Can Redfin make a comeback

How their new business model can lead to success once the housing market recovers

Buying or selling a home represents one of life's most significant financial decisions, with home purchases typically being the largest transaction most people ever make. This leads many to seek professional guidance through real estate brokers, despite their substantial fees - traditionally 6% of the home's value. While sellers technically pay this commission, the cost ultimately affects the entire transaction and often goes underappreciated by buyers.

Real estate agents operate as independent contractors within brokerage firms. These firms provide essential resources like transaction teams, Multiple Listing Service (MLS) access, and various software tools but take approximately 20% of each agent's commission. Agents receive no base salary, earning income solely from successful transactions. The standard 6% commission is typically split between buying and selling agents, with each brokerage taking their cut from their respective agent's share. Some brokerages offer reduced splits after agents reach certain sales thresholds, though agents may still need to pay desk fees.

Two major forces are reshaping the real estate industry. Firstly, home browsing sites like Zillow and Redfin reduce the need for buyer agents to scope out properties that their clients may be interested in. Second, a recent court ruling against the National Association of Realtors (NAR) has significantly impacted industry practices. The ruling found that NAR's policy of requiring buyer agent commissions for MLS listings was anti-competitive, likely reshaping how commissions are structured and negotiated. This will lead to increased discrimination by sellers in favor of buyers who don’t have a buyer’s agent or have an agent who takes a lower commission. This benefits Redfin which is a low-cost provider and even sometimes gives buyers a chunk of the commission that they earn on transactions.

This combination of technological innovation and regulatory change suggests a shifting landscape in real estate brokerage, with potential benefits for consumers through reduced costs and increased transparency. The traditional model of high commissions and split fees between brokerages and agents is being challenged, opening the door for new approaches to real estate transactions that better serve both buyers and sellers.

Redfin manages to improve upon the old brokerage business model in a few ways. They use their listing website to bring in both buyers and sellers as brokerage clients. This is different from Zillow and Homes.com which focus on selling leads to sellers agents. This means that Redfin agents have to spend hardly any time on procuring clients which can be an annoying part of the job. This agent said

Redfin agents in my market make up some of the highest volume transactions per year. Think 50-100 range per agent. It’s a fully built out system where the agent just has to go out and handle the transaction, ie coordination/marketing are all handled. Now the splits are significantly lower than a traditional brokerage, but you have zero marketing costs and full benefits, +401k. I’m not a Redfin agent. This new model is interesting though. I would consider sacrificing 15%-20% of my commission for benefits and no marketing costs

The splits that agents earn are based on their experience. In addition to providing these benefits to their agents, they also benefit customers by charging a lower commission than the other industry players. They are also more transparent in their fees which makes customers feel more in control and less like they are being hustled.

Used Redfin to buy. Thought the same thing, that it was too good to be true. It is true. We had a great experience.

To me, those who use traditional Realtors are like those who still prefer to use a travel agent. It's a comfort thing. "You get what you pay for" is BS, you pay for the realtor to look for homes for you, when instead you can use any platform (Zillow, Redfin, etc) to find your own home.

The other distinct aspect of Redfin's strategy is that it handles title search, settlement, and financing internally. 98% of their buy-side transactions go through their Bay Equity financing arm and 54% of title searches went through their title arm title forward.

It is worth noting that the current agent compensation model that Redfin added is a recent development. Before this, they paid agents salaries and gave them a lower commission but this strategy was not great since in a bear market everyone wants a guaranteed salary but in a bull market, they would be likely to leave for a place offering a more attractive split. Under the old model due to the lower commissions, Redfin had other support employees on staff to handle showings when the lead agents were too busy but now they are saying that the new model will reduce the need for this. Hopefully, the changes to the commission structure will lead to better retention of talented agents and higher margins. It is kind of curious that being a startup in an industry that was ahead of its time in adopting a gig economy approach Redfin tried to make being an agent a more traditional job. It does make me question the competence of management.

Causes of trouble

Since its 2017 IPO, Redfin has seen its share price drop by 66%. The reason for this decline is twofold. Firstly, home sales have been completely in the garbage since the start of 2022.

Apart from that, there have been several strategic missteps from management The old commission model made the company unprofitable even during the 2020-21 boom.

Another concerning trend in the company is the slight decline in transaction market share. Redfin has attributed this to CoStar-owned homes.com's aggressive advertising to gain traffic. In the last earnings call, the CEO mentioned that homes.com was engaging in “unprecedented spending,” which is expected to decrease in 2025. Additionally, Redfin will be able to invest more in marketing next year as their title and finance expansions have increased LTVs, and they will incur fewer costs due to the transition to their new model. Although Redfin’s model is unique, they still have to compete with other sites like Zillow, homes.com, and realtor.com to drive traffic. I do not view the traffic decline as a significant issue if the ad spend ROI was not there. CoStar, being a much larger company with a $30 billion market cap, could be experimenting with different marketing spending approaches.

Overall management has made some poor decisions but it seems like the current strategy is really solid and will be able to generate strong returns once the housing market picks back up.

Valuation

The business has three main assets: the real estate portal, brokerage infrastructure, and relationships with past clients and brokers. Comparing the real estate portal side of the business to the closest competitor Zillow. For the year ended 2023, Zillow had 233M average monthly visitors while Redfin had around 49.4M. Despite Zillow just having 4.7x the traffic it is trading at 12.3x the valuation¹. Traffic of course is not all created equal. Many people frequent these sites because they are curious about what a property near them or owned by someone they know is worth or looks like inside. Therefore paying for traffic when buying intent is low could be money wasted. There aren’t any switching costs. Would it be smart for Redfin to pay for marketing to drive traffic now? Probably not.

Another valuation metric worth a look is the EV/GP ratio, Costar sits at 12.3x, Zillow at 10.5, and Redfin at just 3.76x. Costar is the most mature company of the three and is profitable on a GAAP basis while Redfin and Zillow aren’t profitable even on an adj ebitda - SBC basis. In terms of operating expenses, Redfin could have some fat that it is possible to cut, particularly in G&A since they are at $181M while Costar is at $322.8M despite being much larger. In the last earnings call the CEO basically said they would do more job cuts in the most direct way he could without having headlines come out about it.

Redfin also has a rental business and sells leads to agents, primarily in smaller markets where they have yet to build out agents. They also provide title services to outside customers and sell some data like neighborhood scores to other businesses and sell ad space on their sites.

It is difficult to model out the cashflows of the company since they depend so heavily on macro. Recently the stock has fallen a bunch since mortgage rate relief has come sooner than expected. Nevertheless based on the gross profit and traffic numbers Redfin seems substantially undervalued relative to both Costar and Zillow. Zillow’s execution in particular has also been far from stellar so it seems odd that it trades at a much more premium valuation. Perhaps the market is willing to pay more since it is the dominant player. Based on competitive factors and the new business model though it seems plausible that when the market picks up Redfin will be able to acquire customers at attractive costs and perhaps can also grow using word of mouth. Like the customer testimony I included above mentioned, the online approach seems to resonate heavily with younger buyers. For these reasons, the stock is a modestly sized position of mine, and the bull case for the stock

Appendix A Board Members

Austin Ligon Age: 73 Board Tenure: Since September 2010 (13.5 years) Experience: Co-founder and former CEO of CarMax, venture investor since 2006

David Lissy (Chairman) Age: 58 Board Tenure: Since February 2018 (6 years) Experience: Chairman of Bright Horizons Family Solutions (2020-present), Executive Chairman (2018-2019), CEO (2002-2018)

James Slavet Age: 54 Board Tenure: Since November 2009 (14.5 years) Experience: Partner at Greylock Partners since 2006, former VP/GM at Yahoo!, COO/Founder at Guru

Robert Bass Age: 74 Board Tenure: Since October 2016 (7.5 years) Experience: Partner at Deloitte & Touche (1982-2012), Vice Chairman (2006-2012), Currently on boards of Groupon, Bowlero, BlackStone Secured Lending Fund

Julie Bornstein Age: 54 Board Tenure: Since October 2016 (7.5 years) Experience: Co-founder and CEO of private tech startup (2023-present), former SVP at Pinterest, CEO of The Yes Platform

Kerry D. Chandler Age: 60 Board Tenure: Since August 2020 (3.5 years) Experience: Former CHRO at Bombas, Endeavor, and Under Armour

Glenn Kelman Age: 53 Board Tenure: Since March 2006 (18 years) Experience: CEO of Redfin (2005-present), former VP at Plumtree Software

Brad Singer Age: 57 Board Tenure: Since March 2022 (2 years) Experience: Former COO at ValueAct Capital, CFO at Discovery Communications and American Tower

Selina Tobaccowala Age: 47 Board Tenure: Since January 2014 (10 years) Experience: Co-founder/CEO of HomeBoost, former Chief Digital Officer at Openfit, CEO/Co-founder of Gixo

Appendix B Exec Comp

1. BASE SALARIES

• Glenn Kelman (CEO): $300,000 Declining any additional compensation until profitability

• Chris Nielsen (CFO): $500,000

• Bridget Frey (CTO): $450,000

• Anna Stevens (CHRO): $425,000

• Anthony Kappus (Chief Legal Officer): $400,000

2. TARGET ANNUAL BONUS OPPORTUNITIES

• Chris Nielsen: $375,000 (75% of base salary)

• Bridget Frey: $270,000 (60% of base salary)

• Anna Stevens: $255,000 (60% of base salary)

• Anthony Kappus: $240,000 (60% of base salary)

• Glenn Kelman: No bonus target (at his request)

3. LONG-TERM EQUITY COMPENSATION 2023 GRANTS Target Values:

• Chris Nielsen: $1,600,000 ($600,000 RSUs + $1,000,000 PSUs)

• Bridget Frey: $1,600,000 ($600,000 RSUs + $1,000,000 PSUs)

• Anna Stevens: $800,000 ($300,000 RSUs + $500,000 PSUs)

• Anthony Kappus: $1,280,000 ($480,000 RSUs + $800,000 PSUs)

• Glenn Kelman: No equity grants (at his request)

4. PERFORMANCE METRICS FOR 2023

Annual Bonus Plan Metrics:

• Consolidated Revenue (30% weight)

  • Threshold: $1,157,377M

  • Target: $1,257,377M

  • Maximum: $1,307,377M

• Adjusted EBITDA (60% weight)

  • Threshold: ($37,206M)

  • Target: $2,794M

  • Maximum: $22,794M

• DEI Goals (10% weight)

  • Qualitative assessment of diversity initiatives and outcomes

PSU Performance Metrics:

• Net Income Tranche (11.11% per year)

  • Threshold: ($177M)

  • Target: ($137M)

  • Maximum: ($117M)

  • Actual 2023: ($131M) - achieved 113% payout

• Market Share Tranche (11.11% per year)

  • Threshold: 0.78%

  • Target: 0.82%

  • Maximum: 0.84%

  • Actual 2023: 0.76% - achieved 0% payout

• Three-Year Relative TSR (33.33%)

  • Threshold: 25th percentile

  • Target: 50th percentile

  • Maximum: 80th percentile

  • Measured against S&P MidCap 400 Index

5. VESTING SCHEDULES

• RSUs: Vest quarterly over two years

• PSUs: Performance period ends December 31, 2025, with vesting in early 2026

• No PSU vesting until completion of full three-year performance period

6. 2023 ACTUAL BONUS PAYOUTS Due to performance against targets:

• Financial Goals: 0% achievement

• DEI Goals: 100% achievement Resulting in final payouts of:

• Chris Nielsen: $37,500

• Bridget Frey: $27,000

• Anna Stevens: $25,500

• Anthony Kappus: $26,400

1. Market cap + FV of convertibles