Read more of the extensive research and analysis I've done on the world of real estate tech.
Generally, people buy and sell houses the same today as they did 100 years ago. Aside from property portals like Rightmove, Realestate.com.au and Zillow, the industry hasn’t meaningfully shifted online. Real estate agents are front and center in the transaction, and the bulk of the process still occurs offline.
When I bought a house a few years ago in New Zealand, I used a real estate agent (I didn’t have a choice in the matter). The only way to negotiate with the sellers on price was to have the agent drive across town to my apartment with a contract, cross out the selling price with my counter-offer, and then have him drive to the sellers. This happened multiple times in a process designed to reinforce the central role of the agent. Did I mention it was 10 p.m.? Sound familiar?
The residential real estate industry is huge, and buying or selling a home is likely the biggest transaction people will make in their lifetime. So why does it feel so old? Why do we still transact properties the same way our grandparents did, with agents so dominant?
Real estate technology (also called PropTech in the U.K.) is an extremely active space with hundreds of companies around the world vying to change the industry. New models are launching on a regular basis, and investment in the space is growing.
Coming from an entrepreneurial and then corporate M&A background, I know what a successful business looks like. After founding my own gaming tech firm and selling it, I served as head of strategy at New Zealand’s leading classifieds and marketplace portal, Trade Me, for four years. I left that position in early 2016.
From these experiences, I know that a good real estate tech company is more than fancy technology; it’s about a great product-market fit powered by a business model that works. So I set out to find out which new models were getting traction, globally.
The market landscape
There’s a lot going on in the real estate tech space. For this article, I’ve focused on one specific segment: new models changing how people buy and sell houses. I’m not covering the various tech innovations occurring in commercial real estate, rentals, tools for agents or the myriad other areas changing real estate.
Let’s set the scene. The vast majority of houses are bought and sold using real estate agents. In the U.S. and Canada, about 90 percent of transactions involve an agent, with the remainder as private sales (for sale by owner aka FSBO). The percentage of transactions involving an agent is even higher in the U.K., Australia and New Zealand.
In this article, I look at three new real estate models gaining market traction: fixed-fee operators, for-sale-by-owner services and disruptive players.
I looked for strong product-market fit and business model viability. I’m looking for businesses and business models that can materially change the way people buy and sell houses in a sustainable way, while making money. In other words, a good business.
Fixed-fee operators
These businesses operate under a simple premise: they offer their services for a fixed fee, as opposed to a typical real estate agent’s commission. The average commissions charged by an agent vary from around 1.4 percent in the U.K., 2 percent in Australia, 2.8 percent in New Zealand to 5-6 percent in the U.S.. Fixed-fee operators will typically save homesellers thousands of dollars.
The business model is straightforward. For a simple fee (typically paid upfront), the firm will list a house for sale. Advertising for properties is almost entirely done online via the major property portals. They also typically provide a yard sign. Given that a greater percentage of homebuyers now find the home they purchase from the web than from any other source, according to the 2016 National Association of Realtors profile of homebuyers and sellers, it’s logical the majority of advertising dollars shift online.
These businesses aim to offer at least the same level of service as a traditional real estate agency, and in many cases exceed it by providing services like online dashboards and 24/7 support.
The chart below shows average customer savings by using fixed-fee models. All numbers are in local currencies, and the calculations are based on average home sale prices and agent commission rates, excluding any additional marketing costs.
Aside from Purplebricks in Australia (which is an interesting outlier), the fixed-fee operators usually have a price point that saves consumers between $2,200 and $3,000.
This model is getting the most traction in the U.K., where it accounts for approximately 6 percent of the market. A half-dozen major players compete in the U.K., the leader being Purplebricks (who expanded into Australia in August 2016). Purplebricks was not the first to market when it launched in 2014, but it’s taken off like a rocket; it went public in December of 2015 and now has a market capitalization of £1.25 billion.
Purplebricks employ “Local Property Experts” -- essentially contractors paid when they secure a listing. It’s a similar model to Uber in the sense that the holding company doesn’t employ any agents directly, but pays them for completing jobs.
The consumer pays a fee of £849 upfront, no matter if the property sells or not.
Purplebricks is the clear U.K. leader because of its marketing machine. It has raised a lot of money and spent almost all of it on marketing (to the tune of £1 million per month). One of its model’s biggest challenges is the uncertainty around the unit economics, and if, when and how it will turn from negative to positive. Right now attracting each customer costs Purplebricks more than the £849 fee it collects from them.
The other issue involves how the firm pays its Local Property Experts, Purplebricks contractors who secure listings. Currently, their compensation is based on getting a listing, not on selling a property. This incentivizes them to bring in more listings and more fees, which is good for Purplebrick’s growth story to investors, but marks a disconnect with home sellers (who, of course, simply want their homes sold).
Achieving scale is the key to this model’s success. Right now the firm spends money for market share, which makes sense given the stage of the business and the wider market in the U.K. Over time, customer acquisition costs should decrease, and Purplebricks will need to raise its fees to become profitable.
Conceptually, the idea of Local Property Experts operating as contractors looks good on paper (and investment presentations), but it results in a massive incentive misalignment and churn risk. All customer interaction is through an individual outside of the company’s direct control, who can effectively come and go as they please, with variable service levels. This might work with low-cost, high-frequency transactions like car rides, but for a home sale it presents its challenges.
The best operating models I’ve seen have fully employed their sales force, with all of the resultant benefits and costs. At the end of the day it’s a better customer experience and I’d back that business 10 times out of 10.
(By way of comparison on that last point, not all fixed-fee players around the globe use contractors. There is typically a mix between salaried and contractors for the initial customer consultation, after which the customer is serviced by full-time, salaried employees.)
For sale by owner services
The for sale by owner (or FSBO for short) proposition is simple: save on commissions by selling your home without an agent. These sellers take advantage of the ubiquitous nature of property portals in their markets to advertise their property, and are willing to do everything else (open homes, negotiation, project management, paperwork, etc.) themselves. It’s a non-trivial job, but some are up for the challenge.
FSBO rates vary across mature markets, but rarely account for more than 10 percent of homes sold in any year. Rates for the U.S., Canada and New Zealand hover between 8 and 10 percent, while the U.K. and Australia rates are in the low single-digits.
The leader in this field, and who I consider to be the most successful real estate company nobody has ever heard of, is the Canadian firm ComFree. Founded in 1997, it offers to sell homes for a fee of between $600 and $1,000 Canadian, paid up front. In 2016 it listed over 40,000 properties across Canada with a market share approaching 25 percent in the province of Québec!
Its proposition can best be summed up with, “Sell your own home with our help.” It doesn’t just offer a technology solution, but empowers customers with a proven sales roadmap, tools and expertise. For instance, for an extra fee (paid only if the home sells) home sellers can hire its experts to negotiate for them.
ForSaleByOwner.com is the largest FBSO website in the US. It provides less overall customer support than ComFree, only supporting the listing process and not getting involved in the actual transaction. Its numbers suggest it facilitated roughly 10,000 sales in the past year.
The rest of the FSBO field seems to be dominated by technology startups. Homelister and HomeBay operate in the U.S.; they provide a tech product that steps home sellers through the selling process. As opposed to ComFree, they have a light customer service touch, preferring to empower consumers to own the process.
FSBO operators, especially in the U.S., typically suffer from the same fate. Most of their effort is spent developing the technology that facilitates a hands-off process for consumers. They may get decent traction with early adopters in a local launch at the city or state level, but then traction slows.
There’s only a small percentage of sellers who are comfortable selling a house on their own. The FSBO startup can appeal to those ultra cost-conscious and do-it-yourself individuals, but mass market appeal will always, I predict, lie beyond their reach.
The key success factor for FSBO companies centers on how much support it provides consumers. The winning formula that I’ve seen is, again, full-time employees with specialised expertise -- just as with fixed-fee operators. ComFree has a staff of 400 employees, making it a technology-enabled business as opposed to a pure technology company. Consumers in mature markets aren’t ready for an app to hold their hand; they still want the comforts of a human voice and human touch.
Disruptive players
I’m not a fan of the term “disruptive” to describe new players in a market coming at a problem from a different angle. It’s overused in the business world. A clown waking me up at 2 a.m. is disruptive. Is that a good thing? A business should aim to be disruptive and add value.
One of the striking observations about the residential real estate space is how few innovative businesses there are. Most real estate companies offer incremental improvements to the existing process, not a revolutionary way to do business. If you map the path from consumers wanting to sell their house to actually selling it, these firms primarily focus on optimizing the process or bringing parts of it online.
There’s only a tiny number of truly innovative companies who are remapping and reimagining the entire home selling process. My favorite, and I believe the best example, is Opendoor.
Opendoor is a San Francisco-based startup that will buy a seller’s home in a matter of days. Its proposition is ease, simplicity and certainty. The entire process of selling a house is thrown out the door: no agents, no open houses, no tidying up and fixing the fence before listing.
It’s also reimagining the entire homebuying process by providing 24/7 open homes, a 30-day money back guarantee, and a two-year warranty.
To be clear, this startup has yet to prove itself as a viable business. It’s live in three U.S. markets and has bought around 4,000 homes so far. It’s well-funded and has a great team. But only time will tell if this model resonates with enough consumers to be considered a valuable and disruptive business.
Since Opendoor’s launch and early success, a number of followers have cropped up, each with a slight twist on the model. Knock, in Atlanta, promises to sell homes in six weeks or it will buy it from the seller. Nested, in the U.K., will sell a home within 90 days or it will buy it from the seller. There’s also OfferPad, Redfin Now, and Zillow’s Instant Offers.
So who’s making money?
Traction proves a product-market fit, but at the end of the day the business must make money and turn a profit to thrive. Call me an old-fashioned M&A guy, but I like my businesses to make money.
Let’s take a look at three examples as we explore the money-making potential and viability of these new business models: ComFree, Purplebricks and Opendoor.
ComFree reported approximately $40 million in revenues in 2014, making it the largest company by revenue in my market scan. It has roughly 40,000 listings and a staff of 400.
Its prices are significantly discounted in new markets it enters in Canada. Even so, the average revenue per customer suggests it is able to successfully upsell premium services (for instance, it offers expert negotiators for an additional fee).
Earlier this year, Purplebricks reported full-year revenues of £46.7 million and pre-tax losses of £6 million. At the time, it had 450 local property expert contractors, and its numbers suggest it listed around 41,000 properties in its 2016 fiscal year.
Opendoor has claimed it has bought over 4,000 houses and averages a 9 percent commission fee (yes, you read that right: this disruptive player is charging higher fees than agents). That’s a huge potential revenue pool! On the above numbers, that’s over $75 million in potential revenues (but on very slim margins), but revenues and profitability are highly variable on eventual selling prices, costs to prepare houses for sale, debt servicing costs and the market risk associated with holding inventory (Check out my detailed analysis of Opendoor's business model, Inside Opendoor: what two years of transactions say about their prospects).
So that means the revenue potential is definitely there for Opendoor, but because of its business model design, a few more years must pass before it earns the “money-maker” designation. But it shows promise.
A note about Purplebricks
While its price point is higher than ComFree ($1,093 vs $643 in US Dollars), Purplebricks’ volumes are lower and the cost of customer acquisition is much, much higher (leading to big losses as it builds audience).
Why are customer acquisition costs so much higher for Purplebricks? Because it is relatively new in the market. ComFree has been operating for nearly 20 years in Canada, Purplebricks just two years in the U.K. One would expect (and shareholders would hope) that those costs will significantly drop over time, which is necessary for the company to reach profitability.
The most important difference between the U.K. and U.S. markets for these new models is what sellers pay for agent representation (1.4 percent in the U.K. vs. 5.5 percent in the U.S.). That difference means that operators in the U.S. are able to charge higher prices while still saving their customers money, which will make a big difference in revenue-generating potential and eventual profitability.
What we can learn
There is clearly innovation occurring in the real estate space. I’m interested in the models that are getting the most traction in the market and are making a real impact at changing how people buy and sell houses. From the scan above, some clear learnings emerge:
The models getting the most traction are those that smartly combine technology, human support and a killer consumer proposition. ComFree and Purplebricks have hundreds of staff to support their customers, supported by technology, and offer a compelling proposition of better service with lower cost.
There’s no one, winning model. All share common ingredients, but a number of different ways exist to achieve success.
For sale by owner propositions suffer when they focus too much on technology. The market isn’t ready for an app to sell your house.
There’s exciting innovation occurring with the disruptive players, but it’s too early to say if they’ll be disruptive and valuable. But watch this space.
These models aren’t going to change the industry overnight, but they do represent the best of the new models gaining traction. The future of real estate is coming -- and it will look a lot like these businesses.
