Online Real Estate Transactions
If you haven’t noticed there is a boom going on in real estate. Part of it is COVID, part of it is low rates, part of it is the expectation of being able to do everything online. People are buying and selling homes online, in some cases with no physical visit. Market leader Zillow (Z) is hitting new highs at a $19B market cap at nearly 5x sales. Even smaller rival Redfin (RDFN) has surged to new all-time highs.
In a fairly large survey done by Redfin, they found that a much larger percentage of buyers (45%) were putting in offers on homes that they didn’t physically visit. Instead, they relied on photos, videos, and sometimes virtual tours using Zoom (Z) or FaceTime (AAPL). The same survey shows an increase in competitive situations where there are multiple bidders for the same property. How durable this strong real estate market will be is unknown but buyers and sellers may get used to the kind of speed and increased efficiency that these online methods offer – especially for similar properties in subdivisions and condominiums.
One small and curious name that came public recently is Fathom Holdings (FTHM) which did a small deal with a lone underwriter (Roth) which was easy to overlook. But we are living in a special time. The name is more interesting than we expected.
These guys have created a platform that agents prefer and may yet create the best consumer experience as well. If they succeed the current ~$240M market cap will grow considerably.
Fathom is trying to use the “disruptor” model in this market which has been tried before. Real estate is a market that resists innovation and the agency are kind of like investment banks, try and do business without them at your peril.
The Fathom story can be encapsulated like this – it’s an online platform for real estate agents and instead of charging a percentage it’s a fixed fee that starts at $450 and drops to $99 if they sell enough properties. The pitch to agents is simple – you get to keep more of what you sell. On top of that they also grant agents some stock for sales and referrals which agents see as a great way to save for retirement, children, or whatever. You get more control over your enterprise and you get to keep more of the money.
One of the biggest “cons” cited about Fathom was their “lack of physical offices” which now seems quaint. It also casts the significant “cut” that agencies take in part for their “infrastructure” in a less favorable light.
Now the best properties in the best areas are still going to be controlled by the agencies. This is at least the case today. Homeowners want the “best” when they sell their main asset. They want the kind of service and support of an agent that often prefers to work under the comfort of an agency umbrella.
Fathom currently operates in 24 states serving 110 markets in the US with more to come. According to at least one industry source Fathom is ranked #11 in the US among “independent real estate brokerages. The markets tend to be a bit more out-of-the-way than your typical real estate agency might cover. Due to the impact of COVID on major metros consumers have been active in moving to these areas. Places like Maine, Florida and Texas are the new “it” spots for those fleeing New York or San Francisco.
They are not all remote though as the company serves markets like Austin, Atlanta, Chicago, Dallas, Denver, Houston, Phoenix, and San Diego to name a few but they are not in New York, San Francisco, and Los Angeles at this point. For those looking far and wide there are great listings in places like East Texas where you can find $65M waterfront properties down to $25K country shacks.
It’s also a plus that the bulk of the states they are in are more in the southern regions which is where people have been moving.
In terms of market opportunity the company has identified 775 total markets where the population is at least 50,000 which gives them plenty of room to expand if their model continues to catch on.
The Platform & Business Model
Fathom provides its IntelliAgent technology platform which is kind of like having an agency “system in a box” that provides a suite of services for training, marketing, CRM, business process management, and reporting. One illustrative comparison is Mindbody (MB) which provided an online solution for yoga studios and fitness trainers. Mindbody was acquired at the end of 2018 for $1.9B by Vista Equity Partners. Of course, the dominant provider of these types of vertical solutions is Shopify (SHOP) who provides a full-stack solution to online retailers. Fathom seeks to make it’s IntelliAgent analogous for real estate agents.
The financial incentive for agents is substantial if they no longer have to share their commission with their agency. Fathom provides an illustrative example. When multiplied by the number of transactions and/or with $1M sales – the math gets compelling.
Using the platform as a buyer is very similar to how one might search for properties using any online service. Qualitatively it’s at least as good as Zillow and better than most agency-owned platforms in terms of ease-of-use, filtering, viewing, and navigation.
One strange thing about the Fathom platform is that each market has a separate URL which makes national or multi-area searches impossible. This is fine for people searching based on location but it doesn’t serve in situations where you might want to find “a 4 bedroom house with water access for less than $1M.” Apparently there is a way to search across markets from the website but so far I have not been able to make it work the way I’d like. I can search across markets but not across the US as I can with other sites. Could be operator error but this is one element that could probably be improved.
Agent growth is an important part of the strategy. At the end of 2019, the company had just over 4,000 agents, up from just over 2,700 at the end of 2018. Agents are growing at ~40% a year. The count stood at 4,554 at the end of the June 2020 quarter. There are about 2M real estate agents in the U.S. with 1.4M who are members of the National Association of Realtors.
Because the commissions generated by real estate sales mostly flow through to the agent the gross margins for Fathom are thin. For example in the six months ended June 30, 2020 revenues were $67.5M but the cost of revenue was $63M.
Growth has been strong including during the two quarters reported since the close of 2019. Revenue is driven by the number of transactions and average revenue per transaction. For example, in the June Q the company closed 5,848 transactions (up 31%) with average revenue per transaction up 6% to $6,615 which resulted in 39% revenue growth. Revenue is a function of the number of agents, the number of transactions, and the average transaction size. This will mean quarter-to-quarter seasonal variability that is common in residential real estate.
On the plus side, the company is now covering its mostly-fixed costs like G&A and their variable costs like marketing. They reported a small profit this past quarter. It’s a very asset lite model for a business with only 22 employees at the end of the March 2020 quarter.
Now with more resources from the IPO the company plans to expand faster into their existing markets and open new ones. They are also looking at some ancillary businesses they might expand into. This could include home inspection, home services, title services, insurance, and mortgage brokerage. Let’s hope they don’t overreach.
The company claims its cost to acquire an agent is $825 and their LTV is over $18K. If these numbers hold then over time we could see much better operating profits at a larger scale. If their math holds up then spending some of the $30M they just raised on accelerating their agent growth would make sense. They also provide annual average sales figures for agents which are as follows: 4.9 in year 1, 6.3 in years 2 and 3, and 7.3 in year 4. This would mean that a new agent contributes $2,300 in year 1, $2,885 in years 2 and 3, and then $3,335 in year 4 for a total of $11,400.
If this math holds up it means spending $1M to acquire 1200 more agents would translate into $13.7M in additional revenue over 4 years. We don’t have good data on how CAC costs are trending now or how agent performance will change as more agents join the platform but the numbers suggest high returns on invested capital are possible. All the CAC and LTV discussion is confined to the roadshow presentation and not included in the prospectus.
Management & Culture
It’s fair to characterize Fathom as a bit anti-establishment. It reminds me a little bit of Ubiquiti (UI) which went public with a very different type of founder and vision of how to deliver networking equipment. Ubiquiti managed to build a novel $1.3B networking equipment business by focusing on just the engineering and selling direct to distributors and DIY types. It’s a very different market and investment case but there are parallels.
The CEO, Josh Harley, is an ex-Marine who bootstrapped the company and has built it over the last 10 years. They started out in Texas and North Carolina which still represent a large chunk of the business at 63%. That figure has been declining as newer markets become more productive.
Over the years the company has had one substantive investor, Glenn Sampson, who is Mr. Harley’s father-in-law and owns just over 15% post-IPO. Josh Harley owns 35.8% and Marco Fregenal, the President and CFO own 10.7%. So basically the founders still own 60% of the public company.
While the core team has been together for nearly a decade the company did build the board out in 2019. So far they have done a good job with a solid June Q report and conference call.
There’s some recognition about the importance of culture with the creation of the “Fathom Talent Acquisition Platform” which aims to identify and cultivate agents that would “fit the Fathom culture.”
The company has much more experience than traditional agencies at providing local training and support without needing physical offices. They have invested in people, plans and programs to help agents be successful on the platform. The large national agencies provide training but many smaller traditional agencies have not invested adequately in this area.
They will need more coverage than Roth but could probably add one or two more decent quality firms if they elect to do an organized secondary for existing shareholders prior to lockup expiration.
When Zillow came into the market the established agencies did what they could to block them. The crux of the matter was access to the multiple listing system (MLS). Zillow followed a strategy that was based on aggregating all the consumer search activity for property. If they did that successfully then the market would have no choice but to work with them. It took a while but ultimately that happened. Today Zillow is the default for searching for real estate online.
However, Zillow has become a lead generation platform for agents and agent firms and providers of ancillary services. When viewing a property and clicking on the “contact agent” button on Zillow you will be presented with a menu of agents to choose from. These agents are listed based on how much they pay Zillow. There are some ratings and other numbers to help you pick but that’s how it is. Zillow does provide additional services to their “premier agents” and basically make money off the advertising and lead generation fees.
From a consumer perspective, Zillow is a great way to search for a property but often inconvenient for taking the “next step” in the process. Once you fill in your data and send a message your information is basically sold to whoever is willing to pay for it so you’re going to get lots of emails and calls (if you make the mistake of putting in your real phone number.) To be fair that’s how many other sites offering things like insurance quotes or moving services work.
Zillow is the gorilla and its strategy is to be the central navigator of the real estate “customer journey” and integrate all the vendors from agents, inspectors, lenders, appraisers, title companies, escrow firms, insurance companies, and even movers. At least that is the vision. They have also stepped up their direct buying of homes which is an attractive option for many sellers who want to accelerate the process and minimize contact with strangers coming into their homes.
In contrast to the relatively small real estate advertising market (~$19B), the “home transaction market” opportunity is over $1T. Imagine if Zillow bought Rocket Mortgage (RKT) and Lemonade (LMND)?! That would create a real behemoth.
And there is also Redfin (RDFN) which is a mix of an agent platform and low-cost consumer choice for selling. They still offer the low commission option of 1.5% but have added a “concierge” service where they do some fixing and fluffing for 2.5% and there is now a “RedfinNow” where they buy the house outright for a 7% service fee. I wonder how investors will feel about these companies buying homes if we see another down real estate market?
Redfin also has two other offerings with “Direct Offers” where buyers can make an online offer without an agent and “Direct Access” where buyers can access listings without an agent. Like everyone else, Redfin sees opportunity in expanding into mortgage and title services.
With such a huge market there are many startups and private companies in this space. Many are aimed at speeding up the process. For example, Knock which was founded by an ex-Trulia group provides a platform to enable buyers to buy a new home before selling their old one. And OpenDoor uses data and algorithms to provide “instant offers” which fits into the whole “iBuyer” trend in the current market.
Valuation and Stock Conclusion
Fathom came public at the perfect time. They originally filed for 2.5M shares at $7-$9 and ended up pricing 3.4M shares at $10. Since then the stock has traded up as high as $19.85 before settling back some to ~$17 in trading today. Rounding up to 14M shares outstanding that puts the current market cap at $238M.
Revenue this year should be in the range of $155M which would put the shares at 1.5x sales. That compares to 6.4x for Z and 5.7x for RDFN. Both Zillow and Redfin are more established and have clearer “moats” the investors appreciate. They are also well known and have comprehensive stock coverage. Fathom is mostly uncovered and unknown at this point.
The company didn’t provide a long-term financial model as part of their roadshow so we need to build one from the ground up. After another quarter or two, we will have greater insight into how management is going to deploy their new-found capital and how that will impact the P&L. Then we can take a stab at figuring out how much of the future growth will drop down to the bottom line.
In the meantime, the current valuation seems too large a discount to their other peers and thus far their execution has been strong. Something closer to 3x sales seems more reasonable which would put the shares at $33 which is pretty good upside while we wait to get more evidence on how the company will fare as a public company.