How Losing-Money-in-Real-Estate Becomes Cool

Compass, a real-estate-brokerage unicorn with $800 million in venture funding and a $2.2 billion “valuation,” disrupts – itself?

By John E. McNellis, Principal at McNellis Partners, for The Registry:

Does outspending your competition buy you the best talent? Of course. Does it guarantee you the World Series championship? Not so much. Just ask last year’s Los Angeles Dodgers.

Compass Inc., a residential brokerage company that parachuted onto the scene in New York City in 2012, swiped the spend-it-all playbook and bought the finest brokers in Manhattan, luring them with otherworldly commission splits and promises of a breakthrough technology, a black box that would make selling real estate as easy as ordering Harry Potter on-line. Today, with roughly $800 million in VC funding, Compass is going all out, buying brokers and whole brokerage firms by the bushel, most recently, Paragon Real Estate Group in San Francisco and Avenue Properties in Seattle.

First, a word about its ballyhooed technology. When they see AI, readers of Cow-Calf magazine think artificial insemination, not artificial intelligence. Perhaps you should, too, especially when you read in Wikipedia that Compass, “…is an American technology and real estate company.” When your assets stroll out the door every day at 5 o’clock, are you a technology company? Can technology sell a tired condo with a dumpster view?

According to a group of industry insiders I’ve interviewed*, Compass’ technology has either yet to emerge from its box or, while mildly impressive, is duplicable by the industry’s biggest players. A senior Bay Area real estate executive said, “The Compass technology isn’t any better than what I’ve seen elsewhere.”

So much for user interfaces. Let’s talk about money. Pre-Compass, a young agent split her commission fifty-fifty with the house and, if she proved to be one of its few winners (87 percent of all agents reportedly fail within their first five years), if her sales volume went big, so did her commission share. It could rise from 60 to 70 to 80 percent and even, in a few superstar cases, to 90 percent of the total commission. It’s simple from the house’s standpoint: You make $50,000 if you split equally with an also-ran whose volume is $100,000 a year. But you make $300,000 on a 15 percent share with a superstar doing $2 million. Easy, right? The more an agent brings in, the bigger her share. But, like condo towers, commission splits cannot grow to the sky.

Exactly where even the brightest star ceases to shine for the house is a bit complicated, depending on whether the company charges incidental fees (desk fees, marketing fees and the like), its overhead structure (e.g. how fancy are its offices, does the firm have an expensive agent training program, and so on) and intangibles like how many 50-50 split brokers are happy riding the superstar’s contrail. The consensus over/under line for profitability was 85-15 among the four company presidents I quizzed. Any more to the agent, the house is losing money; any less, the house is profitable.

And that brings us to Compass. Having adopted Silicon Valley’s tattered battle cry—buy market share now, monetize later—its problem is straightforward: How do you lure away pampered top agents already at an 85 percent split? As long as you’re just telling them how special they are (Compass’s siren song: “To us, the agent is the client”), how special you are and how extra-special your new technology will soon be, they’re thumbing their iPhones during your pitch. To get an agent to even look up, you have to offer her serious money. Compass is doing just that: deals that can include six-figure signing bonuses, 100 percent of all commissions for the first year, 95 percent for the first several years and so on. In short, Compass is signing agent deals that are guaranteed money-losers for the company, using its VC war chest as a bonfire over which its agents can roast their marshmallows.

Skeptical of the company’s technology, one company president put it this way. “Think of typical disruption. Usually, there’s a fundamental change in the way the disruptor approaches the old business—instead of you going to the bookstore, Amazon delivered the books to you. That’s real change. With Compass, nothing’s changed, it’s still the same old business, the only disruption is that Compass is wildly overpaying its agents and on its way to destroying brokerage in general.”

“But once it kills off its competition, can’t Compass lower its commission splits with its agents and be profitable then,” your correspondent asked.

“Top agents are prima donnas, they never go backwards on their splits. They would rather quit and go somewhere else at a lower split than reduce their cut in place.”

I asked a Seattle agent who had been pitched hard by Compass whether knowing the company is hemorrhaging like a hemophiliac piñata would affect his decision to join it. “Nah, man, they’re going to figure it all out. They’re gonna have that end-to-end tech platform where the company runs the whole process from listing to loan to roof inspections to closing. It’s going to be sweet.”

“But they’re not making any money.”

“Dude, that’s what they said about Facebook.”

So they did, and maybe Compass will become another FAANG stock. Maybe not.  By John E. McNellis, author of Making It in Real Estate: Starting Out as a Developer. A version of this article was first published on The Registry.

High housing costs & taxes lead to this: “Once we decided we had to get our employees out of California, we went about our search systematically.” Read… Could California Flame Out?

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  23 comments for “How Losing-Money-in-Real-Estate Becomes Cool

  1. Matt P says:

    It would be poetic if it were a realtor company that finally killed the realtor model. Parasites all.

    • Frederick says:

      Matt Indeed I’ve no use for brokers, bankers and lawyers Most of them anyway

      • Javert Chip says:

        Well, you better have one or the other if you’re buying (expensive) real estate.

    • Mark Adams says:

      It just seems like Compass who recently bought Pacific Union is just trying to eliminate the competition. They have other sources of income besides Real Estate so they dont care if they lose money in RE companies for a long time bc they make it somewhere else right? They are HUGE Corporations that have deep pockets. Just like FB. If FB bought RE companies and lost billions a year o for a while it would not matter to FB bc they are making it elsewhere and then when the competition is eliminated they are in total control and things change. Orchard Supply is90 years old. 4-5 years ago got bought out by Lowes. Lowes is closing down Orchard supply by end of 2018 everywhere. So Lowes and Home depot pretty much run the market now. Same thing here.

  2. Petunia says:

    I understand Redfin is already selling its listings through their own agents and now they have a mortgage company too. They are aiming to capture the entire transaction in one platform. Watch them to see how this turns out because the only way it works is to discount commissions and fees.

    • MCH says:

      I guess this is in theory a good deal for the buyers and sellers. Whether the companies in question are a going concern, as long as the mortgage is untethered to Redfin or the company in question, it shouldn’t matter to the buyer.

      I forget , isn’t Redfin owned by Zillow, or was that someone else.

    • Mike Hughey says:

      True about Redfin but that has been going on for a long time. Most buyers have a lender they have dealt with already and dont want to switch unless it makes a huge difference and most I of the time it does not.

  3. Finster says:

    “… buy market share now, monetize later …”

    As systemically rampant as this business model has become, you have to wonder if there is a systemic catalyst. Possibly a form of malinvestment spawned by a decade of ultra-easy credit?

  4. Maximus Minimus says:

    “They’re gonna have that end-to-end tech platform where the company runs the whole process from listing to loan to roof inspections to closing. ”

    Because having the realtor supply their home inspectors is exactly what the buyers need. /s

    • Javert Chip says:

      Actually, I thought “single sourcing” this type of vendor (mortgage, home inspectors, escrow, et al) was illegal…

      • Frederick says:

        What does “illegal” even mean anymore I could tell you stories about “illegal” that would make your hair stand straight up The US is no longer a country of laws IMExperience anyway

        • Javert Chip says:

          There is some (not a lot) of truth in what you say.

          I’d love to see it made illegal for corporations to contribute to politicians in any way, shape or form (including corporate PACs & “charitable” contributions). That shuts the door for sucking up to corporations (for example, Wells Fargo) for further “contributions”.

          Individuals, not corporations, should define our public life.

          FYI: yea, I know campaign contributions are illegal; I also know there are other types of “contributions” that are politically useful.

  5. Iapetus says:

    Isn’t Compass one of those companies that Softbank invested in at the same time its biggest investor, the government of Saudi Arabia, was appropriating billions from captured princes and businessman at its Ritz Carlton in exchange for their release?

    Not sure if this is a coincidence but Compass previously received ‘seed round’ money from Thrive Capital, which is a venture capital firm owned by the Kushner family.–0af98656

    Maybe profitability is not always the primary consideration that determines why firms choose to invest in Compass.

  6. Harrold says:

    If Compass is moving NYC over to the MLS system, then they are indeed disrupting the business there at least.

    Still, that won’t make them any more profitable there than any where else.

  7. BRB says:

    The real change in marketing of real estate in our area (flyover country) came with the affordability/accessability of home based high speed internet connections a decade ago. For many years, agents needed the office to access the internet plus the office support system (processing paperwork, setting showing appointments on listings, etc.

    Now agents can easily work from home for a song. Virtual assistants, showing appointment services and smart phones have replaced the necessity of the brokerage office. Most states now allow Realtors to become broker/owners with a minimum of experience and no requirement of a brick and mortar presence. The large brokerages are used as training centers for people new to the business, with successful agents leaving and going totally independent after 2-3 years. Churn, churn, churn.

    IMO, Compass is chasing an outdated business model.

  8. I have long been suspect of Compass and why they chose to get into the brokerage business when there were already enough brokerages out there. As a Realtor, I don’t see the value in what they provide as being different than what many other brokerages provide.

    They have used their VC money to unveil the new “sign” that is circular and interactive and is supposed to take the real estate world by storm. What do these VC people see in this company because as the article states, and as I said a couple years back in a Wolf Street blog post, there’s nothing different being offered by Compass that even they can explain. Besides smoke and mirrors.

    They have lost agents from the brokerage and they never talk about that. They never talk about the agents who didn’t like the Kool Aid and moved on. It’s like 1999 again with the tech bust. Except they aren’t operating in a new space. Just doing the same old same old in a brokerage where thousands went before them.

    In the end what I find is that it’s stjll about relationships. A lot of my clients don’t want to manage the process themselves. Whether that holds for the long haul or not remains to be seen. For now I just stuff the money in my mattress.

  9. Bruce Kowal says:

    As a CPA in Metro NY area, I have four tax clients who work for Compass. You might want to interview some current Brokers before making such broad statements about the Company.

    • Wolf Richter says:

      Like we said in the article, the BROKERS (your clients) come out great. This was about the COMPANY — how it is overpaying for everything, including brokers.

Comments are closed.