down all brokers going out and showing homes, they just stopped doing it. So, it was painful. You know, there was a belief that they were going to have to let go of all of their brokers. It turned out that that didn't need to be the case, although early on it looked like they were going to. I mean, it was rough at the beginning, that quarter at the beginning of the pandemic was really tough on Redfin, and we thought this was going to be a hard year for them. Turns out that's not been the case at all, Nick.
Sciple: Yeah, it's wild when you look at some of these stats. So, April 7th, they announced that layoff; 25% of the employees were put on furlough through August 31st, 10% left permanently, they sold some stock to shore up the balance sheet. Then already on May 1st, they asked for 14% of their furloughed employees to return. By the beginning of May, seasonally adjusted homebuying demand was almost back to where it was in January and February. And then by the end of June, inquiries were up 40% year-over-year.
So, you go from the circumstance where it is, we might have to shut everything down, maybe we need to shore up the balance sheet, that sort of thing, to now, inquiries were up significantly. And you mentioned those partner-agents earlier, Redfin has had so much demand that they've had to lean more on some of those partners to service this demand.
Beyers: Yeah, that's true, in the short-term that is absolutely true. They tend not to do it because they like to be able to service everything in house, and they get economies of scale when they do so, but you're right, the demand has been so hot. And remember that, because Redfin is a conservative business, they are a national brand, but they aren't actually operating, at least at scale, in every single American market. They're not in every single American market, they're in a lot of them, but in those markets where they are not and where demand is hot, they do use those partner-agents. So, yeah, it's been really interesting to see how that balance has come into play here; they're using a lot more contractors than typically they do.
Sciple: Yeah. And I think that's kind of ironic too, Tim, because if you remember, back the last episode we did on Redfin, there was this controversy where Redfin had rolled out the Redfin Direct offering, which is where, if you were a buyer, you could submit an offer without even using an agent, and then RE/MAX, who had been their exclusive partner, jumped out of their partnership. And so, there's this irony where there's this massive demand, they're sending lots of business to their partner just because of how quickly things are growing, and RE/MAX, you know, cut bait with them a little over a year ago.
But yes, some other numbers, customer inquiries for Redfin agents or their partners increased 38% in July to 58% in October, they are back to hiring agents. So, really significant change throughout the year. What led to that turnaround in the market that really spiked demand?
Beyers: I mean, there's a couple of things, but I think the primary thing is that we just don't have enough homes. And Nick, you and I have talked about this, and I don't have the specific stat, but I think you have it in some of the notes that you brought to today's session here, that we have a real shortage of housing inventory in the United States and so when [laughs] supply does not match demand, prices go through the roof, and demand is really, really high.
And there's a couple of things here, there is a flee, you know, fleeing of cities into suburbs, certainly that's true. There's also a fleeing into the interior; you know, the work-at-home, this idea of like, look, hey, you know what, we are now in an environment where anybody can work anywhere, there are people that have just pulled up stakes, and we probably both have friends, Nick, I would guess, who have pulled up stakes and said, like, you know what, I like New York, I like San Francisco, but I'm out, you know, I'm going to Denver, or I'm going to Salt Lake or I'm going to, you know, Billings, Montana. I mean, just name the state and we're getting an influx of people that are coming from urban areas. And that is a good thing for -- I mean, we had always, sort of, thought this would be part of the Redfin story, but it has accelerated dramatically.
Sciple: Right. So, some of those stats, like you mentioned, Tim, on the last episode, really got me excited or thinking about there's got to be this increase in home buying demand, is if you look back going 20 years or so, even longer, the median age of first-time homebuyers is about 32 years old. Last time we did the episode, the median age for millennials was 30.5. Now, we're probably about 32, right on that number, that would be the long-term median age for first-time home buying. And we had this idea that millennials had been delaying home purchases because of the cost of living in places like New York, San Francisco, large coastal cities.
Well, you kind of had two things that hit at the same time with the pandemic that really, really pulled forward. So, you had this demographic aspect of, listen, if you want to have kids and have the white picket fence and all those sorts of things, there's a certain time in your life where you have to buy a home; structurally it's a life stage thing. And then on top of that, we had this huge surge in remote work this year that, kind of, took the shackles out of a lot of these folks in cities who weren't able to move out to a place where homes are more affordable, etc. And so, you've seen basically this trend we expected to happen, really, gasoline got poured on that.
And just to give you some numbers. So, online searches for home listings with suburban zip codes grew 13% during the Spring compared to a year ago. You look at big cities like San Francisco and New York City, inventory in the third quarter was up 51% in San Francisco, up 20% in New York City; just they can't sell all the homes that are located there. And then you look at, there's limited supply on the market right now, massive amounts of purchasing going into the market, however, there isn't a lot of "for selling," there's been a forbearance put in place on lots of mortgages, those sorts of things.
So, just to give you some numbers on demand. So, August existing home sales are the highest level since 2006. According to the National Association of Realtors, there are 1.49 million homes for sale at the end of August; that's down almost 19% annually. Redfin has some stats from September. So, the number of homes for sale in September was down 23% to a record low. So, you're in these circumstances where, because of some of these trends that have been latent in the market that are really getting pulled forward, there's this massive surge in buying demand, but there's just not enough homes for sale, which really puts Redfin in a tough spot, given that they need to find homes for folks to buy.
Beyers: Even before this pandemic, we were seeing Redfin take on more elements of the real estate transaction. So, they built a title business and then they're building a mortgage business, and then they built instant buying -- which I'm not going to define just yet, because we're going to get to that -- and then they also bought in some concierge services, improve your home before you sell it. So, all of these ways for Redfin to capture more of the real estate transaction and do it in a very high value way that is affordable to the customer. And the unit economics on this has been really good.
And I think, maybe the unheralded portion of the Redfin business that's really come through in a big way most recently is the mortgage business. I actually think the mortgage business, even more than instant buying, is going to be the thing that really catapults Redfin forward. Because here's the thing about mortgage. There's a lot of banks, there's a lot of competition in mortgage, but if you've ever bought a house -- and I don't know, Nick, have you bought a house yet?
Sciple: No, I'm probably going to be one of these people in that millennial demographic, where with the low interest rates and all those sorts of things, I'll be in the buying pool, but not right now.
Beyers: Okay. So, the way it tends to work with -- and I don't think this has changed very much, Nick -- is that your mortgage broker, unless you're really super-deliberate about it, and you're really just relentlessly shopping, it's very often that you're going to try and pair that mortgage as close to the real estate transaction anyway. So, your broker, for example, your real estate broker says, hey, here's somebody who could help you with your mortgage when you're ready. That is very common, like, that really is very often, that's how you end up getting your mortgage.
And so, Redfin just said, hey, look, you know what, as you're looking at this, as you're buying, let us help you, and just pulled out as part of the transaction, they're not the only ones that are doing this, by the way, so is Zillow (Z 5.15%) (ZG 4.77%), Zillow is doing this. So, it becomes very much a referral business. The closer you get to the transaction, the more likely it is you are to win that business. So, I think that Redfin has a lot of ways to compete in this area. And they don't hold the loans, they write the loan, and they sell it, they take a profit and they move on. So, I think, you know, as we get to a more liquid residential real estate market where people are moving more, maybe moving up more, maybe moving from the coast to the interior of the United States, or vice versa, you're going to see Redfin getting more transactions into its system. And the more transactions there are, given the way they've built their business to capture more of that transaction, the more profitable this company becomes over time. So, it's early, but I can see the pattern, which is my point here.
Sciple: Oh, yeah, to your point on the Redfin Mortgage business, so it just had its first full quarter of gross profits in the third quarter, gross margins over 30%. Mortgage revenues for the quarter nearly tripled year-over-year, part of that is because there's just so much demand for mortgages that you can extract a little bit higher rate, but another thing they're doing is, they've talked about expanding to the West Coast, their mortgage offering. So, now they go from somewhere around two-thirds of their customers they could offer a mortgage product to, and now the number they're suggesting is 94% of Redfin brokerage customers they can now offer a mortgage to.
And so, yes, Tim, this idea is, as they get bigger, and they only have about a 1% market share right now, they can touch more and more parts of this transaction, so there's lots of different ways for them to win. And maybe we should talk a little about their recent earnings now, if that's a good time.
Beyers: Yeah, I mean, and it was a very solid quarter. I'll bring up some notes here in a second, but like you said, you know, revenue up 73%, there was just some really amazing number of them --
Sciple: The most recent quarter --
Beyers: Oh, I'm sorry the most recent quarter revenue ...
Sciple: The most recent quarter we're looking at, revenue slightly down, the real estate services revenue up 36% or so. But that revenue being down is because, like you talked about earlier, they shut down that Redfin Now business, the iBuying business. And the way that revenue is recorded, is you've got to record the whole buying and selling price of the home. So, small fluctuations in that business, which was down I think almost three-quarters year-over-year, that really explain that decline in revenue. But if you look at the brokerage business, actually up pretty significantly.
Beyers: Yeah. So, I conflated the actual, I said 73%, it's gross profit. The gross profit business was up 74%. That was up to $93 million from $53 million in the third quarter of 2019. And you're right, like, real estate services, that includes everything, all of those brokerage fees, real estate services gross profit was up to $92 million, and that was an increase of 70%.
They did have a big jump in overall net income as a result of this. You know, in fact, net income I think almost quintupled here from the third quarter of 2019 here. So, a lot of good things are happening with this company right now. And they talk about, I think, some of the softer metrics that are really important here. Redfin is getting more attention in more markets. And one of the ways they measure this is the visits to their website, mobile app was up 38%. And I think you had something in your notes about this, Nick, but now they are ranked No. 2, I think only Zillow is generating more traffic than they are to their website. So, they've become kind of a destination of record.
Sciple: Absolutely. One of the other things they point out this quarter, you know, you talk about the importance of SEO, performance on Google, and how that brings in traffic. Yeah, that top three now is Redfin, Zillow and Realtor.com. Redfin has truly passed a hop into that group. So, they talked about in the most recent earnings calls, and said, based on industry data about searches on Google, competitors traffic, tours arranged by showing time and home sales, we believe that less than half of our traffic growth is market-driven, the rest is a result of Redfin.com ranking higher for more Google searches and a higher likelihood that visitors will return to Redfin.com from month-to-month. And so, it's this idea that, sure, the market has been performing extremely well, but Redfin is also bubbling up higher in search results. So, when folks are searching for homes, Redfin is getting that benefit.
That's particularly important, if I remember back, the National Association of Realtors have some stats about how people meet their real estate broker, and it tends to be a personal relationship or it will be online, those are the top two ways. Well, if you're moving from a city where you currently live to a city where you don't live anymore, that first one tends to be gone, you tend not to know a broker in a town that you never lived in before. And so that second part becomes really significant, and we see this migration continuing to happen from the coast to more inland and suburban areas, that's an area where performance online is really going to drive who captures the market, especially when you think about who are these people buying homes. It's people that are in their 20s and 30s, that are more used to buying things online, Amazon shoppers versus Walmart shoppers, that sort of thing. So, things set up nicely for Redfin, giving these extra catalysts that we're seeing take place. But the company has just been steadily adding market share year-after-year. At the end of last year, their market share was 0.94%, in the third quarter of this year their market share is 1.04%. And you're looking at a market that is still incredibly, incredibly splintered, so there's really a lot of runway for them to keep gaining market share year-over-year. The constraint right now is they don't have enough agents to meet the transaction demand and there's just not enough homes available for sale on the market. So, a good problem to have as a business is there's too much demand for you to meet.
Beyers: Right. Yeah. And let's talk a little bit about, so the area of this business, you mentioned it, because revenue was down 1% on a year-over-year basis, and I'm sorry I misspoke about that, but let's talk about Redfin Now. So, Redfin Now is that instant buying business. So, basically Redfin Now is an instant buying or iBuying is, Redfin or another comes in -- you could think of it as a more advanced way to do house flipping. Redfin will come in, they will make an offer on your home, they're going to take a 7% fee on this one, if I have my numbers right, I think it's 7%. And so, you're going to give up some pricing power, but what you get in exchange is liquidity. You can close, I think it's as within two weeks in some cases, you can actually get out of your home, you're going to get a cash offer, and Redfin will take that home, they'll put it on their books, they will improve it, and then they'll turn it back out onto the market. And to the degree that they can turn that sale very quickly, they can turn that into cash, and they can be very profitable with this.
Zillow has bet much bigger on it, Redfin is thinking about it a little bit differently. I mean, they've really shut down, like you pointed out, Nick, they really shut this down. And Glenn Kelman thinks about this differently than Zillow does. I want to point this out because I think it is important, and it talks about, it sort of illustrates how Redfin is conservative and Zillow is very aggressive. I think Zillow is a very aggressive player, Redfin is a very conservative player.
Here's how Glenn Kelman thinks about it, instant buying is an option on one potential real estate transaction, and so the job of a Redfin agent is almost like a consultant to say, OK, what's the best option for you? Well, your home is maybe 20 years old and you haven't done enough work on it yet, maybe what you want from us is the concierge program. So, instead of doing a 1% listing fee, why don't you pay us another 1% to 1.5% and we're going to bring in a whole bunch of construction help and we're going to work together and make all these improvements on your home. And then you're going to pay for that in terms of the fee that you pay us on the other end when we sell your home, because we're going to dramatically increase the value of your home with these improvements we're going to make.
And that's one way to do it, another way is to just go with the straight 1% listing fee, and another way is to say like, you know what, just sell us your home outright. And so, Redfin is making it so, like the way that Glenn Kelman, sort of, positions Redfin is like, look, we want to help you with the transaction that fits you, not try to impose upon you an instant buying offer. And I think that's different, and it's ultimately, I think, better for the customer.
Sciple: Yeah, that's the thing that Glenn Kelman has talked about, this idea that iBuying is an offer that they want to present to customers as kind of a menu, but it's not necessarily going to be appropriate for most customers who want to bring home the most amount of money on the sale of their house. But the one thing they've also talked about is that by giving those iBuying offers, those Redfin Now cash offers, they're able to use that as an acquisition tool for the brokerage, they can present that Redfin Now offer side-by-side with the value proposition they can give on the broker side. And say, hey, Mr. Customer, these are options available to you, you know what works best for your needs. And that has helped them as an acquisition tool on the brokerage side of the business.
So, one thing we hear a lot with these iBuyers is this idea that over time they will, you know, maybe could replace brokers as a whole and become the new way we purchase homes. It sounds like you're a little bit skeptical of that taking place, Tim.
Beyers: It's not that I'm skeptical of it, it's that I feel like Redfin is, because they are a naturally conservative company, they're just going to be more deliberate about it. And this is one of the things I really like about Redfin, they are a test and then deploy type company. They are not the move fast and break things company, they are the test and deploy company.
So, when they first came out with Redfin Now, they started testing it in some markets, and then they set a limit, they said, here's how much balance sheet cash we can use. And I believe the limit they set was $25 million. And so, once they ran through a portion of that and they saw that they were actually making profitable transactions on Redfin Now, they said, OK, let's increase it a little bit more, and a little bit more, and a little bit more. And that's how they do it.
And so, when I look at how Redfin is expanding, I think you're going to see a lot of test, refine, deploy. I think you're going to see that in mortgage, I think you'll see it in title, and I think you'll see it in instant buying. I actually believe Redfin will get more aggressive with instant buying in the next three years, but it won't be at once, it'll be in a really measured staged way.
Sciple: Yeah. And I think that's an important thing to point out with Redfin as a business, given the conservatism of the management, they were founded or in the early days of their company had to navigate the 2008-2009 financial crisis. They're a technology-enabled company, but their growth is somewhat going to be incremental over time. This is one of those companies that, you know, 10 years from now it's going to be a lot bigger, but it's going to be more of an incremental growth based on housing demand and the ability to hire agents and stand up these other business lines and acquire more customers, but over time, you know, the parts are bigger than the whole.
Beyers: Yeah. And I would say, businesses grow a couple of ways, when we talk about some businesses, they grow really fast on the topline, right? They have a ridiculous amount of revenue growth, and that sort of filters down through the income statement, on to the balance sheet, into the cash flow statement. I think Redfin will see some measured growth, I think it'll be high double-digits, like, high-teens growth, maybe between 13% and 17% annualized for those 10 years. But I won't be surprised at all, Nick, because of the way and the efficiency with how Redfin is run, if that net profit will actually run higher than that. So, you'll see, like, revenue growth 15%, but net profit growth 25%. Cash flow growing 22% or 23%. Because what they're doing, as they scale and they get more of the transaction, they end up capturing more of the profit dollars. And so, they get more from every dollar of sales that they ultimately realize. I think that's the kind of story Redfin is right now. And I think it's going to continue to be that way.
Sciple: Absolutely. They have these advantages in customer acquisition and efficiency on the brokerage side which can help them improve on pricing, which over time gives them a significant advantage, I think, in the market which we have talked about so far. So, we talked about, Tim, when you look out over these next five years or so, what are you going to be focusing on with this business to see that your thesis is going to play out and that it's still on the right track?
Beyers: Yeah, that's a great question. So, things that I'm looking at are the balance sheet and the portfolio. So, I want to see how they manage inventory, and not just the housing inventory, I want to see how they manage their carrying of loans, like, how quickly do they turn loans? And so far, they've been very good at it. And you know, frankly, if they can write loans at scale, banks are going to love them, because if banks don't have to do any origination and Redfin can do origination at a very low cost and write a low-cost loan that becomes more profitable for the bank, and the bank can just carry at a profit, that's an amazing deal for a bank, and it's a good deal for Redfin. So, there's a big win-win here. So, I want to see how fast they are turning their loans and turning those loans into cash.
Same thing with the inventory, if I see good turns there, it's going to tell me a lot, because I believe that at some point, maybe within, say, the next five years, Nick, you're going to see significant gains in cash flow, like, you will see the cash flow really start to balloon and start to blossom here, even as the market, the housing market starts to normalize. The key is the degree to which Redfin can convince people to give them more of the transaction. If you get more of the transaction, the volume is not as important, right now the volume is really driving this business, it's not always going to be that way, so watch for how well they do in terms of getting people to give them more of the transaction.
Sciple: All right. Well, that's what we'll be watching next time we have you back on the podcast to talk about Redfin next time, Tim. So, be prepared, I'll be looking forward to it.
Beyers: Yeah, sounds great. Thanks a lot, Nick.
Sciple: Thanks, Tim.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Tim Sparks for mixing the show. For Tim Beyers, I'm Nick Sciple, thanks for listening and Fool on!
