Independent brokerages and their modern competitors

Traditional brokerages are operated by a single corporate owner. They are called independent brokerages. This is a hard model to scale nationally. Operating a real estate business in one market is drastically different than it is in others.  Over fifty years and countless mergers, strong national and regional players have emerged. Now technology-driven and venture-backed companies are starting to compete with them.

Independent brokerages focus on growing sales volume and reducing support costs

An independent brokerage generates the overwhelming majority of its revenue from commissions. Agents expect the bulk of their brokerage costs to come in the form of their commission split. Because splits are based on a percentage of sales volume, brokerages only generate significant revenue from top performing agents. But brokerages need to ensure that top agents pay a high enough split to cover their costs.

Revenue for independent brokerages comes almost entirely from commission income rather than fees. Source: Realogy.

Focusing on volume to drive revenue

The lifeblood of an independent brokerage is sales volume. The more sales volume its agents generate, the more revenue the brokerage earns. Recruiting efforts focus on agents who already generate substantial volume. And then the brokerage focuses on how to help existing agents sell more.

Brokerages often target top-performing agents based on sales volume. This translates directly to brokerage revenue from future commissions. Source: PR Newswire.

Setting splits to maximize gross margins and prevent agents from leaving

Focusing only on sales volume can be dangerous for independent brokerages. Top-producing agents are unprofitable if their splits are too high. As an example, a brokerages could give a top agent a 100% split. In that instance, the brokerage would generate substantial revenue from commissions. But after commission fees to the agent, the brokerage would make nothing. Brokerages often define revenue after paying out agent splits as their gross margin.

Brokerages want to give agents the lowest split possible. But if splits are too low, the agent will get upset and go to another brokerage. And for agents that are producing more, they may feel entitled to better splits. When contracts are renegotiated, this becomes very delicate. But it's why agents often leave. And a brokerage is not going to be upset if an unprofitable agent leaves.

Many agents will change brokerages based purely off of commission splits. But brokerages have to be careful not to provide splits that are so high they lose money. Source: Indeed.

High fixed support costs hurt profitability

Independent brokerages often have high fixed costs relative to franchises. They have to maintain offices and the personnel in it. They provide support staff like marketing professionals, sales managers, and legal teams. They have to support training and events. They pay for software and technology. And sometimes these services are different in each market. These are all expensive to maintain and support. And if any of these services are eliminated, profitable agents may leave. After all, splits are based on the idea that the brokerage will continue to provide the same service.

@properties, a Chicago-area brokerage, has over 30 offices in just one market. Source: @properties.

Independent brokerages traditionally focus on dense or high-price metros

National-scale independent brokerages tend to focus on areas with high populations or home values. For example, Realogy’s owned brokerages generate almost 50% of revenue from California and New York. Douglas Elliman only operates in around 10 metro areas. This is simply because it’s hard to manage offices across large physical spaces. Once a brokerage opens in a metro area that is new, it makes sense to specialize in nearby areas. The same staff and local management can service multiple locations. Franchises, which let local operators find and manage offices, often thrive outside of these dense locations.

Douglas Elliman operates nationally across over 120 offices. But it really only focuses on  10 metro areas. Source: Elliman.

Modern brokerages provide technology to agents to drive volume

Modern tech-enabled real estate brokerages are betting on large investments in technology. They are trying to use technology to help agents generate more volume and/or earn more.

Driving volume with technology

Whether luxury or discount-focused, most tech-enabled brokerages are trying to use technology to drive more volume for agents. There are two approaches:

  • Software to help agents grow their business: Companies like Side and Compass build expansive software suites for agents. Their goal is to have agents use these tools however they’d like to grow their business. Ideally, this  reduces the need for other standard brokerage services, which can be costly to maintain.
  • Software to make agents more efficient: Discount brokerages often focus on helping their agents serve more clients. Redfin hires full-time agents and helps those agents generate as many transactions as possible.
Modern tech brokerages like Trelora often try to improve the consumer experience. But they are also reducing work for their agents with new tech tools. Source: Trelora.

Using listings to build a unique brand

Most modern tech-enabled brokerages focus on listings to provide a differentiated experience. They understand they can present their listings in a unique way to buyers. And sellers want to list with brokerages that have an advantage with buyers. This process has been successful for Redfin. And it's now replicated by many other modern brokerages. For example, listings from Redfin get preferential placement in Redfin's search. Another example is that Redfin listings have 3D tours, while other listings don't.

Redfin provides preferential positioning for its own listings. Because Redfin’s site has so much traffic this is an appealing reason for a seller to work with Redfin. Source: Redfin.

Two different approaches to driving volume and reducing costs

Traditional independent brokerages often have lower investments in tech. They use their money towards training and supporting offices. Their investment largely relies on personnel - that their agents are skilled and will get better. Modern brokerages invest in technology to make agents more efficient. Their investment is in tech - that great software can help more agents become top producers.

Unit economics of the traditional independent brokerage

Douglas Elliman is the number-6 sales brokerage by volume in the country. It had roughly 7,200 agents in 2018 and 2019, so we’ll use that as their agent count for the duration of 2019. These agents generated $28.8B in sales volume in 2019. They sold 23,460 homes. This resulted in $742.4M in commissions from that volume, of which $525.2M was paid out to their agents. This means the average commission on each home was ~2.6% ($742.4M / $28.8B). And the average commission split with each agent was ~71% ($525.2M / $742.4M).

So, let’s look at the average agent. A standard agent sold ~3.3 homes (23,460 homes sold / 7,200 agents). The typical home sold was about $1.2M ($28.8B / 23,460) and generated ~$31.5K in commissions. Therefore, each agent generated ~$103K in commissions annually ($742.4M / 7,200). The agent keeps ~$73K after paying the brokerage split ($525.2M / 7,200). So each agent generates ~$30K in gross margin ($103K - $73K) to the brokerage. This is a huge premium to the average RE/MAX franchise agent who generates just $2.6K for the franchise.

Elliman leases 375,000 square feet across 125 offices. Let’s assume they spent $70/year per square foot. This means they spent over $25M in office space. They employ roughly 900 non-agent employees. Those employees likely cost over $100M each year. Office and employee fixed costs alone are therefore ~$125M. Beyond this, Elliman had another $100M in expenses. It’s hard to tell what these other expenses were. But they are likely related to marketing budgets and one-time incentives to recruit agents. Ultimately, we’re left with the fact that the average agent costs ~$31K to support. And agents only bring in ~$30K in gross margin.

Elliman is not far from being profitable. But it spends too much on employees, office space, and other areas to generate a profit on the average agent.

But Elliman has  paths towards profitability:

  • Recruit and train more productive agents to increase volume per agent: Elliman can try to help agents generate more than $30K in gross margin. This can come from getting new agents that are already more productive. They can also increase production from existing agents through training. But these are both hard to do. Presumably every agent is trying as hard as they can. New technology, or different training is time consuming and risky. And recruiting top agents can be expensive because top agents may demand upfront bonuses.
  • Reduce costs to support an agent: Elliman can try to reduce its agents' splits to increase the average margin per agent. Alternatively, Elliman can fire some of its staff or reduce office space. Closing just a few offices of firing a few dozen workers would make the average agent profitable. But if any of these impact agent sentiment, top producers will leave, and volume declines will reduce the average gross margin per agent again.
Elliman, operating under parent company Vector Group, lost almost $3M in 2019. This is despite generating over $30K in gross margin per agent. Source: Vector Group.

Unit economics of a modern tech-enabled brokerage

Redfin is the number-six brokerages in the United States by sides. And it’s growing rapidly, up 23.9% from 2018 to 2019. Redfin, like many other modern discount brokerages, employs its agents as full-time employees. And it pays those agents very well. In return, those agents have to support a large number of sales.

Redfin sold 53,235 homes in 2019, generating $497M in commissions. It had 1,390 lead agents at the end of 2018, and 1,553 at the end of 2019, so on average it had 1,472 agents in 2019. That means each agent sold over 36 homes during the year. That is twelve times the average transaction count of a Douglas Elliman agent. The average Redfin home sale generated $9.3K in commission. This means each agent is generating ~$335K in commission's annually. This is also impressive, as it’s over three times the commissions of the average Elliman agent.  But it requires twelve times the number of homes sold.

But Redfin agents are also helped by a large support staff. That includes other agents who handle showings. On this $335,000 in commission, Redfin only generates roughly 28.5% in gross margin after these costs. This means Redfin pays $240K for each agent lead and associated support team costs per year. And this ultimately becomes similar to the split that a company like Elliman has even though the business model looks much different.

Agents at Redfin close a larger number of sales than agents at traditional brokerages do. Source: Redfin.

As a percentage of gross commissions, Redfin devotes 11% to technology, 9% to marketing, and 13% to its general and administrative costs. This means for a standard agent driving $335K in commissions, ~$240K goes to the agent and support team, ~$37K supports the tech built for the agent, $30K is for marketing aimed at driving consumer traffic, and ~$44K supports central operations. Redfin ultimately loses loses $16K per year on each lead agents' $335K in revenue.

Redfin has considerable operating expenses. But tech and general expenses are improving as a percentage of gross commissions. Source: Redfin.

Like Elliman, Redfin is employing agents who are, on average, unprofitable. But Redfin recruits agents on technology and marketing features, not broader services and offices. So they have different options when it comes to how they can improve:

  • Use more technology and process to drive more transactions per agent: The average Redfin home is around $400K. This means to generate $16K in more profit to work with, each team only needs to sell a few more homes. Given Redfin’s impressive progress to date, this seems reasonable. But with agents already selling over 30 homes each, it’s possible agents are already at their limit.
  • Sell more expensive homes: Many traditional brokerages already try to focus on very expensive homes. This is why Elliman can generate so much revenue on so few transactions. Redfin’s average home sold for around $400K. It can try to offer luxury services to to move average home prices up. But arguably they will face much more competition from high-touch brokerages where an agent provides more attention to clients. Redfin has begun this process by launching its Redfin Premier service.
  • Reduce the cost of technology and central support or pay agents less: This is likely the riskiest area for a tech-driven firm. If Redfin feels that it has the appropriate levels of staff needed to drive its technology and marketing  needs, it could begin cutting costs at the corporate level to ensure agents are profitable. If Redfin also thinks that most agents would be top producers with their technology, they could lower lead agent salaries without any concern that some of these agents will leave. But both of these routes risk Redfin losing its core advantage of industry-leading technology and staff.
Redfin is testing luxury services. This could increase the average price of a home bought or sold on its platform. Source: Redfin.

Two other things to note on modern brokerages:

  • Part of Redfin’s solution has also been new business lines. These are separate from what current agents do. So I am excluding it from the analysis. This is the idea behind Redfin Mortgage and RedfinNow. Essentially, Redfin can use its existing marketing and tech to generate revenue from areas current agents can’t.
  • Some modern brokerages don’t employ agents full time, such as Compass and Side. They are a hybrid of the two models but still rely on large tech investments. While they recruit top agents, they must believe that having top-tier tech will make those agents more productive. Ideally, that will lead to agents either generating more business through commissions, or paying more in fees or splits for access to that technology.

Modern brokerages are still slow and expensive

New tech-enabled brokerages are often heralded as the future of real estate. But they have been both expensive and slow to build. Redfin has been around for over 15 years and has under 1% of industry volume. And there is not yet a modern brokerage that has shown strong profitability due to tech innovation

Redfin now ranks among the top 10 brokerages in the country. But it is under 1% of industry volume.Source: RealTRENDS

New models will need to show they can exceed the scale of market leaders

Modern brokerages aren’t as fast or as cheap as many expected. But they are becoming national brands with strong technology platforms. A core question is if their business will grow into their expectations. Redfin is a household name but only 1% of volume. If Redfin can grow to 5% of the industry without too much additional capital, they will be massively profitable. And this is what modern tech-enabled brokerages will have to prove- that a branded, tech-enabled experience will create the best agents, attract clients year after year, generate more commission per agent, and dominate home sales volume.

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