Real estate technology has nabbed a lot of attention amid a booming housing market. Zillow Group (Z -1.44%) (ZG -1.56%) remains the pioneer and industry leader here, and though it has struggled as of late, Opendoor Technologies (OPEN -4.60%) is making the instant cash-offer model a viable solution for homeowners.
Then there's Redfin (RDFN -6.82%), which itself is actually a broker that uses technology to streamline the home buying and selling process. While it has garnered lots of investor praise, it isn't alone in the tech-enhanced brokerage department. Compass (COMP -0.43%), part of SoftBank Group's (SFTBF 4.08%) tech investment portfolio Vision Fund, went public in March and raised some $450 million in new cash from its IPO. Is Redfin or Compass the better buy right now?
Redfin: A true disruptor of the status quo
Redfin is a small but fast-growing broker that uses technology to drive down costs. Its original claim to fame: Lower commissions than traditional brokerage firms. Its agents' commission is just 1% for those who use Redfin to both buy and sell a home, far less than the 2.5% to 3% charged by most of its peers.
The company can deliver this significant savings by streamlining the transaction process with software -- everything from automated paperwork flow to its leading website for prospective buyers to peruse and virtually tour properties for sale. It's expanded on this base offering with its own in-house mortgage and title services, direct cash offers (called RedfinNow, which competes with Opendoor), and most recently the purchase of RentPath to incorporate apartments and rental properties directly into Redfin.com.
It's a tiny firm, with a market share of total U.S. home value sold in first-quarter 2021 totaling just 1.14%. But Redfin's operation is growing fast. Its share of the residential real estate market was less than 1% last year, and revenue in Q1 2021 was up 40% year over year to $268 million. Profitability is still highly variable right now as the company emphasizes expansion (free cash flow was negative $56.1 million in the first few months of the year, compared to free cash flow of positive $46.6 million during full-year 2020).
Redfin is well funded to continue its ambitious growth plans, though. It ended March 2021 with $1.39 billion in cash and investments (and another $102 million in restricted cash), offset by debt of $1.16 billion. Shares trade for just 6.8 times trailing 12-month sales, a significant discount from Zillow's 8.4 -- though Zillow is already consistently profitable. If Redfin can sustain its momentum and pick up market share at the expense of its traditional brokerage competition, this stock could be a real long-term value right now.
Compass: A tech platform for the more traditional real estate brokerage model
Like Redfin, Compass describes itself as a real estate broker that streamlines the homebuying process with technology. Its software suite is designed to help make its agents and affiliates more efficient, and touts AI and data analytics as being integral pieces of its software platform. It's been doing something right. Though founded less than a decade ago, Compass had some 19,000 agents at the end of 2020 and generated $3.7 billion in revenue.
Over the years, Compass has tried its hand at disrupting the high fee structure of real estate transactions, but wasn't able to pull it off. At this juncture, the company employs a more traditional transactional approach, and agents earn the more typical 2.5% to 3% commission from clients buying and selling homes. Nevertheless, its digital-first operating model is winning over agents and prospective homeowners alike. Total transactions increased 67% from a year ago in the first quarter to 40,268, making this one of the largest independent brokerage firms.
As a result, Compass reported an 80% year-over-year increase in revenue to $1.1 billion in Q1. In spite of its size, though, Compass is burning through substantial amounts of cash. Free cash flow was negative $57.3 million (was negative $177 million in the first quarter of 2020). Management expects adjusted EBITDA losses to be as high as $245 million for full-year 2021. The reason is ultimately high commission payouts to agents, most of whom are independent contractors utilizing Compass software. Commission and related expense was nearly 85% of revenue in Q1.
Compass is in decent shape, though. It had $330 million in cash and equivalents and debt of only $10 million at the end of March (which doesn't include the cash proceeds from its IPO, which occurred on the last day of March). Compass stock trades for a meager 1.4 times trailing 12-month revenue, reflecting the company's slim gross profit margin after paying out commissions, but a cheap price tag if the company can continue to grow and start generating a positive bottom line.
Which is the better buy?
It is worth noting that both stocks could undergo some tough times if the housing market cools off. Homes for sale are in short supply this year, and those in the market for a purchase right now are bidding up the value of property on the market. Nevertheless, the long-term thesis for Redfin and Compass surrounds increasing share of the massive U.S. real estate market.
There are some similarities between Redfin and Compass, but the latter is a far more traditional real estate firm, with agents who charge high commissions. Redfin has a more well-developed suite of services and technology platform, which support a truly industry-disrupting low commission strategy. Redfin also generates a higher gross profit margin and has thus demonstrated its ability to be profitable in the past. Compass isn't there yet.
Compass could be way too cheap at these levels, but Redfin gets my nod as the better long-term buy right now -- even if the U.S. housing market is running too hot at the moment.