Redfin, the residential real estate powerhouse, filed their IPO just last week. Founded in 2004, the company has taken it's time to reach prominence. Still, the business is fascinating. In 2016, Redfin completed roughly 35,000 real estate transactions for an aggregate home value of $16 billion. That's over 0.50% of the US residential real estate market! Given how much else is going on in online real estate right now, Redfin's IPO filing presents a timely opportunity to examine the sector.
Redfin is a broker and primarily makes money by charging a commission when sellers list their property and when buyers purchase a home through one of Redfin's agents. On average, the company makes just over $7,000 per real estate transaction. Per the below chart, growth has been solid.
The company has grown by about 40-50% annually and in 2016 did $267M revenue with a $23M operating loss. The business has yet to turn a profit and future profitability levels remain uncertain. Also worth noting is just how seasonal Redfin's business is. Per the below chart, Redfin's revenue spikes in the middle of the year and drops dramatically in Q4 and Q1. Gross margins on an annual basis are modest at 30%, but during slower quarters gross margin can drop as low as 8-10% since Redfin must still foot the cost of maintaining a large real estate broker network.
Despite being such an operationally intense business, the company has been doing what they can to improve operating efficiencies. Operating margin has improved from -20% in 2014 to -9% in 2016.
Valuation Outlook and Comparison to Zillow
The comparison between Zillow and Redfin is an interesting one. The below user funnel helps visualize where each company plays. Zillow is a media company that aims to attract a wide audience in order to sell high margin ad products to real estate agents. Zillow operates at the top of the funnel and thus has a smaller TAM than Redfin (not the entire home market, just the ad budgets of agents). Redfin operates at the bottom of the funnel, the transaction level, and thus addresses the entire residential real estate market which is a magnitude of order larger than Zillow's TAM. However, this increased market size comes at the cost of increased complexity. Redfin is a broker that manages a network of agents which is operationally intense and very costly.
Zillow has experienced tremendous growth over the past few years (see below). The business will cross $1 billion in revenue this year, and as the company reaches maturity, EBITDA levels are forecasted to approach 30%. It is yet unclear whether Redfin can achieve similar results in the long run.
Zillow and Redfin aside, there is a lot going on in online real estate right now. Startups like Opendoor are trying to leverage technology to become market makers in the space, effectively buying homes from sellers instantly and then turning around and selling those homes to new buyers (Redfin is actually testing out a similar service called Redfin Now). Other startups are trying to remove the concept of an agent altogether by building tools to help sellers and buyers transact with one another directly.
Redfin's opportunity is to continue vertically integrating and leveraging technology in order to sell more services to home buyers and sellers. The company is already offering a title and settlement service as well as a mortgage origination product. In the future, it is foreseeable that most services associated with a real estate transaction can be offered by a company like Redfin.
Time will tell whether Redfin will reach Zillow's valuation or higher. In the short-term, expect their IPO to trade at a small fraction of Zillow's current market cap.