Real estate technology company Redfin Corporation (RDFN 2.40%) is trying to change how people buy and sell their homes. Home buying is a complex and often stressful process, but it hasn't changed much over time.
The idea of easily buying and selling your house is appealing, but Wall Street hasn't bought into Redfin's business model; the stock has fallen 90% from its high.
Redfin could be a home run if things work over the long term, but there are some red flags that investors should know about before putting their money at risk.
Why isn't the brokerage business growing?
Redfin is one of the most interesting companies in the real estate space. It's a mixed bag of ideas, from its brokerage business that gives agents salaries and charges a much lower commission than traditional agents, to its Redfin Now segment, which will buy your home outright and resell it (known as iBuying).
The business has accomplished tremendous growth over the past several years, but the company's free cash flow and bottom line have gone in the opposite direction.
Digging into some of the numbers is where you start asking tough questions. For example, check out Redfin's brokerage business, which generates transaction commissions.
Redfin nearly doubled the number of its agents from 1,399 as of June 30, 2020, to 2,750 as of March 31, 2022. However, its total number of transactions didn't increase nearly as much, from 16,519 to 18,418, just an 11% jump.
In reality, most of the real estate services growth resulted from home price appreciation, where the company's average revenue per transaction increased 36%, from $7,576 to $10,346.
You want to move more houses as you bring on more people, and Redfin's inability to increase its volume meaningfully with more people is troubling. That doesn't mean that won't change, but it's something to watch.
Is iBuying going to work?
Redfin Now is the emerging part of the company, where it will buy homes with cash offers and resell them, a practice known as iBuying. The entire transaction value is captured as revenue, meaning that a $600,000 home that Redfin buys will count all $600,000 as revenue.
Redfin's steady growth of Redfin Now is what's primarily driven the company's top-line growth over the past 24 months. The company sold 617 homes in the first quarter of 2022 for $376 million in revenue, up from just $90 million on 171 homes the prior year.
But Redfin Now's gross profit margins were just 5.5% during the quarter, which doesn't leave much room for error. The housing market has become much more volatile since then, and investors will see how well Redfin is navigating a more challenging market in the upcoming quarters.
Caught between a rock and a hard place
Ultimately, Redfin, as it currently functions, is a low-margin company. Its total gross profit margin in Q1 2022 was just over 12%. A low margin isn't necessarily a bad thing; Walmart sells tons and tons of stuff, making a sliver on each item.
But Walmart sells so much that it can make money because all those little slivers of profit add up. Redfin will need to dramatically up its volume to become profitable unless it fundamentally changes its business in a way that raises its margins.
This is why it's discouraging to see Redfin struggle to grow its business volume, especially in the brokerage segment, where the market is highly fragmented. Redfin should be lapping up market share but has struggled to go very far beyond 1% thus far. It is laying off about 6% of its workforce due to market conditions, which could further hurt its growth efforts.
Redfin has long-term potential; any company that can add value to a multitrillion-dollar industry is worth something. The stock's decline has sunk Redfin's market cap to just $1 billion. But there are a lot of risks here too, and Redfin's not a sure thing to work out over the long term. Investors should approach cautiously and always use diversification to minimize their portfolio risk.