On June 12, I published a piece on realtor Redfin (NASDAQ:RDFN), suggesting a short. The stock closed the night before at $32.07. As I write this, the stock is at $43.65. That’s a gain of 36% in less than a month.

I’m clearly looking at Redfin a lot differently than many investors. What’s the other point of view? It might be a “moat” story, or what used to be called a “category killer” story. Maybe Redfin is in the process of building the kind of operating moat that has turned Amazon, Netflix, Apple and others into spectacular success stories in their respective industries. Maybe I missed something big in my first piece. I decided to dig deeper into this possibility.

I tried, but I couldn’t find the moat. Here is my research journey through Redfin’s documents and especially through what is really happening in the realtor industry. Lots of quotes to back my view. Take a look.

An economies of scale moat?

A very distinctive feature of the Redfin business model is low prices. It only charges about 2.0% to buy or sell a home on average, up to a 30% discount versus peers. It offsets part of the discount by paying its realtors a salary and bonus instead of the ubiquitous brokerage commission. Does this business model give Redfin an advantage? Here’s the data:

Source: Redfin financial statements

The data shows that:

  • Redfin is taking market share. Not at huge leaps and bounds, but steadily. But with the low prices, of course it will take some share.
  • Its realty gross margin has actually been declining. I include marketing expenses in Redfin’s direct costs. Marketing expenses have been growing faster than revenues.
  • Overhead expenses have been growing faster than revenues. The whole point of accepting lower gross margins is to leverage on overhead costs. So far then, Redfin has created dis-economies of scale.
  • As a result, dollar losses have steadily increased.

Clearly, then, an economies of scale moat has not evidenced itself to date. But maybe Redfin is building moats elsewhere that will pay off down the line. Let’s explore.

A service moat?

Redfin’s stated goal (2019 10-K) is to:

“Combine brokerage, mortgage, title services, and instant offers to directly purchase a consumer’s home into one solution, sharing information, coordinating deadlines, and streamlining processes so that a consumer’s move is easier and often less costly.”

Honestly, not a new idea. Since realtors first climbed out of the primordial ooze, stepped foot on land and turned a closet into a third bedroom, most work hard to coordinate the home sale process for their customers. The realtor business is all about service. Find a good broker who isn’t coordinating deadlines. Or who doesn’t have a stack of mortgage broker business cards. That is why Zillow claims that there are over 80,000 realtor companies. Having local knowledge about a community, including who is buying and selling homes, has value. As evidence, here are some examples from realtor websites:

“Coldwell Banker can confidently guide you through the process and arm you with the information you need to be a shrewd, well-informed buyer.” (Coldwell Banker)

“We are focused on providing you with the best results and service in the industry. We listen carefully to understand your real estate goals and work hard to create solutions that make sense for you. Whether you are new to the market or an experienced investor, we have the expertise, proven track record, and resources to help you achieve your real estate goals.” (Spadaro Real Estate, Mamaroneck, NY)

“As your local full service RE/MAX® team, we make it our top priority to make the process of buying and selling a home as simple and as stress-free as possible. No one knows the area better than our trusted real estate professionals who live and work in our local communities.” (William Molleck, Re/Max, Peoria, Illinois)

An information moat?

In Redfin’s last 10-K, it listed eight ways that it competes. #1 was “access to timely, accurate data about homes for sale”. Makes sense, and it is something that Redfin certainly offers. But so does pretty much any other realtor, because homes for sale are all posted on “multiple listing services”. Redfin explains this on its own website:

“The Multiple Listing Service, or MLS, is a local or regional service that compiles available real estate for sale submitted by member brokers and agents… Over half of the MLSs in the United States are affiliated with the National Association of REALTORS (NAR)… Some MLSs publish their own websites for consumers to access listing data directly from the MLS, but most share data by offering a data feed so that member brokerages (such as Redfin) can build their own websites. Since Redfin is a brokerage, our website and mobile apps are powered by the MLS, so you’ll get access to the same information as real estate agents…”

Another valued piece of information for prospective home buyers and sellers is home value estimates. Redfin has one. Awesome. But so does Zillow, which is the top site for home price estimates. But so does Realtor.com, RE/MAX, Chase Bank, ZipRealty and HomeLight, according to just the first page of a Bing search for “What’s my home worth?”. Again, the data to make the estimate is freely available, so all one needs to add is a home valuation algorithm, which apparently isn’t that hard to do.

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Again, no apparent moat here.

A technology moat?

Modern moats are generally tech-related. So, I reviewed Redfin’s first-quarter earnings conference call for special technology the company is applying. The best I could find was:

“We were the first to upgrade our website to promote Matterport 3-dimensional scans of homes on April 2. From February to April, new listings with these scans had increased fourfold. And we were the first to offer self-service tours to homes listed by our brokerage but owned by our customers on April 23. Being able to open the door of a vacant listing on your own with just an iPhone is crucial for buyers who are wary of being in a home with an agent or anyone else outside their family.”

Matterport is an independent company in the business of selling its scans to one and all. Get your own scan demo here. Any of Redfin’s 86,000 competitors can and will do the same. Second, a door opening app? Read this article from PC Magazine: The Best Smart Locks for 2020. Again, you have access to the same technology.

Sorry, no visible moat.

A technology investment moat?

Last year, Redfin spent $70 million on technology and development, a number that has been steadily increasing. Is this spending unusual in the realtor space? I collected a bunch of stories about real estate tech companies from industry trade mag HousingWire over a recent span of ten days. You tell me – is Redfin really that special?

“Real estate tech startup OJO Labs announced Tuesday the close of a $63 million funding round and the acquisition of Movoto, a residential real estate search site… Currently, OJO Lab’s AI bot answers questions for potential home buyers and sellers when they are in that “in between” phase… The company goes on to help connect people with agents and service professionals to take them to the next level. Berkowitz said Movoto’s ability to optimize search based on consumer behavior and engagement has enabled it ‘to compete with three massive, publicly traded companies while steadily gaining market share since 2018.’” (June 25)

“Wells Fargo led a $42 million investment round for Mynd Property Management… Mynd manages about 7,500 homes for real estate investors in 16 markets. The company charges mom-and-pop investors a fee to lease units – often remotely, via self-guided tours – and arrange for repairs when needed after diagnosing problems through a video call.” (June 25)

“Since stay-at-home orders and self-quarantines began in March, more businesses have moved to digital solutions and that’s been particularly true for parts of the real estate transaction. A survey from Qualia revealed that there was a nearly 40% surge in remote online notarization from April through May. (June 24)

“It’s Not Rocket Science: Two Lenders Share How Easy Digital Closing Implementation Can Be.” (June 23)

“HousingWire’s Mortgage Tech Virtual Demo Day is designed specifically to help mortgage industry decision makers identify the technology solutions they need to operate efficiently and securely. In a half-day format, technology companies will demo their platforms and answer questions.” (June 16)

Summing up: An even better sell

I return to my original thesis in my last post. I’ve presented evidence that Redfin has no obvious moat. Its market share growth is based on cutting real estate commissions to unprofitable levels. Yet, many investors want to believe differently.

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I reiterate my short recommendation.

Disclosure: I am/we are short 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.

Additional disclosure: I briefly mention that I own Farmer Mac (AGM)

Via SeekingAlpha.com