A Deep Dive Into Compass

In this week's episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a closer look at real estate disruptor Compass (COMP 2.71%), which went public earlier this year. Hear Jason and Matt talk about what Compass does, its strengths, the management team, and whether it can have a bright future even as iBuying gains traction.

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This video was recorded on September 20, 2021.

Jason Moser: It's Monday, September 20th, I'm your host Jason Moser and on this week's financial show, we're taking a closer look at real estate technology company Compass. Joining me is my partner in crime. Folks, you know who it is; it’s certified financial planner, Matt Frankel. Matt, how's everything going?

Matt Frankel: Good, I'm really excited about this one. We haven't done a deep dive in a while and I feel like The Fool, in general, we've just really overlooked this one because we've been paying more attention to the really disruptive to iBuyers, things like that, and ignore the traditional brokerage model.

Moser: I'm glad you said that, because I felt like digging into this company I felt the same exact thing. It seems like it is just completely flown under the radar in our universe here, and I'm not sure why, but we're going to remedy that today, Matt. We're going to be talking today about Compass, which is a real estate technology company ultimately geared towards providing software and tools to the agents. This is not a platform like Zillow or Redfin for example. I mean, this is something that is providing the tools for agents to be successful in an industry that is certainly undergoing a lot of change, thanks to technology, and I think for the most part in a good way. But you know, Matt, real estate has traditionally, has been a very difficult model to disrupt from just the old traditional get a real estate agent to buy or sell your home. You're going to pay a hefty commission to do that to the tune of 6% or so. In many cases, we're seeing some companies coming to the market now that are trying to disrupt and bring those costs down. Redfin, for example, is really helping to bring those commission costs down. Interesting business from a number of different angles and just to give a little background for listeners real quick, this is an IPO from March of this year, 2021. It's a founder-led business in the real estate technology space, but real estate technology doesn't really fully cover Matt, so let's just talk first and foremost, what exactly does Compass do?

Frankel: They are a brokerage firm. They use tech, they don't try to compete against traditional brokerages. They try to leverage technology to make that model better. Their mission is to empower agents to really do their jobs as best as they can. They have a pretty big reach. I will tell you the statistic that surprised me the most about Compass. They have over a 6% market share of the entire U.S. real estate market. It is still sold through Compass agencies. To put that in perspective, Redfin is 1%. The entire iBuying industry combined, which I'm sure we will mention a couple of times on the show, is 1%. They're a big, big player for it to be an under-the-radar company and I wonder if they're under the radar everywhere or just for me because they're not in my market yet. They're disrupting the old technology I guess you would call it. They are not really looking to reinvent the wheel.

Moser: Well, I think that's an important point you make there, and we'll talk a little bit more about Robert Reffkin, the founder of the business. But really, one of the core premises, one of his core beliefs is that while we're witnessing this technology disruption in the real estate space now, he believes that people will remain a vital part of the real estate process going forward. I mean, we will talk about iBuying and the risks involved with that. But I mean, this is not going to be a business that just has this monumental shift to where everybody is just doing their business online. Now, he firmly believes that people will remain a vital part of this process, which is why he's built this company.

Frankel: The whole selling point for iBuying is that it eliminates a lot of pain points from the traditional model. You don't have to have a bunch of people in and out of your house all the time. You don't have to worry about open houses, you don't have to negotiate quite as much. It can be really tough to find leads, things like that. Compass is trying to take the approach to solve a lot of pain points through their technology. They make it easier for their agents to find leads that are more likely to buy, for example, which could cut down on the volume of traffic into someone's house sounds and really market the property better. They are trying to disrupt it from that side. Whether or not you need physical human beings involved in the real estate process, I'm not the right person to ask about that. I'm the one who is all about the iBuying. I think that iBuying is going to be the way we buy and sell houses in the future, for the most part. But there is a lot of room to really disrupt the traditional process. Right now, I can get more money from my house on the open market than I can through the iBuyers, so I need an agent to do that. So why not use an agent that has the best technological tools available to them, and that's where Compass adds value.

Moser: I agree with you to an extent on the iBuying thing. I do believe that it's going to become more and more a way of doing business going forward, that to me is clear. There are going to be people out there that feel very good about using that service, but you noted the trade-off there. That's something to remember with iBuying. Typically, iBuying makes it easier. Now that comes at a cost. You're not necessarily going to realize the same value on the sale through iBuying that you might through the other traditional means. Now, there's also the potential for commission costs and transaction costs to eat into those gains that you might realize pursuing options other than iBuying, but I do think you're right for the most part, iBuying is going to be a part of it. But when you look at the housing market in general and you think about how large the opportunity out there is, we're talking about trillions of dollars that underpin our housing market here just domestically. When you look at the market opportunity that Compass is quoting here based on the work that they're doing, and they see a market opportunity today somewhere in the neighborhood of the U.S. here run $180 billion. Even just capturing a little bit of that, that's a massive market opportunity, something we'd love to see.

Frankel: Yes, they have their traditional brokerage services which are condition-based generally. They also provide title insurance, which is their closing services that's included in that $180 billion. They recently partnered with Guaranteed Rate, which is the mortgage company I used to when I bought my vacation home recently to create their own mortgage lending subsidiary. Through those three parts of the business. They think that they see a $180 billion opportunity. It's hard to see why. There are roughly 6 million home sales in the U.S. each year for a total of about $2 trillion in volume. Compass last year got $145,000 of those, out of $6 million. They have a pretty large market share. One thing I will say about Compass too, they have a 6.2% market share in the second quarter. They're only in 60 or so markets in the U.S.; their coverage spans about 45% of the U.S. population. They've achieved over a 6% share of the entire U.S. housing market. While being able in markets that less than half of the population. That's pretty impressive when it comes to market opportunity. I think you're actually further along in achieving their market opportunity than a lot of their peers that we talked about. It's definitely a massive opportunity, especially when you add in the services like title insurance in mortgages?

Moser: Yes. You would assume or at least it would be understandable if you assume that because this is such a new IPO, it's something that really we just saw here at the beginning of the year. You would probably think, okay, this is a small business, is probably not profitable and they're probably haven't crossed over that one billion dollar revenue threshold yet and then you look at the income statement. You're like this is a company that generated $5.5 billion of revenue over the last 12 months. It's growing like a weed, man. From 2019 to now, revenue is better than doubled. It just strikes me as, wow, I mean, there is a lot to this business. I mean, they're really bringing in some real money there and given the market opportunity and what they are doing, it seems like they're doing something right and it seems like it would be fair to assume that growth has a good chance of continuing.

Frankel: Yes. My first thought was that as just another brokerage business, things like when we started looking into it. Remember, we're comparing the second quarter of 2020 here, which was terrible. They did over 65,000 transactions in the second quarter alone. That's a 140% year-over-year growth. Yes, the whole industry grew really big compared to the second quarter of 2022 because it was bad. Compass grew at four times the rate of the industry average. That's pretty impressive growth. Gross transaction volume nearly tripled year-over-year in the second quarter, a 186% growth. You can't argue with those numbers. Their product is their agents. With iBuying, the product is like your home. But with Compass the product really is their agent. They want to make their agents add value to the transaction. I think whether you're an iBuying believer like me or not, the problem with the traditional model is agents take that 6% commission that you've mentioned earlier. Do they really add 6% of value to the transaction? If you're selling a $500,000 home, that is $30,000 of agent commissions. Did they really earn that money? There have been times when I've sold a home where I thought they did and there have been times when I've thought they didn't. One who sold my key West house when we moved up to Colombia and pocketed, I think $24,000 in the process. It sold in a day and it sold to a buyer that he already had.

Moser: You didn't really need the agent, it's what you're saying. I'm with you and I think we've had the same experience, we've had transactions where it felt like the agent was just indispensable, but we've had other transactions where we felt like, "Oh, man, I could have done that."

Frankel: There's two ways to do it. Eliminate the agent entirely, or make the agent add value. Compass really takes the approach where they want their agents to bring value to the table, to be able to market the property better than another agent could or better than the seller could on their own. To source leads to find buyers that are more qualified to leverage technology to market the property more efficiently, to cut down on the number of showings that you're doing, really just eliminate these pinpoints in the transaction process. Because I don't want to pay 6% of my home's value for something that's just going to aggravate me for a few months. I'm sure a lot of buyers feel the same boat.

Moser: I feel like there's probably room for both. I think that's really what we've been getting at is, clearly there's going to be a future with iBuying and that is the get rid of the gauge all together and just sell my house. That comes at a little bit of a cost, but you get maximum convenience. If you want to pursue the potentially lengthier option there of realizing it's as much value on that sale, I'm sure they're going to be plenty of folks out there that will still love to employ an agent to get that done for them. Again, I think a lot of it is just location. It's going to change from place to place. Now, it is interesting. Now, tell me, we're at a point here domestically, when you say massive housing shortage, I think I saw something to the tune of five million units. There's a lot of catch-up that needs to be played here on the part of homebuilders, so they are obviously going to stay very busy for some time to come, but I think that all speaks to, I think we will continue to likely see a fairly in demand housing market for the most part, big picture here in the U.S.

Frankel: Like inventory is low right now, I read that same report. In a normal time you want to keep demand a little bit ahead of supply.

Moser: Sure, absolutely.

Frankel: Not five million units ahead of supply. Just to put that in perspective, there's about 140 million homes in the U.S. That means that's five million less than we really need to fill all the demand. In a normal time, it's usually in the 2-3 million range that were short, and there's a lot of reasons they were short. Homebuilders are a big one, it's not only material costs, it's that they can't find labor right now, the labor shortage is everywhere, not just in restaurants, it's everywhere. Homebuilders are having trouble finding qualified labor to keep up with demand. A lot of homebuilders have stopped taking new orders, because they don't want to build big backlogs. When there's no new homes being built and point being, you need five million more homes.

Frankel: People are going to look at the existing market and that's really what you're seeing now and that's why Compass is really thriving right now. If they actually built five million new homes tomorrow, it will be bad news for brokers.

Moser: Yeah, I suppose so, but we can count on that not happening I think. What is a company like Compass, what's their edge? Do they have one? Is it just the technology? Is it the drives? Is this network of agents that they serve? Is it a little bit of a lot of things? What do you think this company's edge is?

Frankel: It's all the above, their scale is a big edge. I mentioned they have over 6% of the market. That's a big network of agents. I think I read over almost 11,000 agents in the last quarter were on their platform. That's a pretty big scale. Scale is a big advantage of that business, especially when you're dealing with technology. It just gives you a big data advantage, you can leverage buyer data, seller data, things like that. That's a pretty big advantage, I think. And the fact that they're nationwide. I mentioned they're not in every market yet, but I'm looking at the map right now and they're in all the big population centers. I don't live at a big population center which is why they're not near me. They're in pretty much every major market, they're a national brand. I think scale is a very big advantage for them.

Moser: It feels to me, and we could pivot into leadership as well, because I feel like from everything I've read, Robert Reffkin is the founder of the business, he's the CEO of the business. He's a young guy, a 41 years old entrepreneur who seems very passionate about what he's doing, he owns 6% of the company's still and he seems to be very customer-centric, I guess. When I say customer-centric, I mean his view on serving the agent. He says that I like to say that Compass building technology accelerates what agents are doing already. It strikes me that when you have a CEO, a founder who's in touch with building tools and services that his "customers want and need" typically, when you're giving customers what they want, what they need, you're going to do pretty well overtime.

Frankel: Speaking of building services for customers, you didn't mention the other founder. He is currently working on the key strategies for the business [...].

Moser: Yes.

Frankel: He used to be our director of engineering at Twitter. He founded a few businesses, one was acquired by Twitter, that's how we came to work there. One of his businesses was acquired by Google [Alphabet]. Great experience building stuff for the pair of them. Robert Reffkin is just kind of the customer centric guy, he's all about serving us, and especially about his agents, he's very agent-centric. He wants to empower his agents to do their jobs better. Compensations are getting to 6%. Say Coldwell Banker agent is getting 6%. He wants that 6% to be much more valuable to the end consumer. [...] is doing a great job of building the platform, you can't really argue with that resume.

Moser: No, you can't. To your point there, if he's advocating for the agent, the business itself, Compass is making money from providing the software and the services, they're not really tied to those commissions at all. Is there a risk there I guess I'm asking, where in time we see companies like Redfin, or we see the move towards iBuying that's bringing down those commission costs; is there a risk there with Compass that windling commission costs then impacts their revenue, or is there revenue relatively insulated from that?

Frankel: One big misconception about iBuying, this is actually very good news for the traditional brokerage model, is that it doesn't have commissions. iBuying can be more expensive than the 6% commission model. Offerpad's standard rate is 6% more than the 6% standard broker commission. Not only are you likely to get underbid on your house by these iBuyers compared to what you're going to get on the open market, but the commissions are generally in the 7% range in Redfin's case, Zillow's case, Opendoor's case, they're all in the percent ballpark.

Moser: I mean, that doesn't surprise me though, you're paying for that convenience. That is that trade-off there. I've always felt like iBuying is really just scratching that itch for people who don't have unlimited time. When time is an issue, iBuying becomes more and more attractive.

Frankel: What Redfin does through its brokerage business, it takes the seller side of the commission. Normally that 6%, 3% goes to the selling agent, 3% goes to the buyer's agent. It takes a 3% selling agent commission and cuts it in half. The Redfin commission is 4.5% total. It's not nothing. We're not going to see these big commission pressures, especially from the iBuying world anytime soon. I don't think in that way they have to really worry about how they make money aspect of it. I think if they are adding value, 99% of real estate's still sold through traditional brokerages. We mentioned how much iBuying is growing. iBuying stores have a 1% market share, which means that what Compass is doing has a 99% market share.

Moser: I'm glad you said that, because to me, it's very easy to fall for that sexy iBuying is the future headline with your Opendoor's and Redfin and Zillow and their pursuits in that market, but the fact of the matter is, I mean, we've talked about this over the last decade, I think that real estate has just been one of those markets less prone to disruption from technology, it's just the way we've always done and so they just keep on doing it that way. Any time you're going to see iBuying gain share, but you're still going to have this massive opportunity in the traditional model. It strikes me, is very difficult to believe that that traditional model goes away anytime meaningfully, at least over the course of the next decade.

Frankel: Yeah. Even the most bullish people on iBuying like me, think it's going to take decades to play out. I think by 2040, iBuying will have the majority. That's 20 years from now. I don't even think it's going to be dominant, I think it's going to have the majority in 20 years. I'm like the most bullish person I know on iBuying. It's not going away anytime soon, especially in smaller markets, it's really going to take a long time. The iBuying model really makes sense in densely populated areas where there's a ton of housing data, where it's real easy for these iBuyers to algorithmically judge the value of a house. In more spread out areas, it's not as practical. You're going to see a big need for agent assisted transactions for decades to come. Even if you're really bullish on iBuying. I'm not that worried about the industry going away anytime soon.

Moser: One last question before we wrap up. Because I think this is one of these things I look at, I'm trying to figure out exactly why this is the case. But we've got a business here that is clearly growing very quickly. No, it's not profitable yet, but it's shocking up these +90% gross margins. It seems like a very high-margin software-type business participating in a massive and growing market opportunity, in a resilient and really unnecessary market opportunity. Why do you think this business is trading for what seems like such a low multiple today in the context of so many businesses out there where 30-time sales is the new PE. This is a business that has a $5.5 billion market cap. It's basically trading at one-time sales. No, it's not profitable yet, but it's going to get there. I wonder, do you have any feeling as to why maybe the market might not be giving this off the same type of love it's getting a lot of these other tech darlings.

Frankel: The short answer is, it's a lower-margin business, real estate in general. When you sell a home, 6% profit margin or 3% profit margin for the seller is the agent. A lower-margin business is really the big key to it. It's really tough to make the gross margins you're seeing from some of those 30-time sales companies in any real estate business. If you look at any of the iBuying big guys, they're trading for very small multiples of sales just because it's low-margin business.

Moser: Well, definitely one worth keeping an eye on. It certainly piqued my interest and I'm going to learn more about it myself. I appreciate you taking the time to dig into it today for us and our listeners, Matt. I think that's going to do it for us for this week though. Thanks again for taking the time to jump in here and give us your two cents.

Frankel: Sure. Always happy to be here. The stock market is still down today. I haven't even looked.

Moser: Yeah. But you know that's just the way it goes. You got to take the good with the bad.

Frankel: It's a good day to do nothing in the market.

Moser: Exactly. That's why we play the long game. All right, Matt, looking forward to seeing you next week. Thanks again.

Frankel: All right, Jason.

Moser: That's going to do it for us this week, folks. Remember, you can always reach out to us on Twitter @MFIndustryFocus or drop us an e-mail at [email protected]. As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser, thanks for listening and we'll see you next week.