Redfin Corporation

Ladies and gentlemen, and welcome to the Redfin Corporation Q3 2022 earnings conference call. All lines have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation. If you should require assistance throughout the conference, please press star zero on your telephone keypad to reach a live operator. At this time, it is my pleasure to turn the floor over to your host, Meg Nunnally. Ma'am, the floor is yours.

Good afternoon and welcome to Redfin's financial results conference call for the third quarter ended September 30th, 2022. I'm Meg Nunnally, Redfin's head of investor relations. Joining me on the call today is Glenn Kelman, our CEO, and Chris Nielsen, our CFO. Before we start, note that some of our statements on today's call are forward-looking. We believe our assumptions and expectations related to these forward-looking statements are reasonable but our actual results may turn out to be materially different. Please read and consider the risk factors in our SEC filings together with the content of today's call. Any forward-looking statements are based on our assumptions today, and we don't undertake to update these statements in light of new information or future events. On this call, we will present non-GAAP measures when discussing our financial results. We encourage you to review today's earnings release, which is available on our website at investors.redfin.com. for more information related to our non-GAAP measures, including the most recently directly comparable GAAP financial measures and related reconciliation. All comparisons made in the course of this call are against the same period in the prior year and less otherwise stated. Lastly, we will be providing a copy of our prepared remarks on our website by the conclusion of today's call, and a full transcript and audio replay will also be available soon after the call. With that, I'll turn the call over to Glenn.

Thanks, Meg, and hi, everyone. As many of you have by now heard, Redfin today laid off 13% of our employees and announced the closure of Redfin now. The reduction since April 30 has been 27%. We're grateful for the dedication and ingenuity of the people leaving and heartbroken that we don't have enough customers to pay for their work. Our June layoff was a reaction to slowing 2022 home sales. Today's layoff assumes a housing downturn that lasts at least through 2023, letting us earn adjusted EBITDA next year even if home sales declined at the levels of the great financial crisis when the U.S. population was 10% smaller. We still plan to generate our first annual net income in 2024. Redfin generated $600 million of third quarter revenue compared to a projection of $590 million to $627 million. From the third quarter of 2021 to the third quarter of 2022, we increased the share of transactions closed by Redfin agents and from customers whom Redfin referred to our partner agents, but only by two basis points. We had warned investors on our last call that our June layoff of so many agents would be a setback for third quarter market share. So we consider any gain a victory. We lost $90 million compared to a projection of $87 to $79 million. The adjusted EBITDA loss was $51 million. The entirety of the earnings shortfall came from Redfin Now, which has been selling its homes at lower than expected prices. As recently as August, we still anticipated full-year gross profits from our property segment, which includes both Redfin Now and our concierge service. The property's 2022 gross profits to the third quarter were negative $5 million, and we now forecast full-year gross profit losses of $22 to $26 million. Our inventory of homes has declined from its August peak of $432 million to $265 million as of October 31st, with another $92 million under contract to sell. Of the purchases that went under contract in the second quarter, 67% had sold or were under contract for a sale by September 30th. By October 31, that number was 82%. We expect to complete the liquidation of our RedfinNow inventory in the second quarter of 2023. Starting from the end of the third quarter, this will return more than $100 million of cash to our balance sheet. Our decision to close our iBuying business is only partly due to the challenges we've had selling Redfin Now homes. Prices may stabilize in 2023, but the cost of capital, especially the capital coming from our balance sheet, is likely to remain higher for the foreseeable future. That has already lowered how much Redfin and other iBuyers can pay for homes, which in turn has discouraged Redfin.com visitors from contacting us about an instant offer. Those visitors who still want a cash offer will largely be routed to Opendoor through a partnership that has been in place since 2019 with renewed activity in the first half of 2022. iBuying for Redfin has never been an end in itself, but only a means to meet more homeowners when they first consider moving. Now that iBuying's contributions to listing demand have become smaller and less certain, it isn't worth the risk. We can sell more homes over time by focusing on our core business, building our online audience, and giving customers the best brokerage, mortgage, title, and rental service. In each of these areas, our performance is improving, even as housing demand has fallen. We increased our share of listing search traffic in the third quarter and expect those gains to accelerate now that we fixed a bug in our software that, from April 25th to August 30th, precluded new online visitors from getting listing recommendations. This bug was the main reason that, from the third quarter of 21 third quarter of 2022, Redfin.com visitors declined by 5%. Fixing the bug boosted our traffic in the final month of the third quarter and beyond. Even with the bug, Redfin's year-over-year decline in third quarter visitors was nine points better than Realtor.com, which we seek to overtake as America's number two real estate site. By September, the magnitude of our year-over-year decline was one point better than the top incumbent, Zillow.com. We now expect listing search share, which we measure by comparing our visitor growth to that of Zillow.com and Realtor.com, to accelerate. In July, we began competing significantly better for people who start their home search on Google, which is the main source of new Redfin.com visitors. For Google searches on a home address in the first 10 markets Redfin opened, we started appearing first, more often than any other competitor. These home address searches account for about two-thirds of the traffic we get from Google. In October, traffic from new visitors coming to Redshed via search engines had increased 14% year over year. Since the most reliable, earliest indicator of transaction share growth is search share growth, our gains in search engine ranking will probably raise our fortunes more than any other development we discussed today. Improving sales execution can have a compounding effect on search share gains. Until recently, our sales force has struggled to overcome a change in customer behavior. Since the great financial crisis, home buyers have become more casual and convenience-driven in asking for service from the array of agents they can now meet online. To yield the same number of sales, our website and mobile applications have had to generate more and more customers, both for Redfin agents and especially for partner agents. But that started to change this year. In a 2020 pilot that didn't expand to all of Redfin until the 2022 home buying season, we reduced the number of customers each agent serves and close rates shot up. Of the Redfin customers who end up buying a home, 37% stuck with the Redfin agent per purchase on the, excuse me, of the Redfin customers who end up buying a home, 37% stuck with the Redfin agent per purchase in the second quarter of 2022, up from 28% in the second quarter of 2021. This was the first significant year-over-year gain across a full quarter since 2019, when we started measuring how many Redfin customers who end up buying a home stick with Redfin for the sale. Loyalty deals, which we define as repeat and referral customers, as well as customers from a Redfin agent's personal network, also kept growing as a fraction of our brokerage's total deals, up from 31% in the third quarter of 2021 to 33% in the third quarter of 2022. A new discipline of managing agent performance should bolster both loyalty sales and especially close rate. This, in turn, can develop the brokerage into a second engine of Redfin's growth, with Redfin.com's traffic gains as our first engine. In each of our top 20 markets over the last six months, the brokerage's share of homebuyer sales grew faster than our share of homebuying demand. But we also need to improve the brokerage's gross margins. Our July 6th price increase, in which we eliminated a commission refund averaging well more than $1,000 for home buyers in 22 markets, has had almost no sales impact. We now plan to eliminate the commission refund in all markets, starting with the customer's writing offer on December 1st. Pilot data indicates this will lower the total number of brokerage transactions by a minuscule 0.13%, while lifting gross margins five points. Redfin's bedrock principle is that Americans deserve a better deal from brokers, but our focus now is on saving customers money where they value it most, in listing fees and mortgage rates. Improving close rates, driving loyalty sales, and increasing revenue per sale will increase the efficiency of Redfin's main gross profit engine, but we've also lowered the brokerage's cost. Our November layoff has reduced the number of field personnel to match lower levels of U.S. housing demand. but it has also increased the ratio of revenue producing agents to support personnel field management and training. The 2023 ratio will be higher than in 2022, but also higher than in 2021 when real estate services had 33% gross margins. Since the housing market is expected to keep worsening, we may not be able to get all the way back to 33% margins in 2023, but we can get close. And when a balanced market returns, real estate services can earn even higher gross margins. If Redfin.com is the first engine of our growth and the brokerage's network of loyal customers is the second, the mortgage and title services we can offer brokerage customers is the third. In the five years that we spent trying to build our own lender from the ground up, our attach rate for any given month never exceeded 8%. Since Redfin acquired Bay Equity Home Loans in April, the percentage of Redfin homebuyers using Redfin for a mortgage has kept increasing from 12% in June to 17% for the third quarter. Gains from here may be more gradual and occasionally uneven, but mostly we expect increases to continue. In the three markets where we've been especially focused on integrating the Redfin and Bay Equity sales forces, attach rates over the last three months have been between 23% and 25% and are still rising. With title service, we're doing even better. In the third quarter, title forward's attach rate was 40% of eligible brokerage transactions, up from 29% in the second quarter. In the third quarter of 2021, the attached rate was only 8%. Redfin's investment in its agents as employees, which gives everyone a stake in selling our entire product suite, is one reason for our success. The other is the quality of our mortgage and title service. Among Redfin brokerage customers, BayEquity's third quarter net promoter score was 12 points higher than other lenders. But that investment in employing agents is still controversial. On the day of Alea, we're painfully aware that employing our agents limits Redfin's resilience to extreme volatility. Employing agents has magnified Redfin's losses in the 2022 bust and limited our share gains in the 2020 boom. If Redfin were a portal or even a traditional brokerage with contractors on 100% commissions, idleness would mostly be a problem for our agents, not our company. But our identity isn't binary. We decide from month to month and sometimes week to week whether to staff our brokerage to handle 50% or 75% of the demand generated by Redfin.com. The rest of the demand is routed to partner agents who often pay us a third or more of their commission on a closed sale, nearly all of which is gross profit. To make our business more resilient with higher gross margins, we could staff to send more demand to partners, limiting the number of agents left idle in a downturn. It'll always be more profitable for a brokerage to employ an agent busy with million-dollar customers and to use partner agents for occasional sales of $200,000 homes. What happens in between is where we use our judgment, balancing margins and share growth, risk and reward. It's best to make those calculations not a priori, but based on what will deliver the most profit in the current market. Our focus is squarely on 2023 earnings. But that focus won't tilt the balance far from employees. Compared to partners, our employees close sales at a higher rate, build customer relationships that lead to repeat and referral sales for our benefit, and drive higher mortgage and title attach rates. This gap between employee and partner performance is only widening. The judicious allocation of opportunities to our own agents is how we make the most profit per homebuyer. And it's why our growth is more durable than if we were purely dependent on increasing online traffic or recruiting agents. Improving the performance of our brokerage mortgage and title business is the most well-established way to increase the gross profits we earn from each online visit to Redfin.com. But we're also investing aggressively in digital services with gross margins above 70%. Our referrals to partner agents has been the first example of that approach. Rent, a rentals marketplace that we acquired in April 2021, is now the centerpiece of our strategy to expand it. We told investors that it would take us six months to find Rent's new leader and that this leader would then need at least 12 months to turn Rent around. John Ziegler started as Rent's CEO in August 2021. We added Rent's listings to Redfin.com in March 2022. and relaunched the company, formerly known as RentPath, under the rent name in June 2022. By August, sales were growing fast. Net bookings, which are the annualized revenues from new customers, less the annualized revenues from departing customers, were negative 4 million to 5 million in every quarter of 2021. In the first two quarters of 2022, net bookings were already positive, but only barely so. For the third quarter, net bookings were plus $5 million, and we expect an even larger gain for the fourth quarter. On the strength of these bookings, in the fourth quarter of 2022, rent will generate its first quarterly year-over-year revenue growth in years. We expect rent to start generating adjusted EBITDA by the fourth quarter of 2023. From September 21 to September 2022, sales productivity more than doubled from And we've now assembled a team of account managers focused on customer retention and add-on sales. In the third quarter, the revenue loss due to churn as a percentage of total revenue fell 15% year over year. But the most important change has been in the development of a second product line to complement REN's listings marketplace. Digital tools for property managers to market their communities on search engines and social media sites and to respond to inquiries from potential residents. Rent's listings marketplace began adding more clients than it lost in August 2022, but that trend began for digital tools six months earlier in February. As a result, digital tools account for, excuse me, as a result, digital tools accounted for 25% of Rent's third quarter revenue compared to 22% in the third quarter of 2021. Selling property managers both the fish and the fishing poles lets us form more lasting client partnerships. with more than double the revenue per client. One reason Rent has been able to focus on these tools has been the increasing contribution of rentals visits from redfin.com. In June, redfin.com added 12% of rental visits above and beyond the visits to Rent's site. By September, this contribution had grown to 18%. Before we turn the call over to Chris, let's talk about the housing market, which more people are worrying may collapse as it did in 2008. This concern has seemed only half right to us. 2023 sales may decline to levels similar to the great financial crisis. The U.S. population has grown 10% since 2008. But outside of pandemic boom towns like Boise, we expect prices to be more stable because homeowners have more equity today than in 2008, allowing many to sit out this downturn. Mortgage purchase applications in the last week of October fell 41% year-over-year. The number of homes for sale is starting to pile up with a 7% year-over-year increase through the end of October. But that is compared to historically low 2021 levels. The number of new listings on October actually fell 18% year-over-year. This is the season when Redfin's listing customers take their homes off the market for the holidays, but what's different in 2022 is customers' caution about relisting next year. Our agents report that this inventory may not be coming back anytime soon. The problem with demand is that housing has become unaffordable. From October 2020 to October 2022, the monthly payment for an American family buying the median priced home increased by 71%. For that same family to rent a median priced apartment, the monthly payment increased by 24%, still far faster than income growth. of weight, the rate of household formation in late 2022 was less than one quarter what it was at its summer 2020 peak. It will remain that way until the cost of housing declines substantially. Over the summer, home prices eased only slowly in response to higher interest rates. Almost every other debtor in the American economy immediately felt the Fed sting, but homeowners have been reluctant to sell their homes when that involves giving up a 30-year mortgage at a fixed 2.8% rate. If every homeowner had a fixed-rate mortgage, the pricing logjam might never have broken. But builders and iBuyers face higher holding costs and are now the ones forcing prices down in an otherwise deadlocked market. This is a major reason why the seasonally adjusted Case-Shiller Home Price Index, which increased 2.4% from January to February, fell 1.3% from July to August. August data came out on October 25th. The magnitude of both the gain and the drop are nearly unprecedented. Low liquidity adds to the volatility created by massive rate swings. In places like Phoenix and Atlanta, more than 10% of the sales are from home flippers. Home builders are more creative than the iBuyers about pricing, but almost as motivated. One of our Houston agents has seen builders offer a $10,000 check for closing costs, a $3,000 gift card, and a free refrigerator. A Dallas area builder is offering agents $10,000 in extra commissions and a chance to win a Mercedes. More commonly, builders are subsidizing a lower mortgage rate, sometimes by as much as 1.5 points. These incentives, which don't show up in pricing data, are why iBuyers hate holding homes near a new development. Falling prices will eventually spur sales, but the immediate effect on buyers will be discouraging. What this means for Redfin is that the only growth we'll get next year is what we take from others who charge higher fees and offer slower service with a customer experience that often breaks the moment an online visitor asks for help. Taking share in a falling market is always hard, but there's a reason we told investors on the eve of our public offering that we were born in the dark. We've run a mid-margin business through terrible ups and downs. After years of competing against companies with billions in cumulative losses, austerity can feel like a relief. The overriding concern our investors have is whether we can get through this downturn without running out of money. We'll pay our debts come heck or high water, and we'll keep growing. Redfin's still regional listing search site can gain on its rivals for years to come. Our rental business can double. Our brokerage's progress on close rates and loyalty sales can send our share through the roof. Our lending and title business can print money. It's going to be a long night, but Redfin can still thrive in the darkness, and when the sun rises, we'll be stronger than ever. Take it away, Chris.