Since inflation hit a 40-year high in June 2022, the U.S. Federal Reserve has embarked on the most aggressive campaign to raise interest rates in its history.
It's hurting consumer spending across many categories, but the real estate sector is bearing a significant share of the pain.
In September, sales of existing homes in the U.S. came in at an annualized rate of 3.96 million units, the lowest level since October 2010, when the economy was emerging from the Global Financial Crisis. That's bad news for every service provider in the real estate industry, including technology company Redfin (RDFN 8.49%).
As a result, Redfin stock has plunged 93% from its all-time high set during the housing boom in 2021. But green shoots have started to appear, and I think now could be a great time to buy ahead of what could be a powerful bounce-back in the housing market. Here's why.
Redfin has transformed its business to adapt to the tough housing market
Redfin used to draw half of its revenue from a business practice called iBuying, which involved purchasing homes from willing sellers and attempting to flip them for a profit. But the company closed that business in 2022 as home prices stagnated and pivoted its focus toward high-margin segments like real estate brokering, mortgages, and seller services.
Redfin has 1,744 lead sales agents covering most of the U.S. housing market. In the recent third quarter of 2023 (ended Sept. 30), they represented 0.78% of all home sales across the country. While that doesn't sound like a big number, keep in mind there are 3 million active agents in the U.S., so Redfin's team is punching above its weight (statistically speaking).
The company uses that scale to good effect. Selling a high volume of homes allows Redfin to charge listing fees as low as 1%, compared to the 3% fee that is typical across the industry. As a result, more sellers flock to Redfin which keeps fees down for everyone, and thus, the flywheel spins faster and faster.
The company is also building a mortgage business, which was accelerated through the acquisition of Bay Equity Home Loans in 2022. Over the last four quarters, Redfin has originated $4.4 billion in mortgages, which was a 25% increase from the prior-year period. Considering the substantial decline in home sales I mentioned earlier, any growth in this segment is a major win right now.
But Redfin will be very focused on expanding its portfolio of digital businesses going forward because they carry extremely high profit margins with low costs. It's selling advertising spots on its flagship Redfin.com website, and the company recently struck a deal with Zillow to display new construction listings on its website, too. The first batch of listings was published in late October, and Redfin expects to earn $750,000 in profit per quarter from the agreement in the early stages.
Redfin's focus on profitability is paying off
Redfin's management team accepts that it will be really hard to generate growth while the housing market is so difficult. Its third-quarter revenue came in at $269 million, which was a 12% drop compared to the same time last year.
However, thanks to a series of cost cuts over the past year, combined with contributions from its growing portfolio of high-margin businesses, Redfin's gross profit actually jumped 8% to $98 million. Unfortunately, after accounting for operating costs, the company's bottom line (net income) was still negative to the tune of $19.3 million.
But Redfin focuses on non-GAAP (adjusted) earnings before interest, tax, depreciation, and amortization (EBITDA) as its core measure of profitability. It strips out non-cash expenses like depreciation, amortization, and stock-based compensation. Its third-quarter adjusted EBITDA came in at $7.6 million, which was a huge milestone, given that it was deeply negative throughout the first half of the year.
It's one reason investors have sent Redfin stock soaring by 22% since the release of its Q3 results.
Image source: Getty Images.
Why Redfin stock is a buy right now
As I mentioned, Redfin stock is down 93% from its all-time high. There are a few reasons for that: The elimination of half the company's revenue when it closed its iBuying business, the slowdown in the real estate market, and its dwindling balance sheet, which currently shows just $167 million in cash, equivalents, and short-term investments available.
However, Redfin made a critical move in Q3 to shore up its financial future. It agreed to a $250 million deal with Apollo Global to refinance its debts due in 2025, pushing them out to 2027 instead. Considering the company just achieved profitability on an adjusted EBITDA basis, this decision gives Redfin three years to build up its cash reserves through its business operations without requiring a fresh capital injection.
That's a big win for investors because the company might have otherwise needed a capital raise, which would have been extremely dilutive at its current stock price.
When the housing market does bounce back, Redfin will be in an incredibly strong position to not only return to top-line growth but also generate substantial amounts of cash thanks to its focus on brokering, mortgages, and digital businesses.
While predicting the direction of the housing market can be tricky, experts do believe the Federal Reserve has finished raising interest rates, and it might even start cutting them from June next year. That will almost certainly reignite enthusiasm among home buyers and sellers, so it's unlikely Redfin stock will remain at this beaten-down price for much longer.
