The real estate market has been on a tear over the past year, with U.S. home prices logging a 12-month gain of 20.5% as of March 31, according to the Case-Shiller National Home Price Index. Technology-backed real estate companies like Redfin (RDFN 5.34%) were among the biggest beneficiaries on the way up.
But that's all changing -- and quickly. The Federal Reserve is currently increasing interest rates at an aggressive pace in a bid to fight high inflation. At the beginning of January 2022, consumers were paying a fixed rate of 3.22% for a 30-year mortgage, but that has jumped to 5.23% as of this writing.
The move is having a significant impact on the housing market already, with demand 17% below Redfin's expectations during May. The company is now laying off employees to compensate for the decline in sales, but that might not be its greatest threat right now.
Adapt and survive
Redfin is on a mission to change the way real estate brokering works. Traditional agents typically operate within small firms and are confined to one geographic location, where they have a deep knowledge of the local market. But Redfin has elevated real estate brokering beyond the local office, employing thousands of lead agents to sell homes at scale.
By doing this, Redfin is able to charge listing fees of between 1% and 1.5%, which is far below the industry norm of 2.5%, and the company says it has saved its customers over $1 billion since inception.
Record-low interest rates triggered a demand surge for housing during the pandemic, so Redfin went on a hiring spree, nearly doubling the number of agents on its roster since mid-2020.
But with demand rapidly cooling thanks to a rising federal funds rate, Redfin has made the difficult decision to cut 8% of its workforce. The layoffs will be broad. with software engineers, research and analytics staff, and agents who were hired during the homebuying frenzy over the last two years set to lose their positions.
Redfin represented 1.18% of all U.S. home sales by value in the first quarter of 2022. It's punching far above its weight, considering there are approximately 3 million active real estate agents across the country, so the company's recent layoffs could be a warning shot to the rest of the industry about what's to come.
Redfin's greatest risk
Redfin operates in other segments of the real estate sector beyond brokering. Its iBuying business made up 63% of its total revenue in Q1 2022. The company has a strong presence in the rental market thanks to its takeover of RentPath, and the company also entered the mortgage business when it purchased Bay Equity Home Loans earlier this year.
Still, investors should focus on iBuying, in which Redfin buys homes directly from willing sellers, then tries to flip them for a profit. The company sold 617 houses in Q1 and purchased a further 398 at the same time.
It's an incredibly risky business, as real estate tech giant Zillow Group learned the hard way. The company suffered catastrophic losses in iBuying during 2021, forcing it to exit the segment -- and that was while national house prices were rising.
Redfin had $245 million worth of properties in its inventory as of the end of Q1, and since it's observing a sharp drop in demand, there's every possibility it could suffer a loss on that portfolio in the coming quarters.
What's Redfin's next move?
In a note to employees, Redfin CEO Glenn Kelman said the company would brace for years, not months, of fewer home sales. The coming layoffs will be part of a broader plan to right-size the business and work toward profitability to manage through that environment.
It's a prudent shift in direction, given that Redfin lost $116 million in 2021 and now faces the risk of losses in its iBuying segment if it can't sell its inventory of homes above the prices it paid. Redfin stock has suffered as a result, losing 79% of its value year to date amid rising interest rates and the broader tech sell-off.
Investors may want to observe Redfin from the sidelines for the next couple of quarters to see whether demand recovers. However, if the company proves it can achieve profitability, the current stock price would be a bargain, considering that its market valuation of $871 million is less than half of the $1.9 billion in revenue it generated last year.
