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Redfin house
(Redfin Photo)

Is Redfin a real estate brokerage or a tech company?

That’s the key question as the Seattle company — originally founded in 2002 under the name Appliance Computing Inc. — looks to raise up to $100 million on the NASDAQ stock exchange through an initial public offering.

It’s not an easy question to answer, and it’s one that Wall Street will certainly be asking as Redfin CEO Glenn Kelman and his executive team hit the road in coming days to sell investors on the prospects for the 15-year-old company.

Glenn Kelman
Redfin CEO Glenn Kelman. (Redfin Photo)

Redfin’s own description of itself —a self-described “technology-powered residential real estate brokerage” — points to the conundrum facing what would be the first company to go public from Washington state this year.

On one hand, Redfin uses technology everyday to make the real estate process easier, investing heavily in its mobile app, machine learning and other proprietary technology services. On the other, its fortunes are still very much tied to the people-powered business of helping Americans buy and sell homes.

For Redfin, the technology side of its business has a specific allure, especially as it enters the public markets. It very much wants to be perceived — amongst investors at least — as the next Zillow (market value $8.1 billion) rather than the next ZipRealty, the doomed real estate brokerage which sold to Realogy for just $166 million in 2014.

There’s a lot of money at stake on what, in many ways, boils down to semantics.

“The implications on valuation are dire,” notes Nat Burgess, founder of Seattle tech advisory company TechStrat. He points to real estate brokerage holding company Realogy, whose market value of $4.5 billion is actually less than its annual revenue of $5.81 billion. Seattle-based Zillow, with a market value of $8.1 billion, is trading at nine times revenue by comparison. Put another way, if Redfin were to be valued as a traditional real estate brokerage like Realogy when it completes its IPO, it would have to sell 50 percent of the company to the public.

Burgess said that’s clearly not “Goldman Sachs’ plan,” the underwriter that’s helping take Redfin public.

Goldman Sachs, along with the company’s venture capital backers, very clearly want Redfin to be viewed as a technology company.

There’s absolutely no question about that, says Robert Hahn, a management consultant at 7DS Associates who writes regularly about real estate and technology.

“If Redfin is a brokerage, making $256 million in revenues and losing tens of millions every year … it’s worth zip. Zilch. Zero. Nada,” writes Hahn. “If Redfin is a technology company that happens to make money from commissions … it’s worth $3 billion or so (or more!)”

Goldman Sachs would never take Redfin public as a real estate brokerage, he adds.

Ironically, that means Redfin will be drawing strong comparisons on its IPO road show to Zillow, its longtime Seattle-area nemesis. The more that Wall Street looks at Redfin as the next Zillow, the better.

“Investors looking for comps need only look to Zillow, which is trading at a 48 percent premium to its 52 week low,” notes Burgess.  “Zillow’s success will, ironically, fuel the ascent of its number one competitor.”

Even though there are vast differences between Redfin and Zillow — the most clear of which is that Zillow does not employ any real estate agents — it will be incumbent upon Redfin’s Kelman to make the case on Wall Street that it shares more in common with its cross-town rival, Zillow, than with traditional brokerages like Windermere, Century21, Coldwell Banker or Re/Max.

Representatives for Redfin declined to comment for this story, citing rules that prevent companies from seeking press in advance of an IPO.

Burgess, for one, sees benefits in Redfin’s model. And he thinks Kelman and crew will successfully sway investors to the Redfin tech story.

“Long term, they can disrupt the traditional brokerage model and build a technology-enabled services company that generates profits,” said Burgess, adding that Redfin’s brokerage business will bring many advantages.

“Redfin will own the listing, own the customer and, potentially, the mortgage underwriting fees as well,” he said. “But Redfin is burning cash and will have to invest a lot more to get there.  In order to be successful long term, they will have to be valued as a tech company today.”

Sprinkled throughout Redfin’s IPO filing are statements about its technology prowess, noting the efficiencies it gains through the use of everything from mobile apps to machine learning to help people buy and sell homes more effectively.

“Because we’re one of the only major brokerages building virtually all of our own brokerage software, our gains in efficiency, speed, and quality are proprietary,” the company wrote in its IPO filing. “Because our leadership and engineering teams have come from the technology industry, and have structured the business to invest in software development, we believe those software-driven gains are likely to grow over time.”

Redfin spent a whopping $34.5 million on technology last year, one third of its overall operating expenses.

Under a section of the IPO filing entitled “How We Win,” Redfin also points to its next-generation technologies.

From stocks to books to lodging, technology has made it easier, faster, and less expensive to buy almost everything in our lives except the most important thing: our home. To solve this problem, Redfin uses a wide range of next-generation technologies. We invented map-based real estate search. We use machine learning and artificial intelligence to answer customers’ most important questions about where to live, how much a home is worth, and when to move. We draw on cloud computing to perform computationally intensive comparisons of homes at a scale that would otherwise be cost prohibitive. We use streaming technologies to quickly notify customers about a listing. And we embrace new hardware, such as three-dimensional scanning cameras that let potential homebuyers walk through the property online. The goal of all of these technologies is to empower our customers and increase our agents’ productivity. This leads to consistently better customer service at a lower cost. We pass the resulting savings to our customers.

Even with all of the language around machine learning and cloud computing, there’s no question that Redfin is a brokerage, with the bulk of its revenue coming through the labor-intensive process of helping people buy and sell homes. Last year, Redfin brokers and affiliated real estate agents helped people in the U.S. buy and sell more than 75,000 homes, representing $35.3 million of Redfin’s $41.6 million in revenue.

It employed 935 lead real estate agents at the end of March 2017.

Redfin’s business is growing, and the company gained market share in 81 of the 84 markets in which it operated. Even so, Redfin’s market share stands at just 0.58 percent nationwide. In its oldest markets, Redfin’s market share still hovers below two percent.

As the company notes in the IPO filing, “we’re just getting started.”

Given all of this, Redfin’s fortunes are closely tied to a hot housing market in the U.S., one which recovered from an epic bust about five years ago. And the company is doing quite well. In existing markets where Redfin has operated for at least nine years, its total revenue and gross profit margin on real estate operations has increased since 2014.

Redfin Real Estate Performance - 2006-2008 Markets: Seattle, San Francisco, Los Angeles, Boston, Washington, D.C., and Chicago
Redfin Real Estate Performance – 2006-2008 Markets: Seattle, San Francisco, Los Angeles, Boston, Washington, D.C., and Chicago. Charts via Tim Ellis of Seattle Bubble.

The same is true for markets that Redfin expanded into between 2009 and 2013. While the growing revenue is definitely due in part to Redfin’s success in growing its market share, the increased profit margins appears to be tied very closely to the overall growth in home prices. Here’s a look at their profit margins in those two market cohorts compared to the national level of the S&P Case-Shiller Home Price Index:

Redfin Real Estate Gross Margin and Case-Shiller Home Price Index
Redfin Real Estate Gross Margin and Case-Shiller Home Price Index. Charts via Tim Ellis of Seattle Bubble.

Even more interesting is the analysis by management consultant Hahn of 7DS Associates, which finds that Redfin is making about $350,000 per lead agent. That’s four times as much as Realogy’s NRT unit, which averaged $89,583 per agent. Citing those numbers and Redfin’s market-share gains, Hahn concluded that it “qualifies as a solid butt-kicking in my book.”

Long-time followers of Redfin have often drawn comparisons to Uber and Lyft — also people-powered businesses that have used technology in an attempt to transform age-old industries.

Neither of those heavily-funded companies have yet ventured into the public markets, but they will likely be closely watching to see how investors react to Redfin. Will the Redfin IPO usher in a new era of people-powered tech companies? Or will it just be viewed as another real estate brokerage?

Wall Street will have the answer to that question in the coming months, so stay tuned.

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