Shares of Zillow Group (Z -0.02%) dropped 11.5% in March, according to data provided by S&P Global Market Intelligence. News broke that realtor commissions would be fundamentally changed moving forward, sparking fears of lower demand for Zillow's services.
The real estate industry is set for major changes
Last month, the National Association of Realtors (NAR) announced that a legal settlement is expected to result in a 25% to 50% reduction in realtor fees on residential real estate transactions. Nearly 90% of home sales in the U.S. are handled by NAR members, who have generally charged a 6% standard commission on the sale price, so the total impact could be enormous.
Image Source: Getty Images.
Zillow attributes most of its revenue to advertising services provided to realtors, and the residential market accounted for 75% of its total 2023 revenue. Slashed realtor commissions shouldn't have a direct impact on Zillow's financials, so the steep drop in share prices might seem strange on the back of that news.
Investors are worried that demand for Zillow's services will be hurt if the economics of the realtor business are changed. Real estate professionals will have less cash, so their advertising budgets are likely to be reduced. That's especially true for smaller operations that were already getting by on narrow margins and irregular cash inflows. This might also squeeze some part-time or less motivated professionals out of the market, and reduced competition might result in diminished need for marketing and lead generation.
Rival Redfin (RDFN -1.51%) also slumped on the NAR news, even though the SPDR S&P Homebuilders ETF (NYSEMKT: XHB) rose, illustrating the macroforces driving the stock prices last month.
Is this an opportunity to buy on the dip?
Zillow's addressable market and unit economics are less attractive moving forward, but the long-term success of the stock is still tied to the U.S. housing market. Unfortunately, that has also been challenging over the past year and a half. High interest rates, low supply, and limited affordability have combined to crush sales volumes. Zillow's residential revenues fell 5% last year.
US Existing Home Sales data by YCharts.
However, there seems to be light at the end of the tunnel. The Fed is keeping rates steady with the explicit goal of cutting them later this year, which will stimulate demand for housing. Recent data has been encouraging: New home starts increased 11.6% in February, reaching the highest level in two years. The volume of existing home sales also increased 9.5% in February. These are bullish data points that weren't reflected in Zillow's March performance.
Economists generally expect a slow-and-steady improvement in the housing sector after a few years of major disruptions. Zillow's core business is likely to follow this trajectory once realtors fully digest the new commission structure. The company has also shrewdly moved into the rental space, allowing it to monetize housing for the large chunk of Americans who don't plan to own property for now.
Zillow's forward price-to-earnings (P/E) ratio is below 34 now, and it's even cheaper relative to cash flow. The company has a rough couple of quarters ahead, but long-term bulls have a chance to buy at a reasonable valuation following headline-driven selling.
