These two companies are disrupting the traditional real estate market and both have more than doubled from their March lows. But are they a buy?
These companies’ share prices fell dramatically when COVID-19 emerged due to the perceived impact it would have on real estate. However, they have been less impacted than many investors anticipated, but are they worthy of investment?
Zillow Group, Inc. (NASDAQ: Z) (NASDAQ: ZG) is the largest real estate and rental website in the U.S, with its mobile apps alone driving 2.1 billion visits in the latest quarter.
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The bull case for Zillow
In 2018, Zillow shifted its business model dramatically, introducing a new segment called “Zillow Offers” which focuses on buying and selling homes directly. This bold move has helped to drive growth with this segment accounting for an ever-increasing portion of revenue and 2,394 homes sold in Q1. This appears to be the future of Zillow’s business, creating a seamless way to buy and sell, also leaving an opportunity to expand other services such as home loans, renovation, and moving services.
Co-founder and CEO Rich Barton has an 87% approval rate on Glassdoor, which is an encouraging sign for investors. Barton has a track history of starting successful companies, founding Expedia (NASDAQ: EXPE) within Microsoft (NASDAQ: MSFT) and later Glassdoor. Barton returned as CEO of Zillow in 2019 during turbulent times for the company and has helped lead the company through its transformation.
If you need any indication as to how popular Zillow is right now, in the past 12 months, the term ‘Zillow’ has been searched more on Google (NASDAQ: GOOG) than ‘real estate’ in the U.S.
The bear case for Zillow
Zillow has stated that it expects to see transaction volume fall by 50% in Q2 before picking up towards Q3 of 2020 and recovering to pre-pandemic levels by 2021. It is also expecting a drop in home prices of about 2-3%. These headwinds are noteworthy but they should not affect the long term outlook for the company.
Zillow performed well in Q1 despite a global downturn with total consolidated revenue increasing by 148% year-over-year to $1.1 billion. Zillow reduced the number of homes by 1,800 from a year previously in the last quarter to minimize risk. It ended the quarter with $2.6 billion in cash and investments on the balance sheet — its largest ever. The strong balance sheet will allow Zillow to navigate the current crisis and short term headwinds.
Redfin (NASDAQ: RDFN) is a “technology-powered” residential real estate company founded in 2004 that went public in 2017 and is roughly a third of the size of Zillow.
The bull case for Redfin
Perhaps the most notable difference between the companies is that Redfin has salaried agents rather than third party agents. Redfin, therefore, takes the entirety of the 1% commission it charges rather than the average of roughly 3% to gain market share. This means there is a high fixed cost for the company, but this structure could prove to be very profitable over time.
Redfin has other offerings such as lending and title services, which grew 39% in Q1. Taking, for example, the services Redfin offers in insurance and mortgage lending, complement their core offering and are very profitable. By offering these in-house and using technology, it can speed up the process of buying and remove the hassle. ‘RedfinNow’ is another segment that contributed strong growth with $79 million in revenue in Q1of 2020 up from $21 million a year previously.
CEO Glenn Kelman has a 73% approval rating on Glassdoor. Kelman has also stated that he has sold companies before and that with Redfin, he is not willing to make the same mistake, which is promising for investors in it for the long haul.
The bear case for Redfin
Redfin has been growing rapidly, and ‘RefinNow’ has been particularly successful. However, this also poses a risk regarding the balance sheet if they are left with inventory they can’t sell. Although Zillow does not provide a complete offering, it is the dominant player in the space and is a threat to Redfin.
Redfin’s revenue increased by 73% year-over-year to $191 million. To weather the current crisis, Redfin put on hold new offers on homes and laid off 10% of staff to help strengthen the balance sheet. It also sold more stock, which leaves the company with $426 million in cash and Government securities on the balance sheet. Gross profit also increased by 368%. Although COVID-19 has been a significant headwind, Kelman believes that “Real estate commerce has probably virtualized itself more in the past two months than it had in the prior 20 years,”
Both of these companies appear worthy of investment with excellent management teams and a vast market opportunity. They are both disruptors and I believe it is not a winner takes all scenario. Redfin is riskier due to the company’s size, but there is perhaps more upside than Zillow.
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