Redfin (RDFN -3.58%) shareholders have lost almost everything in the past 18 months. Going back to February 2021, its shares are down over 96% at recent prices. 

So what gives? In short, the housing-technology company has seen its business grow quickly, but a brutally fast downturn in the housing market (where it generates almost all of its revenues) caught it in a bad position, with skyrocketing expenses, and investors are bailing. But despite the risks, there's a lot to like about Redfin for investors willing to stomach a lot of volatility and some very real risks. It's probably stronger than you think, and the upside on the other side of the real estate downturn is tremendous.  

Redfin's stock has crashed, and the risks are real

Down almost 97% at this writing, Redfin investors who bought near the peak are essentially a rounding error away from a total loss at this point. And while I've already summed up the high-level reasons why, there's a little more to the story, and that "little more" is important to better understand how Redfin makes money.

In short, it's an online real estate brokerage for residential real estate, but it also buys homes directly from homeowners (in the industry this is referred to as "iBuying") who want a quick sale or don't want to go through the usual listing process and prefer to list the house for sale with their Redfin sales agents. 

In 2021, Redfin's revenue exploded. Real estate services-segment revenue increased 39% to over $900 million, while properties-segment revenue more than quadrupled to $881 million. Redfin's $1.92 billion in 2021 revenue was 117% higher than what it was in 2020. Remember, Redfin is an 18-year-old company, and last year was an incredible year of growth.

It was also an incredible year of growing expenses and costs. Total operating expenses more than doubled last year, and the company burned $302 million in operating cash. Through the first half of 2022, operating expenses continue to climb, up 26%, while operating cash burn is also on track to increase even as the housing market has deteriorated. As a result, the company has taken steps to cut costs, laying off almost 500 people in June while seeing another 210 people leave and not be replaced. It laid off an additional 26 employees in July tied to loan processing. Cost-cutting via firing employees is never pleasant. But with the massive deterioration in housing transactions, Redfin's priority has quickly shifted from growth to cost-containment. 

Here's the good news: Redfin ended Q2 with $654 million in working capital, giving it a sizable margin of safety to ride out the current housing market downturn. 

So what's the bull case?

In short, there is still a massive structural problem with housing. Over the past dozen years, household formation has significantly outpaced both new home construction and the number of existing homes available for sale:

US Household Formation Chart

US Household Formation data by YCharts

On the other side of this downturn, that structural dislocation will still be there, with millions of young families wanting to own a home. Redfin is likely to be a big winner from this trend. 

What happens next?

In the near term, there will almost certainly be more pain. Redfin will likely have to continue cutting costs and managing its balance sheet very closely. It has a sizable margin of safety in its balance sheet but can live off working capital for only so long. But it must also retain its best people so that it can quickly return to growth and seize the opportunity when activity does pick up in housing. And we don't know how long it will be before the cycle turns. 

And that means that, by and large, Redfin stock will be very volatile, and likely trade from day to day based on investor sentiment and speculation on housing. If we see further deterioration in its results, shares could continue to fall. If it doesn't manage costs and the balance sheet well, it could get even more painful. 

But once the cycle does turn, if Redfin manages its resources well, it should be positioned to be a huge beneficiary from buying and selling activity. Its website is a huge traffic driver, and its low-cost brokerage model is appealing to many sellers. 

Put it all together, and this isn't for the faint-of-heart or for people with money they can't afford to lose. But for investors with a multiyear time horizon and a stomach for volatility, the risk-reward profile on a strong turnaround for Redfin could deliver enormous multibagger returns.