Redfin Corporation

Greetings and welcome to Redfin Corporation's third quarter 2023 earnings conference call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Meg Nunnally. Thank you. You may begin.

Good afternoon, and welcome to Redfin's Financial Results Conference Call for the third quarter ended September 30, 2023. I'm Meg Nunnally, Redfin's Head of Investor Relations. Joining me on the call today is Glenn Killman, 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 directly comparable GAAP financial measure and related reconciliation. All comparisons made in the course of this call are against the same period in the prior year unless 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. Hi, everyone. Despite a housing market that has gone from bad to worse, Redfin gained share and earned adjusted EBITDA profits in the third quarter of 2023. Our third quarter results from continuing operations show how much more efficient we've become over the last year. Revenue declined year over year by 12%. but gross profits increased by 8%, and adjusted EBITDA improved by $20 million, with improvements in nearly every segment. Including the gain from closing Redfin now, the year-over-year increase in our adjusted EBITDA was $59 million. We've also raised capital. In the third quarter of 2023, we bought $36 million of 2025 debt for $29 million, leaving $235 million remaining. Then, at the end of October, we secured a $250 million loan from Apollo Global Management, which we can use to retire the remainder of our 2025 debt, giving ourselves more time to develop a significantly profitable business before our 2027 convertible notes are due. The share of home sales brokered by our own agents and through referrals to our partner agents also increased from 0.75% in the second quarter of 2023 to 0.78% in the third quarter. Our share is still below its level from a year ago, as we haven't fully recovered from the share loss in the first half of 2023 due to layoffs and the closure of Redfin now. But we're glad to be growing again. For the first time since our earnings call discussing results from the second quarter of 2022, our quarterly guidance forecast the possibility of year-over-year revenue growth. Any growth should be very profitable, as every one of our businesses has gotten more efficient, none more so than our core real estate services business. Despite real estate services' third-quarter transactions declining 20% year-over-year in line with the housing downturn and revenues declining by 16%, Adjusted EBITDA improved by $9 million. There will still be ups and downs, but mostly we plan to keep drawing visitors away from rival sites due to the addition of rentals and now new construction listings. As we recruit a more sales-driven agent with completely variable compensation, we also expect to take more sales from other brokers. We're getting more gross profit from less revenue in part because of increasing contributions from high-margin businesses. The simplest, most significant change in our strategy has been to become more digital by routing more real estate services demand to partners instead of employees and by building our rentals marketplace. This strategy has led to the formation of several new digital businesses, still small enough to be grouped with Title Forward in our other segment. That segment grew 54% and generated more than $3 million in third quarter adjusted EBITDA, up from roughly $50,000 in the third quarter of 2022. Those profits are large to the result of businesses we launched in the second quarter of 2022. A mortgage marketplace for connecting Redfin.com visitors to lenders and display ads on Redfin.com. We expect to develop more sources of digital revenue over the next year. Just last week, Redfin.com published the first batch of new construction listings from Zillow, which we expect to add more than $750,000 in profit per quarter. These digital businesses are only one reason why Redfin's overall gross margins improved from 30% in the third quarter of 2022 to 37% in the third quarter of 2023. Within real estate services over that time, gross margins improved from 26% to 30%. Just as important, Redfin has made ourselves less sensitive to housing's ups and downs. Even as we've developed one digital revenue stream after another, We've gotten out of a business that involved holding hundreds of millions of dollars in houses and launched a pilot eliminating agent salaries. While some of our rivals have made a virtue of spending, Redfin is proud of how quickly and thoroughly we've restructured ourselves to be faster, more efficient, and more competitive. Few companies that have gone through that process have ever wanted to go back. The downturn has made us stronger. Redfin will become more digital over time, but only where it makes sense. Where our own employees can serve our audience better with more profits, we will. We believe having that flexibility when many businesses are either completely reliant on partners or handle virtually every customer themselves will make us more profitable over time. And we'll have more opportunities to earn money from our audience as that audience grows. Comparing the third quarters of 2022 and 2023, visitors to Redfin.com grew by 1%. This was the first year-over-year gain in 2023. This gain has been the result of our increasing ability to compete for traffic against our two historical rivals, Zillow and Realtor.com. According to Comscore data, the gap in year-over-year visitor growth between Redfin and these sites averaged 11 points in the third quarter. We'll continue measuring our progress against our long-time rivals, but have also begun monitoring traffic to CoStarsHomes.com, which has benefited from a major ad campaign since the second quarter of 2023. That Redfin's growth came in the face of this campaign and with U.S. home sales still falling makes it all the more impressive. We attribute our success to a better search experience. We're still drawing more visitors from search engines like Google, and still improving the listing recommendations that keep visitors coming back for more. But the most fundamental improvement may be in how we present search results in a feed that combines listings with market news and agent insights. This growth in Redfin's audience, especially among people looking at rental properties, is only one reason rent earned its first quarterly profit since Redfin acquired rent in April 2021. The revenue booked per salesperson has increased 362% since the third quarter of 2021, when RENT's new leader came on board. In the third quarter of 2023, revenues increased 23% year-over-year, the fourth straight quarter of growth after years of declines. RENT's third quarter net bookings, which are the annualized revenues added through sales to new customers, less the annualized revenues lost from departing customers, grew 51% year-over-year. We expect Rent's growth to continue, especially in its core online marketplace for connecting potential tenants to properties. We're also driving sales from an expanded line of digital marketing solutions for promoting our customers' apartment buildings on search engines and social media sites. Unmatched by our largest rentals competitors, these products help us open new accounts with customers who are trying to reduce the number of specialized marketing vendors that they pay. To keep growing our marketplace, our focus will be on generating more traffic and tenant inquiries. After a year of rebranding as Rent and unifying the code base for rent.com and apartmentguide.com, Rent is now able to invest in tried and true demand driving tactics, email campaigns, improvements on our mobile applications user experience, efficiency gains in search engine marketing, and machine learning based software for engaging visitors. This is why we're optimistic that Rent's growth will continue. Even as we gain strength in our digital businesses, we're also reducing fixed costs in our core business of brokering home sales. We've begun hiring Redfin agents in San Francisco and L.A. on the promise of a new, all-variable compensation plan, which takes effect January 1st. The goal of this new pay plan, which we're calling Redfin Max, is to offer agents the best of both worlds. On self-sourced sales, our agents will keep as much as 75% of the commission. which compares favorably with what many traditional brokers pay. But unlike many traditional brokers, Redfin will also offer agents the support staff and customer introductions to build a larger business. We're not aiming to make much money on agent self-sourced sales, as few traditional brokers have ever earned a decent margin. Our goal is to recruit agents who can close Redfin sourced sales at a high rate. The margins on Redfin sourced sales should remain well above those of other brokers. Even if Max agent sales turn out to be largely self-sourced, lowering margins on a larger volume of sales in our pilot markets, the impact on Redfin's overall gross margin will be negligible. We won't extend Redfin Max to a large number of markets unless we become convinced that it will net more gross profits. For Max to succeed, a new cohort of motivated, high-caliber agents has to close only a few more sales each year than we normally would with the same set of site-sourced opportunities. This is a bold change, but not as bold as it could have been. The Redfin Max plan still employs our agents because we know from experience with online inquiries how important it is to take a team-based, systematic approach with customers who want immediate service from an agent assigned to them by our site. Employing agents also lets us ensure the agents put the customer first. But all variable pay should let us hire more agents in max markets so we can bet more on growth with less at risk for Redfin through a downturn. The reception so far to Redfin Max has been good. From October 16th, when recruiters first got the max materials through October 31st, six agents already agreed to join us. Candidates we'd been courting for months signed on, almost on the spot, saying this plan made the decision easy. Several agents who long ago left Redfin contacted me the week of the launch to ask about coming back. Our goal is to add about 60 top producing agents in San Francisco and L.A. Redfin Max is one of several big changes afoot at our brokerage. We began developing several others the week of September 10th when Jason Aleem assumed sole responsibility for our brokerage. For example, we're now testing incentives for customers who buy a Redfin listing. or who commit to hiring a Redfin agent early in their home search. We're overturning our most intricate systems for scheduling tours and assigning customers to ensure our best salespeople host our first meeting with the customer, when before we'd scheduled those tours with contractors. Already, this has led to a double-digit increase in the percentage of customers met on their first tour by our salespeople. The remainder are still meeting the contractors we call on for backup property access. We'll keep you posted on whether Redfin Max agents can succeed in our system or if our other new initiatives drive sales. What investors should know now is that our brokerage is moving fast in simplifying its policies. The more analytical approach we've had in the past let us optimize the sales tactics of a large sales force in a stable market. But in a more volatile, competitive market filled with solo practitioners who can turn on a dime, we're taking more risk to go on the attack. The speed and scale of these initiatives would have been unimaginable in prior years. As our brokerage gains market share, we'll also get more title and mortgage sales. The attach rate for our title business increased from 39% in the third quarter of 2022 to 57% in the third quarter of 2023. 18% of our brokerage's third quarter home buyers use Bay Equity for a mortgage, up from 17% in the third quarter of 2022. In the second quarter of 2023, Bay Equity's attach rate was 19%. Both Bay Equity and Title Forward remained vigilant about costs, having laid off employees in October to improve profits in a falling housing market. As we said in our last earnings call, we expect that lifting lending attach rates much above 15% will take time, especially when the proportion of all cash buyers is rising in step with interest rates. But we believe a long-term attach rate goal of between 25% and 30% is still realistic. We're now experimenting with new incentives for managers and, where the law allows, for agents. The investments we've made in handling every aspect of a customer's move, those investments aren't paying off now because no one in the lending industry is making much money. But when rates ease, whether in 2024 or beyond, the equities gains on sale will likely increase. Easing price pressure may lead to higher brokerage attach rates, And a refinancing business will boom. Before turning to the housing market, let's discuss the $1.8 billion verdict in the federal class action lawsuit in Missouri against the National Association of Realtors and several major brokers. This is an outcome that Redfin has long prepared for. From the day years ago that we launched a brokerage to give consumers a better deal up to last month when we were the first major real estate company to announce our break with the National Association of Realtors. The Missouri verdict may lead to reforms in how agents talk to listing customers about the fee offered to buyer's agents. The litigation has already led the National Association of Realtors to change its guidelines to local multiple listing services, which will now accept listings that don't offer a commission to buyer's agents. Redfin has long counseled our agents to support any fee a listing customer wants to pay a buyer's agent. Alone, among major brokerages, we exist to charge customers lower fees. But the Missouri verdict and other court cases may lead to a revolution in our industry, not just reform. If buyer's agents become less common, Redfin will prosper in that world, too. We run the largest brokerage website in America, as well as a national network of contractors trained and licensed to provide low-cost, on-demand property access. We've built self-service technology for buyers to set up their own tours and to make offers on our listing without a buyer's agent. We can use that technology to market the properties listed by our agents directly to consumers, taking share from other brokerages. And we may open that platform to other listing agents who work with us as partners. We've sometimes been ahead of our time. If a massive disruption is in fact at hand, we aren't going to fall behind now. With that said, let's discuss the housing market. Goldman Sachs last week forecasted existing home sales will fall further. from 4.1 million units in 2023 to 3.8 million in 2024, a level not reached since 1993, when the US population was 22% smaller. US gross domestic product grew at a blistering 4.9% in the third quarter of 2023, keeping the pressure on the Federal Reserve to hold interest rates higher for longer. Even as war, political gridlock, and sovereign debt have put the global economy on a knife's edge, But now, like Satan in Paradise Lost, surveying the dismal expanse of rocks, caves, lakes, fens, bogs, and dens of his new home in hell, I feel a twinge of optimism. If homes were only a speculative asset, our sales prospects would indeed be grim. But most people buy a home to move to a better life. Those plans can be deferred from 2022 to 2023, but not forever. The number of people asking for listing consultations increased meaningfully in the closing weeks of October as part of an overall year-over-year increase in customers contacting Redfin agents. For the first time in years, we see signs that home prices may soften, a welcome development for home sales and for America when affordability has been at a four-decade low. Owners always mark listings down that didn't sell in the summer, but there are more price drops this fall since at least 2015. We know from our experience building Redfin through the multi-year great financial crisis how false starts can break your heart. In such a volatile market, any full-year projection, even one from Goldman Sachs, is mostly just gizzard-squeezing guesswork. For now, we have to assume that next year will start like this one is ending, with a whimper. Chris and I will run Redfin from quarter to quarter, rejecting most discretionary expenses until the housing market improves. This will be especially true in the first quarter, which in most of Redfin's loss-making years has accounted for nearly our entire loss. In the past, we've made investments in the first quarter based on the number of sales we expect to close in the third quarter. But in 2024, we'll defer many of those expenses until we can see if any rate relief is likely to come in time for the summer home buying season. We can't entirely avoid a seasonal first quarter loss. but minimizing it will give us more ways to win through the rest of the year. As we've planned for 2024, a phrase from my youth has often come back to me. When we both were just graduating from college, my identical twin brother broke his leg very badly. In the hospital, he was all sweat, skin, and bones. Since he couldn't go to the store himself, my contribution to his recovery was a low-fat regimen of muscle-building, grape-nut cereal. During his physical therapy sessions, I'd yell, 100% pure grape nuts. The science was dubious, but ever since, he has been able to run a mile faster than I can. Redfin has suffered its own setbacks, but now we're running faster than ever before. Hardly a day goes by that I don't say to myself, 100% pure grape nuts. Take it away, Chris.