Redfin: A Disruptive Growth Play In Real Estate (NASDAQ:RDFN)

The digital transformation revolution is offering enormous opportunities for growth across all kinds of areas. Technology is transforming industries such as communications, entertainment, enterprise management, and commerce, to name a few noteworthy examples among countless others. The real estate sector is now poised for disruption too, and Redfin (NASDAQ:RDFN) could benefit from exponential growth opportunities due to this trend in the years ahead.

A Disruptive Business Model

Redfin has a clear mission “to redefine real estate in the customer’s favor”. The company’s name is an anagram that encodes “Friend” and “Finder”. The company is well-known for charging a commission of 1.5% or even 1% if you sell and buy with Redfin as opposed to the standard 3% commission charged by most competitors.

Redfin uses technologies such as map search and virtual house showings to increase exposure, improve the quality of the customer experience, and to deliver efficiencies and cost savings. Digital signatures and online document management make the process faster and smoother too.

Source: Redfin

In addition to this, Redfin offers services like Redfin Concierge where the company fixes up the home in exchange for a 2.5% or 2% fee, and RedfinNow by which the company buys the home outright for a 7% fee. Redfin also has a small but growing presence in areas such as mortgage origination, title settlement, and advertising services.

Source: Redfin

Redfin’s innovation is not only about technology but also about the incentive structure in the real estate business. One of the major problems with the traditional real estate industry is that most real estate agents are typically independent contractors working solely on commissions. This can create the wrong incentives since the agent’s economic interests are not well aligned with those of the client.

Redfin agents, on the other hand, are company employees. These agents are paid a salary and earn bonuses so they are not tied to commissions alone. Redfin also offers healthcare benefits, paid time off, and parental leave.

The bonus paid to the agent depends not only on the price of the home but also on customer reviews. The main idea is that agents should work to provide the best possible service and to find the right home for clients as opposed to eagerly trying to close any kind of deal to make a commission.

Redfin is not the only company driving innovation in the real estate sector, names like Zillow (NASDAQ:Z) and Opendoor (NYSE:IPOB) are two examples that typically come to mind. However, it is important to note that there are some major differences in these companies and their business models. The three of them compete in the iBuying segment, and they can overlap in other areas, but there is plenty of room for multiple players to do well in this market over the long term.

Zillow competes with Redfin in iBuying, and it attracts a lot of traffic to its different websites, competing with Redfin for potential customer leads. But Redfin is a real estate broker and Zillow is mostly an advertising platform, and the two companies can be mutually beneficial to each other. Last year, for example, Redfin and Zillow reached an agreement regarding listing attribution and syndication.

Opendoor is focused on iBuying, and it has in fact partnered with Redfin in several markets. This partnership allows Redfin customers with qualifying homes in several markets to request an Opendoor offer as an alternative to selling their home on the open market. Redfin management has repeatedly said that it is planning to be cautious in its iBuying ambitions, and it seems like the company is more focused on leveraging its data and providing more choices for customers as opposed to trying to build a big business in this segment over the short term.

Redfin, Zillow, and Opendoor can be considered competitors to some degree, but it is not like they need to destroy each other to succeed. Lots of companies are doing well in areas like e-commerce, online entertainment, or enterprise management software, and the same thing will probably happen in innovative real estate businesses.

In comparison to Zillow and Opendoor, Redfin is the only one of these three companies that operates purely as a real estate broker, and it is leveraging on technology and a better incentive structure to disrupt traditional real estate brokers.

This approach is paying off, Redfin is the most recognized broker in the U.S., and it has the most visited website in the sector by a large margin. The company is delivering both strong sales growth and consistent market share gains over the past several years.

Source: Redfin

Source: Redfin

Strong Momentum And Promising Outlook

Like most other areas of the economy, the real estate industry is going through a truly unprecedented period. In spite of this unusually challenging context, Redfin delivered revenue numbers substantially above Wall Street expectations during the second quarter. Revenue came in at $214 million, an increase of 8.2% year over year and beating expectations by $27.13 million.

The company has a strong track record in this area; Redfin has delivered revenue numbers above Wall Street expectations in 11 of the past 12 quarters, which shows that management tends to be conservative regarding guidance and to consistently overdeliver.

Source: Seeking Alpha

The company’s market share declined 1 basis point from the second quarter of 2019. This was due to two main factors: First, Redfin has a relatively large presence in the western part of the U.S. that was more strictly shut down in March and April.

In addition to this, the company faced shortness of agents during the quarter because in early April, it decided to furlough nearly 40% of its field agent workforce until September 1.

The week before the company made that decision, customer inquiries were down 41% year over year. Fast forward to the end of June, and inquiries were then up 40% year over year, which shows how exceptional this whole period has been. In hindsight, the furlongs may look like a mistake, but it was a reasonable thing to do based on the information available at the time.

The point is that many of the client leads during the second quarter were managed by external partners while the company’s agents were too busy, and this produces smaller revenue and lower profits per transaction. Partners also generate fewer transactions overall, because customer success rates are higher with Redfin agents.

Management expects to be fully staffed against the current forecast of 2020 demand at some point in the fourth quarter, and it plans to keep hiring from that point based on future demand expectations.

Online traffic trends are clearly encouraging. Average monthly visitors increased by 31% in June and were increasing at a similar pace in July. This is well above the 26% increase in average monthly unique visitors that occurred between 2018 and 2019. The data indicates that demand is accelerating, and Redfin will be better positioned to meet this demand in the near term.

The real estate industry is entering a very particular period. New home construction has remained low after the 2008 crisis, so inventory has been declining. At the same time, millennials are having children and looking for bigger homes, and historically low mortgage rates are providing a huge tailwind for housing affordability. The pandemic is also putting the home once again at the center of our priorities.

Inventory levels are notoriously low nowadays, and prices are rising. This can be a powerful fuel for demand, which bodes well for Redfin, both in the brokerage business and also in the iBuying segment.

ChartData by YCharts
ChartData by YCharts

Reasonable Valuation

Redfin is a high growth business; as such, the company will continue investing for growth in the coming years, and profit margins will remain thin and volatile. That said, the stock doesn’t look overvalued at all based on revenue multiples.

The table below shows Wall Street revenue estimates and the implied price-to-sales ratio for Redfin in the years ahead. A forward price-to-sales ratio around 4.85 for 2021 and 3.76 doesn’t look too excessive for a company that can generate revenue growth rates around 30% in those years.

Fiscal Period Ending Revenue Estimate YoY Growth FWD Price/Sales
Dec 2020 835.12M 7.09% 6.39
Dec 2021 1.10B 31.94% 4.85
Dec 2022 1.42B 28.86% 3.76
Dec 2023 1.81B 27.21% 2.96
Dec 2024 2.19B 21.02% 2.44
Dec 2025 2.58B 17.91% 2.07
Dec 2026 3.47B 34.74% 1.54

Source: Seeking Alpha

Redfin has a market share of less than 1% in a highly fragmented industry, which provides enormous room for growth since we are talking about a company with a disruptive business model and a proven ability to gain market share over time. The company’s track record shows that it tends to outperform Wall Street growth expectations, and it wouldn’t surprise me at all if Redfin continues delivering above expectations in the future.

Risk And Reward Going Forward

Redfin is a risky proposition, no doubt about that. Real estate is a very cyclical industry, and there are plenty of uncertainty drivers on the macroeconomic side nowadays.

From a fundamental perspective, the risk of a race to the bottom in real estate brokerage commission is particularly noteworthy. Many traditional brokers will continue adopting technology and competing in price, and there is always a risk that the competition could get to unreasonable levels.

The iBuying business is particularly risky, and it can lead to big losses when mistakes are made. Redfin is also facing competition from larger players in this market. Management is being cautious in this area, and Redfin has access to enormous amounts of data to make better decisions over time. But still, the risk in this business cannot be overlooked.

Those risk factors being acknowledged, the real estate industry desperately needs to provide better customer experience, and the sector is offering plenty of room for innovation for a company such as Redfin.

Redfin is in the right place at the right time, and the company is executing well in a challenging period. As long as management stays on the top of its game, the stock should be able to deliver attractive returns over the years ahead.

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Disclosure: I am/we are long RDFN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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