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Since the start of the pandemic, the biggest challenge that the residential real estate industry faced had been a lack of inventory.\u00a0 The number of listings in many markets were at historic lows, and it wasn\u2019t uncommon for listings to get bombarded with multiple offers almost as soon as they hit the market.\u00a0 This lack of inventory, coupled with record low interest rates and out-of-control inflation, continued to drive up pricing.\u00a0 Since only one buyer \u201cwins\u201d any bidding war, dozens of people left each negotiation feeling slighted.\u00a0 With homes selling at record prices within a matter of days, and with so many potential buyers continuing to lose bidding wars, real estate professionals were screaming from the rooftops, \u201cLIST YOUR HOME NOW\u201d.\u00a0 They knew that these unprecedented market dynamics created a seller\u2019s market unlike anything they had ever seen.\u00a0 The veteran brokers were all too familiar with the cyclical nature of the business and they were well aware of the fact that these conditions would not last forever.\u00a0 Even though inventory was so low, the increased prices along with the speed of each transaction, resulted in many brokerages having their best year ever in 2021.\u00a0 Within the past few months, headlines were published with bullish news of record breaking years in the brokerage industry including:<\/p>\n
A record year for real estate brokerage firms<\/a> (June 2022)<\/span><\/p>\n RealTrends 500: Top four brokerage captured historic rise in market share<\/a> (March 2022)<\/span><\/p>\n Sotheby’s International Realty Achieves Historic Year with Record $204 Billion in Global Sales Volume<\/a> (Feb 2022)<\/span><\/p>\n eXp World Holdings Reports Record First Quarter 2022 Revenue of $1.0 Billion<\/a> (May 2022)<\/span><\/p>\n Residential Real Estate Agents Have Record-Setting Year<\/a> (March 2022)<\/span><\/p>\n 2021: A Record-Breaking Year for Real Estate Transactions<\/a> (May 2022)<\/span><\/p>\n It wasn\u2019t just the existing brokerages that were growing rapidly.\u00a0 There was also a significant amount of venture capital that was being deployed to startup brokerages with unique models including iBuyers, Power Brokers, Discount Brokerages, Auction Platforms, and Virtual Brokerages.\u00a0 In addition to funding going to brokerages, venture capital flooded into startups aiming to modernize the entire residential real estate ecosystem.\u00a0 From cloud based mortgage originators, to high-tech title companies, to software enabled appraisal firms, and tech powered inspection companies, billions of dollars were invested in an attempt to remove all of the friction that exists in the home buying\/selling process.\u00a0 Since capital was so cheap, and the industry was in such need of modernization, hundreds of startups received billions of dollars in investments, all promising to streamline the process of buying\/selling\/renting.\u00a0 And during this period, investors were only concerned with one metric: Growth.\u00a0 There was very little focus on profitability, because as long as a company could continue to scale revenue quickly, there were always going to be people ready to cut more checks.<\/p>\n Recently, the residential real estate industry has come to a grinding halt.\u00a0 <\/span>Gary Keller<\/a>, Co-Founder and Chairman of <\/span>Keller Williams<\/a>, recently said that the current market \u201c<\/span>is the most confusing I have ever seen<\/a>\u201d.\u00a0 <\/span>Spencer Rascoff<\/a>, Co-Founder of <\/span>Zillow<\/a> and <\/span>Pacaso<\/a>, said \u201c<\/span>Housing demand has fallen off a cliff<\/a>\u201d.\u00a0 There are several reasons for this abrupt stop to the gravy train.\u00a0 First, mortgage rates have increased significantly due to the Federal Reserve\u2019s aggressive steps to curb an inflation number that hadn\u2019t been seen in decades.\u00a0 As interest rates increase, it increases the cost of capital which decreases the affordability of buying homes.\u00a0 The traditional school of thought is that when interest rates increase, the price of homes decrease.\u00a0 But that is not what happened this time around.\u00a0 Since inflation is still out of control, the price that homes are listed for has either stayed flat, or in some cases continued to increase.\u00a0 The combination of low inventory, increased mortgage rates, sky-high pricing, and fear of a looming recession has created a perfect storm that has begun to decimate the residential real estate industry.\u00a0 While this dynamic clearly has a negative effect on buyers and sellers, I wanted to focus this article on the residential real estate industry.<\/span><\/p>\n A wave of layoffs and bankruptcies started rippling through the industry.\u00a0 Companies like <\/span>REX<\/a> ($145M raised) and <\/span>Reali<\/a> ($290M raised) suspended business operations and let go of almost all of their staff.\u00a0 Mortgage companies <\/span>terminated thousands of employees<\/a> including <\/span>JP Morgan Chase<\/a> (1,000+ layoffs), <\/span>LoanDepot<\/a> (4,800 layoffs), <\/span>Blend <\/a>(200 layoffs), and <\/span>Better<\/a> (3,000 layoffs).\u00a0 Anecdotally speaking, I have multiple contacts that had been offered roles in the real estate industry, only to have the offers rescinded due to market conditions.<\/span><\/p>\n There is no doubt that the real estate industry was in need of modernization.\u00a0 Anyone who has bought or sold a home can attest to the level of frustration that comes with the process.\u00a0 My family purchased a home 10 years ago, and it was one of the most anxiety inducing events of my life.\u00a0 I looked at the modernization of the industry as welcomed news, and many companies in the ecosystem started to make significant progress in the goal of streamlining the processes.\u00a0 Many even dreamed of the day where you could <\/span>buy a home with a single click<\/a>.\u00a0 But like most advancements in tech, the unit economics were not pretty for many of these startups, and the main reason why many of these companies were able to build such positive momentum was because they were subsidizing their growth with billions of dollars of venture capital.\u00a0 Their goal was to improve unit economics as their companies added scale, and eventually become cash flow positive and self-sufficient resulting in an IPO, Acquisition, or other liquidity event. \u00a0 Unfortunately, many of these startups are still losing millions of dollars a month, and there isn\u2019t a clear path to profitability.<\/span><\/p>\n The problem of profitability had been well known and well documented for years, but it rarely became an issue because fresh capital was always just around the corner.\u00a0 For some of these companies, they even found a way to go public during the past few years through a process which allows for much less transparency then a traditional IPO called Special Purpose Acquisition Companies (SPAC).\u00a0 Almost every PropTech company that went public through a SPAC over the past few years are now trading at pennies on the dollar, and as a result of their poor performance, these types of deals have fallen out of favor and have all but disappeared.\u00a0 With traditional IPOs being out of reach for companies burning cash, the SPAC market disappearing, and VCs no longer interested in putting good money after bad, the options for many of these unprofitable startups are getting more limited by the day.\u00a0 Although I hope that I am wrong, I believe that there will be a big wave of bankruptcies over the coming months.\u00a0 I also believe that we will see consolidation at a pace like we have never seen before.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/p>\n No single company made a larger impact in the residential real estate industry than <\/span>Compass<\/a>.\u00a0 Horrendous financial news was <\/span>reported by Compass a few weeks back<\/a> when they announced their Q2 2022 financials.\u00a0 Anyone who reads my blog will know that this came as no surprise to me.\u00a0 Since I have covered this company extensively over the past few years, I\u2019m not going to get into detail on my thoughts about Compass in this article, but you can refer back to my prior articles from <\/span>May 2021<\/a> and <\/span>May 2022<\/a>.\u00a0 After they released their quarterly financials, Compass announced more cuts to their headcount, including laying off their well <\/span>respected CTO – Joseph Sirosh<\/a>, along with halting the financial incentives for new recruits which had been used in the past to fuel their record breaking growth.\u00a0 Although I have questioned the financial stability of Compass for years, I have always been a huge fan of the company and it is hard to not be impressed with their accomplishments (in less than 10 years, they became the largest residential brokerage in America).\u00a0 However, their challenges are only going to increase during this unprecedented slow down in the market.\u00a0 Recruiting is the lifeblood of a brokerage, and it is highly unlikely that they will be able to recruit at the same pace that they had been, since they are removing financial incentives coupled with the bad press that they are receiving.\u00a0 There are going to be some dark days ahead for them.<\/span><\/p>\n Realogy<\/a> (now called Anywhere) owns and\/or operates <\/span>Century 21<\/a>, <\/span>Coldwell Banker<\/a>, <\/span>ERA<\/a>, <\/span>Sotheby\u2019s<\/a>, <\/span>Better Homes and Gardens<\/a>, and <\/span>Corcoran<\/a>.\u00a0 Last week they announced a fresh series of layoffs.\u00a0 Their stock is trading at $9.06 down from a 52 week high of $21.03.\u00a0 Other industry leaders, including <\/span>Re\/Max<\/a>, <\/span>Keller Williams<\/a>, and <\/span>eXp<\/a> are also trading at or near their 52 week lows.\u00a0 For an industry coming off of its best year on record, it is hard to fathom the level of despair that we are seeing just a few short months later.<\/span><\/p>\n PropTech investments in the residential brokerage ecosystem have exploded in popularity over the past few years.\u00a0 There are many ancillary businesses that support the sale or purchase of a home including companies that provide the following services:\u00a0 Mortgage, Title, Inspections, Insurance, Notaries, Payment Processing, and Advertising.\u00a0 The funding that these startups received over the past few years has led to significant strides in modernizing the industry, but a lot of work remains.\u00a0 Disrupting an industry, especially one as large as real estate, requires time and lots of capital.\u00a0 Since so many of these companies are still wildly unprofitable, and most need additional infusions of capital in order to survive, I fear that funding will dry up and many of these companies will be forced to pull back on investing into their innovative platforms in order to survive.\u00a0 This will most likely erase much of the great work that has been accomplished, and we will be left with legacy companies and business models that are still in such need of improvements.<\/p>\n To make matters worse, there are a slew of lawsuits in process that if successful, will completely change the way that brokerages charge clients for their services.\u00a0 These lawsuits have been covered in exceptional detail by <\/span>Inman<\/a> and <\/span>The Real Deal<\/a>, and I highly recommend reading both articles linked above.\u00a0 The residential brokerage industry in the US currently generates about $80B in Gross Commission Income (GCI) annually.\u00a0 While that seems like a huge TAM, there are approx. <\/span>105,000 brokerage firms<\/a> and <\/span>1,500,000 Realtors<\/a> vying for their piece of the pie. \u00a0 \u00a0 Additionally, all advertising dollars, referral fees, and other services that agents utilize to grow their personal brand, market listings, and fund their business comes out of the same pot of money.\u00a0 The timing of this litigation could not be worse for the industry, and there are <\/span>potential outcomes that can result in up to a 50% drop in GCI<\/a>.<\/span><\/p>\n Even with all of the headwinds facing the industry, there are plenty of opportunities for companies to be successful.\u00a0 The great news about the real estate industry is that people will always need a place to live.\u00a0 Even in a worst case scenario of high interest rates, reduced sales, and a reduction in what brokerages can charge, the industry will always generate billions of dollars of revenue annually.\u00a0 The key to success will be in building a model with a cost structure that allows it to scale without the need of endless cash infusions.\u00a0 It is often in times of despair when revolutionary entrepreneurs turn challenges into opportunities, which can result in the next generation of Googles, Amazons, and Netflix being founded.\u00a0 I remain bullish on the future of the industry, but something needs to change and we need to look into the future with a completely different mindset.<\/p>\n