Redfin's Opportunity?

In this podcast, Motley Fool analyst Asit Sharma and host Dylan Lewis discuss:

• The $1.8 billion decision hitting The National Association of Realtors and real estate brokerages.
• Why real estate might be an industry at a crossroads, and whether it means opportunity or challenges for companies like Redfin.
• Three lessons from WeWork's bankruptcy filing.

Motley Fool host Deidre Woollard caught up with Jean-Manuel Izaret to talk about his book Game Changer and the strategies companies use when they set prices.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Nov. 1, 2023.

Dylan Lewis: Housing is expensive, rates are high, but the cut going to agents might be going down. Motley Fool Money starts now. I'm Dylan Lewis and I'm joined over the airwaves by Motley Fool analysts, Asit Sharma. Asit, thanks for joining me.

Asit Sharma: Dylan thank you for having me.

Dylan Lewis: Today we've got two stories on the state of real estate. Our first one, the National Association of Realtors, and several real estate brokerages are facing damages of nearly two billion dollars. After a jury ruled that they conspired to keep commissions high, as those damages could swell and could reach up to five billion dollars. But the story to me with this one is, it seems like we may be approaching one of those industry cross-road type moments in real estate.

Asit Sharma: It has that feeling, Dylan. I wonder if the pressure on home buyers now, with supply being short, interest rates being so high, is not part of the propellant of this movement to break apart like a rigid structure that's been here for a long time. I've got some thoughts on this, but you broke down pretty well when we were preparing for the show on the cracks of the matter. Maybe, if you can explain that for members, I've got some thoughts on it.

Dylan Lewis: Under NAR rule, a home seller is required to pay commissions to the agent representing the buyer, which sellers in this case have claimed, forced them to pay excessive fees. Those commissions are generally set with NAR and there's consistency across NAR members, and so there is this thought of the cooperative compensation rule coming into play here. Under the verdict of this, sellers would no longer be required to pay their buyer's agents, and agents would be able to set their own commission rates, which as you might imagine, could mean rates would go down. I look at this Asit and a lot of this seems to be what you'd expect when there is a consolidation of power in an industry.

Asit Sharma: I think so, Dylan. It's just weird how this arrangement has arguments on both sides, this sharing of commissions between the seller's agent and the buyer's agent. On one hand, it's provided a really uniform structure of incentive which has seemed fair for a very long time if you're on the part of the industry, if you're a real estate agent and I think that's helped the US housing market grow. Just the uniformity, the structure, but this is a country that favors competition, so it's not the most competitive arrangement in the world. I think if you're a home seller, you have a legit question like why do I have to pay the commissions that the buyer is bringing to the buyer's agent? When we think about how entrepreneurialism in the US is typically structured, that actually makes zero sense. You have two really good arguments on why, maybe, you should maintain a commission structure like this, and why on the other hand, it's not constructive. I think the pressures that we're facing today may have colored the fact that this finally got through the court system and has reached the point that it has now whether this will result in a fair system, a more entrepreneurial system around the incentives of real estate. I lean to yet will, but again, for people who've been in this business for a long time. Now what's the incentive for them to go out and represent buyers and sellers? Does this actually drive cost up more? That's an open question as well.

Dylan Lewis: One of the things that I thought was interesting with this story was we saw Zillow and Redfin, both get punished by the market yesterday on this news. I think both were down over 5%. I think Redfin might have been down over 10% at one point during the day. Neither of those companies are named in this suit, and neither of them really make money from real estate commissions. It's not really part of their business model and yet they get caught in the wake here. I look at a company like Redfin and I say actually I feel like this is opportunity for Redfin with how they've been positioning themselves in the market for the last five to ten years.

Asit Sharma: I think it is long term, because Redfin has been positioning itself strategically as a place you can go and not have to pay such a high fees just to transact a home sale. But on the other hand Billy Duberstein who is a contributor at the Motley Fool, who I really like, I think he's a smart guy, He summed this up yesterday and he said, look Redfin's whole model is to drive down cost. They charge like a 1% to a percent and a half for a listing fee. Well, if the courts are going to break up this buyer seller fee arrangement and there's going to be competition for traditional brokerages to now they have to go out and really compete on fees, that's going to drive down cost in the industry as a whole. All of a sudden the brokerages that weren't competitive with Redfin, now that spread has diminished. Suddenly Redfin and at least in the near term may have more competition, which I thought was pretty interesting.

Dylan Lewis: It sounds like you might be describing a race to the bottom there Asit.

Asit Sharma: I hope not, at least for all those young home buyers. Luckily we bought our home years and years ago, so I'm not in the market. But man, I have empathy for anyone in this day and age who is faced with this commission structure which seemed less onerous when interest rates were worth [laughs] 3, 4, 5% lower than what they are today, if you're out there trying to get a 30 year mortgage.

Dylan Lewis: Asit, over to our second real estate story today, from homes to offices, following a botched IPO process. Years of operating losses, and now a tougher environment with hybrid and work from home, we are seeing reports this week that WeWork will likely be filing for bankruptcy, having issues getting payments over to creditors. Asit, there's been so much coverage of WeWork's demise. It is a well worn territory at this point. I think rather than zoom in on the individual details here, I think maybe we can take a step back and look at some of the investing lessons here, and things that investors maybe can take away from this story, and from this multi-year saga. One of the ones that jumps out to me most, is how important it is for business model and financial statements to sync up, and when you have things that are out of step with that, it is probably going to lead to a calamity. That's what we saw with WeWork.

Asit Sharma: That's such a great way to put it, Dylan. It brings to my mind something that I've developed just from my own analysis called the three B's. I think of this in terms of debt, are you bridging, are you building, or are you bailing? [laughs] You can use debt for three purposes. The interrelation of the financial statements of WeWork, even after 2020, when they restructured after Adam Neumann left the scene, really what you saw was a picture where there was liquidity, so there was bridging money there on the balance sheet. But the income statement, the statement of cash flows, told you that long term what was going on was a lot of bailing among the financial statements. There was no solvency, which is, can you repay your debts? That's what solvency is. But there was liquidity, meaning can you live to fight another day? Yeah, I mean they were until, TechCrunch says that the bankruptcy is going to maybe go down as soon as today, so they lived to fight a few more days.

Dylan Lewis: Yeah, it's incredible to see, and I love that bridging versus building idea or bailing idea. I think with WeWork, there was this idea that maybe the business model would change over time, and ultimately we didn't see anything that gave us that sign. At core this was a leasing business, and they never were able to get away from the leasing business economics, which would have helped change the financial picture for them.

Asit Sharma: You can trace this right to the balance sheet, Dylan. What's the biggest asset on the book [laughs] of WeWork today? It's actually just their lease assets, their right of use on the leases on those. They've got on the bottom side of the balance sheet, the liability against those, so they have to keep paying the lease expense. Then we flip over to what the financials look like. They did improve a bit from 2020, the top line stabilized a bit. Even the operating expenses per location, they managed to bring a little bit under control. But this model just wasn't built to work. There was no way to have enough pricing power, enough utility of the buildings, the right type of membership subscription to make that dollar of revenue be able to withstand all the expenses that it got battered with from the restructuring costs they had to go through to all the ongoing pre location cost to keeping the type of environment that folks want to work in. In such a shape is that they could keep these subscriptions. There's a lot of maintenance. Even if you own the operating asset of the lease, you're responsible for certain things in that lease for the upkeep and also for all the coffee and fund that goes on in those WeWork locations. The model itself, even after restructuring wasn't built right. I think you've got something here that is so fun to look at. Dylan, sometimes we look at asset of financial statements, and we just don't know. How does this idea could work out? I think it could have some legs. But this was that rare case where you could be even a novice investor and just see like nothing was adding up for the last two to three years. I think that's where your eye was going on when we were talking about this earlier.

Dylan Lewis: Yeah, there's just a fragility to that financial position. That, if everything goes right, you're fine. But if you wind up with any hiccup along the way, those losses mean that you're drawing on cash to maintain operations. If you have a heavy debt load that gets more and more expensive over time. I think we just saw that unravel here. I think it's a great example to study. If you want to look at the interplay between financial statements and just learn about these things. I do also want to talk a little bit about the SoftBank side of the WeWork story. Because this was an investor for them that fueled their rise to a $48 billion valuation. It has been in the mix as an investor, and a provider of capital to where the company is now, below an $100 million valuation. We talk often about wanting to water flowers, and not water weeds. Do you feel like SoftBank might have stuck around a little too long with the story?

Asit Sharma: It's easy to say this in retrospect. We know Masayoshi Son and SoftBank in general, his investment company, our patient investors, and sometimes crazy patient investors, and sometimes it seems just crazy investors. But at the same time, Masayoshi Son has pumped billions into other companies and been very patient as they've sustained billions in losses, and then those models turn around and work. Coupang is a great example of that; the South Korean e-commerce company that spent, by my estimation, somewhere between eight and 10 billion between losses and capital investments to take over the logistics space in South Korea and be a first mover. That's the ethos of SoftBank. But I feel that there's also an element of maybe throwing good money after bad here. SoftBank put the big dollars in at the beginning through the Adam Neumann cycle, and then they provided essentially that liquidity as time went on. I think there was still some hope that the model would prove itself out with more time, but it just on paper was never a strong proposition. Finally, this is even too much for SoftBank. They're going to let this one go. But like any great investment firm or venture capital firm, this is not their only bet. They have bets spread out among a number of different investments. Have hit some rough times lately, but I'm sure they're feeling some relief to call this one [laughs] the end and to move on.

Dylan Lewis: You mentioning their investing style reminds me we were just in New York together and Motley Fool co-founder and CEO Tom Gardner interviewed Michael Lewis, and they were talking through the incentives and the approaches of private investors. They were talking a little bit about how given even everything that happened with FTX and everything we have seen, it's not entirely clear that given the chance to redo everything, a lot of those private investors would have changed anything because the model is look for big upside ideas and invest, and you are almost punished for missing those ideas. Coupling that with what we were just talking about with SoftBank, I do feel like there's a cautionary tale here, and maybe it doesn't always make sense to follow the stories that are being brought public by some of these private investors because their approach might be a little bit different.

Asit Sharma: In some cases, they are actually rolling the dice with a very talented founder, or a really great idea. Why this can work for these entities, Dylan is because they've got capital. This also goes back to walking into your favorite casino. If you like to gamble on vacation, you get this intuitively. There's a certain amount that you come in with. If you've got a little bit of an edge, you can play a little bit longer into the evening. With great venture capital firms and even mediocre ones as well, the more the capital, the more the bets can be spread, and the more you can say, yeah, I take those chances again, I know it sounds crazy. But look, we only have all these funds today because we took these chances when we were smaller, and now we have greater capital that we've got to allocate, and the system works. Now, of course, they'll pride themselves on their ability to identify which are the better business models, and also to assess founders to see what kind of person is on the other end of the table. Look, Sam Bankman-Fried, Adam Neumann, they turned out not to be great bets if you're betting on a person. But for every one of these gentlemen, many luminous CEO founders go on to establish great companies that often have a payoff in the public market, so it is a game of numbers in some ways, and a fascinating one for those who have the money, and for the rest of us, we can learn a bit by studying what they do, seeing what works and what doesn't.

Dylan Lewis: Asit, appreciate being on the other side of the table for you for this conversation. Thanks so much for joining me today.

Asit Sharma: Thanks so much, Dylan, it was really fun.

Dylan Lewis: Coming up, the price you pay for streaming services, airline tickets, or your next Uber ride is probably something your investing brain should be paying attention to. Jean-Manuel Izaret heads up the marketing, sales, and pricing practice for the Boston Consulting Group in North America and Motley Fool Money's Deidre Woollard caught up with Izaret. Let's talk about his book, Game Changer, and the strategies companies use when they set prices.

Deidre Woollard: Well, I think most of us have this simplistic view of pricing, fair market value that you just price as much as the market will bear. Your book shows that it's a lot more complicated. Why is pricing more than just trying to get to the most a consumer will pay, without going over what they're going to pay?

Jean-Manuel Izaret: There is that element, no doubt. But each time you set a price, there's two things that you tend to forgot. You set a price for something, whatever is the offer, and you set a price in units. It seems like the unit is assumed. If I'm buying a car, well, I'm buying a car, I'm paying for the car. But you can actually buy a car by the month and that's called leasing, or you can buy a car by the day and that's called rental, or you can buy a car by the mile and the time, and that's a cap. Recently you had a new business that sprang up 15 years ago, which is buying a car by the right. The unit that you choose is actually, much more important than people imagine because it tends to create entirely new business for almost the same thing. As we got into products that are more digital, the units by which you pay something is something that varies a lot more because you have more choices by which to go. Let me give you an example. We all are talking about generative AI and all these models, are they going to replace us somewhat? Well, there's a simple view. If gen AI is priced by user, it's going to enhance users, and if it's priced by the task, it's going to replace users. When you see gen AI models that are just sold as a subscription per user, for instance with Microsoft, it's basically, a tool that will make people smarter and summarize emails and all of the good things that you could have, it's not going to replace people. But if you in a call center have a gen AI model that can answer the phone instead of humans and it's priced by phone calls that are answered, then suddenly it will replace humans. The unit by which you price has a fundamental impact on the business that you create, and even potentially on society.

Deidre Woollard: You talk about a lot in the book and that I think so many of us are experiencing, which is the bundling and unbundling, and rebundling of things. In the book, you talk about cell carriers when they made this switch to bundled plans from unbundled. We have airlines going the other way unbundling, like now, you have to pay for your bill, you have to pay for your bags. Right now we're dealing with cable, and streaming, and it seems like we're halfway between the bundle and the unbundle. What types of inputs are driving these decisions that the companies are making?

Jean-Manuel Izaret: Many different inputs. You have some businesses where it is possible to bundle and others where it's not possible to bundle. But in the consumer space, when you have several products, considering about whether or not to bundle is usually a good idea. There's a simple rule of thumb, which is, when you are at the beginning of the markets and there's an expansion of the offers and you have a high growth that is coming toward you. Companies tend to have an advantage in bundling things together. At the beginning of when the airlines are coming together, saying that you're going to have the newspaper and a great meal and it's all going to be nice and a lot of amenities are bundled into the offer. You attract more customers and you round up your service that allows you to pad the margins on top of just paying for the fuel and for the plane. You carry that for 35 years or 40 years. Competition comes in and low cost providers like EasyJet and Southwest come in with no frills offers. Your bundled offer seems bloated, there's too much in there and too much that is not really needed. Therefore, the airlines went to unbundling. Therefore you have a cycle of growing. To grow, at the beginning, you need a really good product. When you have a good product that has a lot of traction, you tend to bundle a lot with it in order to make as much money as possible. Then people are saying, well, do we need all these things together? Then unbundling starts to happen and the market cycle starts over again. The telco industries and the cable companies have had several cycles like this, which is why they had cycles of bundling and unbundling. Each time there is something new that is coming, they're trying to bundle it with the old thing they add in order to make the old thing almost new. That was true for bundling cellphones with regular phones and then cable with TV and with streaming services. Each time you add new things, there is this this tension that happens.

Deidre Woollard: Well, you hinted about a company that does dynamic pricing earlier, which is Uber. Dynamic pricing is something I think that we know exists. We don't always like it as a consumer, we don't like to pay more for the same thing. But what factors go into a company's ability to use dynamic pricing?

Jean-Manuel Izaret: That's an excellent question. There's a number of factors. Moving into dynamic pricing can be advantages if you have a fixed capacity that you need to fill in, and a number of people are willing to pay a very different amount for that fixed capacity. It could be a good idea if you have a fluctuating demand that is hard to predict and so it's hard to predict what would be the right price. Two good examples of this are airlines and concert tickets. For airlines, you don't exactly know always what is going to be the demand at any point in time. What people are willing to pay can be very different depending on business travelers versus tourists. Last minute people and students and all that. People have different willingnesses to pay for almost the same seat. Getting to a dynamic pricing model was quite advantageous for many of the airlines. Similarly, for tickets, you're going to set up a concert hall. You can have many people that could come. The demand might fluctuate depending on what happens. Everybody might be willing to pay different prices. There's the tendency to say, I could vary the prices in order to offer different prices to different people, might not be a bad idea. It becomes a really terrible idea is when the actual prices tend to vary by an order of magnitude that people are not used to. For instance, if on Uber it takes 30 bucks for you to go back home from where you work. Then on an evening, because there was a consta ser, there was a surge pricing and now you need to pay $250 for the same ride. You feel really terrible. It's more than almost 10 excess It is a driver, it's a car. Why am I paying? Because of scarcity. It's the same feeling that if you're in the desert and you are really thirsty and someone offers a bottle of water and says you need to give me all your life saving. You're like, no, even if I die I'm like, you're going to feel really terrible. People taking advantage of extreme situation of supply and demand, really elicit feelings that it's unfair to get the prices to go to the extremes that they could go. Companies who implement dynamic pricing need to be really careful at not letting the algorithms run completely wild and have price differences that are 10x, 20x, and 30x. Because they elicit feelings of anger from customers and it's never a good idea to anger your customers.

Deidre Woollard: Very true. One of the things I found really interesting in the book was you talked about this study with Capuchin monkeys. This is really interesting to me because it's about psychology. These monkeys were rewarded for giving a stone to the researchers. If they got a cucumber piece, but then the researchers started giving, as I understand, some of them got grapes. Then the monkeys that saw the other monkeys get the grapes. They got mad because they saw like, wait a second, I'm doing the same thing, but I'm getting a lesser reward. It's really fascinating how psychology plays into pricing.

Jean-Manuel Izaret: That's right. The sense of what is fair and not fair is very much ingrained into our brain very deep. I'm not sure if it's the peoples somewhere. But monkeys have the same sense of fairness that we have, which is basically against discrimination. For the same reasons, people should be treated the same way. Discriminating is usually not a good idea, that applies to pricing. But now if you ask people whether they think that the seniors should get a discount for a number of products, you can to tend to find agreements across the world that people, yes, sure. Seniors should get discounts. If you ask them, well, is it if seniors get discounts, should young people get discounts? Then you have half of the people who think that seniors get discount, others think that, students and younger people should get discounts. You don't have the same agreement. What's the fair price and how should it vary is also a societal norm. That depends on the conditions. You find in societies like the US and India, people tend to want to give discounts to seniors because the retirement systems are not as robust as other countries like Japan and France where people are more favorable to giving discounts to students, but not to senior people. The sense of what is fair price and small variations really depends on the social context and what people get used to. To come back to my airline example, there was a lot of pushback at the beginning when airlines started to price things differently. But we understand today that because everybody pays a different price, more people can travel. We think it's a good thing that more people can travel. We have ways to make this travel very affordable for people that otherwise wouldn't have been able to travel while business people who can afford to pay more actually pay more. Society at this stage has accepted this as it's OK to have such price variations. The lesson for company is that it's OK to differentiate your prices, but you always need to be able to justify that to the public. You always need to be able to say, we're doing this for a reason. For instance, if the reason is because these customers are more loyal to us than others, you could also become a loyal customers and you would get a loyalty discount. That's perfectly fine and very well acceptable. If I am giving a discount with no reason just because I like you better than the other, that's really not acceptable. That's what happened with the monkeys.

Deidre Woollard: I want to move on to one of your games that you talk about, which is the choice game and Starbucks as an example of this, which makes sense because any of us who have ever gone to a Starbucks. You can spend a ton on a drink with extras, but you can also get a relatively cheap coffee. What are some of the pros and cons of the choice game and how does that play out across different industries?

Jean-Manuel Izaret: The choice game is the one that takes the most advantage of what you mentioned earlier, psychology and some psychological biases that we have. If you sell only one single product, then you have a number of competitors. If you don't price your product right, your customers are going to go to your competitors and that's really not good. But you think about Starbucks. If once you walk into a Starbucks, the price of one of the items is slightly more expensive than you're willing to pay, well, you have a few other choices that you're going to have. You are within the Starbucks. Starbucks is not going to lose a customer. What's the advantage of a company playing with the choice model is you're going to have less price sensitivity if you wish. You're going to be able to guide your customers to what is the best choice to them. There are some biases that customers have that are quite well known and well documented for the past 40 years, which is, customers when you offer them three choices at three different prices, high, medium, and low will always tend to prefer the one in the middle. On average, there's very few people that are saying, I deserve the best. Others like I can't afford. I need to be very careful. Some will be there, but people tend to choose the middle option. Which is why many companies have adopted a choice model by offering what's called good, better, best lineups. Starbucks have pushed this to an extreme where you don't have just three options. You have 50 and more options and different variations that you can have. But it's always the same ideas. I'm giving you choices and if you pay more, it's because you wanted to. I'm always giving you a pretext, something good that you could pay more for. Some people will take that offers and others want and over the balance of power in the market will be fairly rewarded. That's why many companies go to the choice game.

Dylan Lewis: As always, people on the program may own stocks mentioned and the Motley Fool may have formal recommendations for or against snow buyer sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.