US online real estate portal Zillow has a market capitalisation of US$4.6bn, roughly the same as Australia’s REA. Given Zillow’s market is 14 times as large, several Australian investors think this could be the steal of a lifetime. It could be cheap, but it’s never going to have the same margins as REA. The way we sell property in the US has some important idiosyncrasies.
The online real estate market is an interesting example and one of the only instances that I can think of where we Yanks are getting stitched up compared to you Aussies [Editor’s note: healthcare, tax returns, toll booths … need I go on?]. When it comes time to sell a house, we end up paying our brokers a 6% commission. This is incredibly high—much higher than you typically pay. So why, in the land of Silicon Valley, hasn’t the internet burned this inefficiency to the ground?
The main reason is that our transactions have brokers on both sides: a selling agent and a buying agent. Two brokers means two fees, or twice the cost. The interesting quirk of that is that the buyer doesn’t actually pay their broker’s fee. Instead, the seller pays their selling agent the entire 6% commission, and then the selling agent splits it with the buying agent. That may seem like a trivial point since both agents get paid—who cares who is actually making the payment? But it is an intelligently subversive means to reinforce the current two-agent structure.
The follow on effect of this setup is that buyers have no reason not to use an agent since they aren’t paying for it. The buyer broker provides listings, comparable pricings, advises and handles the price negotiation, and takes care of all the admin and legal paperwork and various other items that come up during a transaction. This all makes for a very lucrative industry for real estate brokers.
One other critical difference is a structure in the US called the Multiple Listing Service, or MLS. There are roughly 850 MLS’s in the US, each representing a metropolitan or regional area. The collective MLS structure was created years and years ago as a way of efficiently disseminating listings to all brokers. When you sign up a listing as a broker, you input it into your local MLS database. The MLS then aggregates all listings in the area and makes that data available to all realtors in the area. Now everyone knows what’s for sale in a timely manner. Sound familiar? And it’s virtually free. It is also important to note that the MLS’s are governed by the brokers.
Because the MLS’s essentially control the listings, they decide who gets to see them. They send them to their member brokers of course, but they also they feed them through to a number of online portals like Zillow (Nasdaq:Z), Trulia (which recently merged with Zillow) and realtor.com.
As eyeballs have flocked to sites like Zillow, so too have the advertising dollars, helping the online portals report impressive growth figures. Their valuations have soared as well. Even though Zillow has seen a decline in its stock price recently, it is still trading at astronomical multiples of earnings and cash flow (neither of which is in the black btw). What do investors love about it? They believe that it will follow a similar path blazed by Australia’s REA Group (ASX:REA): become the dominant online real estate portal and capture all of the digital ad spend.
I can’t be sure, but my sense is that investors will be disappointed if they think Zillow can recreate the magic of REA. I touched on the structural differences between the US and Australian real estate markets. Currently, Zillow makes its money by selling leads to the buying agents. This is different from Oz where REA earns its fees from the selling agents.
In order to advertise a property you were trying to sell, you had to pay someone to publish it, historically in a newspaper and now increasingly online. These classifieds benefit from powerful network effects – better selection leads to more buyers, which leads to higher sales profits which attracts more future sellers which creates a better selection, and on and on. Classifieds are typically “winner take all or most” markets.
By paying a website to publish your listing, you hoped it would attract more buyers. Buyers eventually clued in to which websites offered the most listings, and visited those websites more often. This attracted a higher share of future listings. Once realestate.com.au established itself as the leading destination on the web, it didn’t make sense for listing agents to pay anyone else to list their properties. Now that REA dominates the market, it knows it can charge brokers a high price to list because it is the only place for buyers to find homes online (although Fairfax (ASX:FXJ) is belatedly trying to upset the status quo with Domain). This is why it has been a highly profitable business for over a decade.
Zillow does not directly earn any money by listing properties. It earns money by generating “leads”. It lists properties for free, and then serves as an advertising platform for brokers who are either (1) trying to find home buyers to represent or (2) trying to attract buyers to other properties that they are selling.
In Oz, realestate.com.au is so valuable because the nature of its content (the listings) is unique. It is the only place online where you can find a comprehensive list of all homes for sale. In the US, the MLS’s collectively give away listings for free. As a buyer, I can go to Zillow, Trulia, realtor.com, redfin.com or my local MLS website and find the same information. Most buyers may go to Zillow first, but they typically search all of those websites. So there is very little value in the type of lead that Zillow generates. This is why it has failed to consistently turn a profit despite being the undisputed #1 destination for most homebuyers. Contrast that with REA which has been able to grow profits consistently every year after reaching $10m in revenue.
Investors in Zillow are essentially playing a very long game and betting that it will be able to disintermediate either the buying agent or the MLS from the ecosystem. Those are essentially competing sources of advertising and inefficient layers of cost, they argue. A selling agent paying a buying agent is essentially paying to advertise—it’s an inducement to attract buyers. If you could eliminate the buying agent, then some of that saving could be reinvested in online advertising which would boost Zillow’s value. Taking it one step further, if Zillow could somehow eliminate the MLS structure all together, then it would have removed the main obstacle to it becoming America’s realestate.com.au.
I have my doubts. Ultimately, the brokers control the listings and the MLS’s and have a very real appreciation for the potential threat posed by Zillow. They know exactly what happened in Australia and the UK, and I do not expect they will let it happen here. They don’t need Zillow—they could stop using it tomorrow and it would have virtually no effect. There are too many alternative websites that offer the same data to customers, and ultimately would offer the same lead generation value to the brokers.
While I would love to pay a lower commission the next time I buy a house, I don’t think the Aussie model will make its way here in time.
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