I know, I know. We have talked a ton about Redfin and Realogy and Keller Williams in these pages the past couple of months. It’s because the 2017 earnings reports were released for two of them, and the other one… well, made some bold moves and bolder statements. And the rest of the industry wants to talk about eXp and Compass and iBuyers and HUGE FOUNTAINS OF VENTURE MONEY!!!ZOMG!1!1!
But lost in the shuffle is one company that is pseudo-public: HomeServices of America. It’s still the second largest brokerage in the country. And it’s a wholly-owned subsidiary of Berkshire Hathaway Energy. Say what? What in the world does real estate brokerage have to do with power plants and electric utilities? Nothing, as far as I can tell, but it’s how Warren Buffett wanted to structure that acquisition so… that’s where you find the tidbits of information, in the 10K for BHE, a giant holding company of various power utilities.
Obviously, there is no analyst earnings call (or at least, none that I could find). There is the usual Letter to Shareholders from Warren Buffett. But BerkshireHathaway does not do things the normal way. So there isn’t much granularity to comments there, though I do want to touch on them.
Here’s the thing, and the reason why I’m writing this. We have to talk about HomeServices. Something’s going on there, and it’s not good news for traditional brokerages. Taken together with challenges facing Realogy, and the recent developments at Keller Williams, it is yet another hint that we’re at an inflection point of some sort.
Without more detail, it’s impossible to conclude anything solid. But hey, this ain’t an analyst report; it’s a blogpost for the industry. So let’s do this.
HomeServices by Volume and Transaction Sides
Thankfully, we have some additional numbers for HomeServices thanks to the invaluable RealTrends 500 by Steve Murray and team which was just released. And as has been the case since like forever, HomeServices is second only to Realogy… and it’s not close.
- 2017 Volume of $125,423,556,020 (gotta love the Andrew Jackson tacked on for precision, don’t you?)
- 2017 Transaction Sides of 328,355
For the purpose of comparison, the top five by Transaction Sides look like this:
|2||HomeServices of America, Inc.||Minneapolis||MN||328,355|
|4||Keller Williams Realty, GO Management Offices||Arlington||TX||34,077|
For Volume, we have this:
|2||HomeServices of America, Inc.||Minneapolis||MN||$125,423,556,020|
|3||Douglas Elliman Real Estate||New York||NY||$26,115,055,090|
|5||Pacific Union International||San Francisco||CA||$14,139,205,239|
Four things to talk about with this Top Five list.
First is the obvious one: HomeServices is breathing down Realogy’s neck. That gap used to be far larger. The reason, of course, is that in 2017, HomeServices acquired the third largest brokerage by volume, Long & Foster.
Thanks to Inman News, we have the numbers from last year:
|2||HomeServices of America, Inc.||Minneapolis||MN||245,154|
|4||Long & Foster Companies, Inc.||Chantilly||VA||81,032|
And for Volume from last year:
|2||HomeServices of America, Inc.||Minneapolis||MN||$86,009,311,021|
|3||Long & Foster Companies, Inc.||Chantilly||VA||$28,934,452,173|
|4||Douglas Elliman||Huntington Station||NY||$24,551,000,000|
The observant reader who can do simple math will quickly realize that the 2017 numbers for HomeServices is only 2,169 transaction sides and $10.4 billion more than the combined 2016 numbers for HomeServices and Long & Foster. That is 0.66% and 9.12% growth, respectively.
Second thing about that list (quite apart from RealtyOneGroup just disappearing into thin air off the list completely, which is strange… and likely means they didn’t report their numbers to Steve Murray at all) is the giant gap between #2 HomeServices and #3 Hanna Holdings or Douglas Elliman. HomeServices is some 3.6 times larger than Hanna by Transaction Sides, and 4.8 times larger than Douglas Elliman. In other words, it’s starting to look a little bit like HomeDepot and Lowes… and everybody else.
Or does it?
Because the third thing about that list is not on the list at all. It’s the glaring absence, the deafening silence. And one can’t blame Steve Murray or his team at RealTrends, because I’m certain that the actual brokerage who is #4 by Sides and #3 by Volume did not bother to report to RealTrends.
That would be Redfin, who didn’t tell RealTrends but did tell Wall Street that they did 35,038 Transaction Sides and $21.28 billion in Volume (not counting referrals to Partner Agents).
Let that sink in for a minute.
The fourth and final thing is just an oddity. I don’t know how to square the circle on this, but maybe the guys at RealTrends or HomeServices can. In the BHE 10-K, we find this mention:
HomeServices closed over $107.8 billion of home sales in 2017, up 24.6% from 2016, and continued to grow its brokerage, mortgage and franchise businesses. HomeServices’ franchise business operates in 47 states with over 365 franchisees throughout the country.
Is this number correct? Or the RealTrends number correct? Could it be that the 10-K number somehow excludes the numbers for Long & Foster prior to the close of acquisition?
Who knows? I don’t know and frankly, I don’t know that I care all that much. Because the impact of all those transactions and all that volume is really murky, to say the least.
HomeServices by Revenue and Profitability
This is where things get a bit tricky. As we all know, HomeServices of America is not just a brokerage. It’s a vertically-integrated one-stop-shop with mortgage, title, escrow, insurance, relocation and franchising (under the boy-that’s-a-mouthful BerkshireHathaway HomeServices brand).
Since it’s just one small part of a giant energy holding company, BHE isn’t going to break out sub-segment information to tell us what part of HomeServices was brokerage alone (which is the part I’m truly interested in for a lot of reasons).
Having said that, here’s what BHE’s 10-K tells us about HomeServices:
- Revenues of $3.443 billion
- Operating Income of $214 million, 6.2% operating margin
- Net Income of $149 million, 4.3% profit margin
I’ve usually equated operating income/margin to Company Dollar, since for brokerages, the only real Cost of Goods Sold is the agent split. But that obviously doesn’t work here, since HomeServices here is the conglomerate, not just the brokerage. Nonetheless, operating income of $214 million on revenues of $3.4 billion? That’s 6.2% operating margin. Hard to call that extraordinarily healthy. 4.3% profit margin isn’t amazing either.
It gets worse, however.
In the notes, we find this paragraph:
Operating revenue increased $642 million for 2017 compared to 2016 due to an increase from acquired businesses totaling $542 million and a 4% increase in average home sales prices for existing brokerage businesses. Operating income increased $2 million for 2017 compared to 2016 primarily due to higher earnings from franchise businesses, partially offset by lower earnings from brokerage businesses mainly due to higher operating expenses at existing businesses. [Emphasis added]
So adding Long & Foster, the third largest brokerage in the country with its own affiliated business lines, was responsible for more than 5/6th of the gain in revenues… which means that the core organic growth of HomeServices was only $100 million in revenue year over year or 3.6%?
What’s more, the Operating Income number went up by $2 million, or less than 1%, after adding Long & Foster because “lower earnings from brokerage businesses” offset higher earnings from franchise businesses? What in the world is going on here? Well, the reason is right there: “higher operating expenses at existing businesses.”
Oh, and that Net Income number? Not that impressive, unfortunately:
HomeServices’ net income increased $22 million, including $31 million of income from 2017 Tax Reform. Excluding the impact of 2017 Tax Reform, adjusted net income was $118 million, a decrease of $9 million compared to 2016, primarily due to lower earnings at acquired and existing brokerage businesses, partially offset by higher earnings at existing franchise businesses. [Emphasis added]
In other words, without the Trump Tax Cut, HomeServices would have shrunk profits by $9 million after adding the third largest brokerage in the country by volume? Am I reading this correctly?
The 2016 version of HomeServices made $9 million more than the 2017 version, with far fewer transactions and far lower sales volume? Could this be correct?
Of course it could. Once again, the drag on earnings is the “acquired and existing brokerage businesses.”
Speaking of Long & Foster
A couple of interesting things to note on the Biggest Acquisition Ever in Real Estate Brokerage! I mean, people were talking about it for weeks. The terms of the deal were not disclosed, so no one had any idea what the third largest brokerage by Sales Volume with over 11,000 agents in more than 230 offices across some of the most valuable real estate markets in the country in Washington DC Metro area was worth! Especially once you figure in all of the mortgage, title, escrow, insurance, and so on.
We don’t know the answer fully, but we have some hints now.
Let’s turn to the BHE 10-K:
In 2017, the Company completed various acquisitions totaling $1.1 billion, net of cash acquired. The purchase price for each acquisition was allocated to the assets acquired and liabilities assumed, which primarily related to residential real estate brokerage businesses, development and construction costs for the 110-megawatt Alamo 6 and the 50-megawatt Pearl solar projects, and the remaining 25% interest in the Silverhawk natural gas-fueled generation facility at Nevada Power. As a result of the various acquisitions, the Company acquired assets of $1.1 billion, assumed liabilities of $487 million and recognized goodwill of $508 million.
Now, in the notes, we find that the $508 million of goodwill was in fact charged to HomeServices. So we know for a fact that Long & Foster (and Houlihan Lawrence, another major acquisition overshadowed by the big deal) had to be the cause of that goodwill.
I found out that the 110-megawatt Alamo 6 (and possibly the 50-megawatt Pearl project) was sold to an undisclosed buyer for $385 million. I saw no goodwill charge on BHE’s notes. Also, looks like the remaining 25% interest in Silverhawk cost BHE $77 million.
Obviously, there may have been other smaller acquisitions by BHE’s various energy companies and utilities that weren’t big enough to warrant mentioning by name. But subtract those from $1.1 billion and we get $638 million. The assumed liabilities… well, if you want to figure those out for solar arrays and hydropower plants, be my guest. I’m not going to bother.
That means, Long & Foster went for some price more than $508 million and less than $638 million since we know for a fact that Houlihan Lawrence was also purchased in 2017. That seems like a lot of money at first, until we realize that we’re talking about the third largest brokerage in the country by volume in 2016.
Remember Redfin? The new #3 brokerage by volume who doesn’t report to RealTrends? As of this writing, Redfin’s market cap is $1.87 billion. Compass? With the $450 million from Softbank, its valuation is around $2.2 billion. Compared to that, suddenly the $600 million or so that HomeServices paid doesn’t look so amazing.
Look, it may be that Redfin and Compass investors are going to be really, really sad and pissed off in a few years because they’re overpaying for what are basically brokerage stocks by ginormous multiples. That is entirely possible.
On the other hand, if HomeServices paid around $600 million for Long & Foster, to see profits drop by $9 million due to “lower earnings at acquired and existing brokerage businesses,” well… you don’t exactly make that up in volume. That’s an unmitigated disaster.
Final Note: Warren Buffett Speaks
We can’t end this look at HomeServices without referencing the Letter to Shareholders that Warren Buffett puts out every year. Because he mentions HomeServices by name and real estate brokerage.
Here’s what he writes:
I have told you several times about HomeServices, our growing real estate brokerage operation. Berkshire backed into this business in 2000 when we acquired a majority interest in MidAmerican Energy (now named Berkshire Hathaway Energy). MidAmerican’s activities were then largely in the electric utility field, and I originally paid little attention to HomeServices.
But, year-by-year, the company added brokers and, by the end of 2016, HomeServices was the second-largest brokerage operation in the country – still ranking, though, far behind the leader, Realogy. In 2017, however, HomeServices’ growth exploded. We acquired the industry’s third-largest operator, Long and Foster; number 12, Houlihan Lawrence; and Gloria Nilson.
With those purchases we added 12,300 agents, raising our total to 40,950. HomeServices is now close to leading the country in home sales, having participated (including our three acquisitions pro-forma) in $127 billion of “sides” during 2017. To explain that term, there are two “sides” to every transaction; if we represent both buyer and seller, the dollar value of the transaction is counted twice.
Despite its recent acquisitions, HomeServices is on track to do only about 3% of the country’s home brokerage business in 2018. That leaves 97% to go. Given sensible prices, we will keep adding brokers in this most fundamental of businesses. [Emphasis added]
Well, those are some encouraging words from Mr. Buffett; I do believe that the folks over at HomeServices can relax a touch knowing that he’s impressed with the growth and plans to keep adding to HomeServices.
The $9 million drop in net income of HomeServices isn’t even a rounding error for Berkshire Hathaway. Even the $3.4 billion in revenues (not profits, but revenues) is ho-hum for Berkshire Hathaway. Here’s what Buffett wrote:
Viewed as a group – and excluding investment income – our operations other than insurance delivered pretax income of $20 billion in 2017, an increase of $950 million over 2016. About 44% of the 2017 profit came from two subsidiaries. BNSF, our railroad, and Berkshire Hathaway Energy (of which we own 90.2%).
Their pre-tax profits were $20 billion in 2017. They have $116 billion in cash and US Treasuries just sitting there earning next to nothing, waiting to be invested. Buffett said so in his letter.
If Buffett thought it worth his while, he could buy the top 100 brokerages on the RealTrends 500 list (including all of Realogy, Redfin and Compass), plus Zillow and Move and pay cash.
So why doesn’t he? HomeServices could literally have 50% market share and the top three portals tomorrow if Buffett wanted to.
I have no idea, but I do have a hypothesis: brokerages don’t make enough money for the risks involved. 10-year U.S. Treasuries are yielding about 2.8% as of this writing, and for all intents and purposes, that is risk-free. HomeServices generated net income of 4.3% (and 3.4% without the Trump tax cuts)… most definitely not risk-free.
150bps with the risk of downside? I wouldn’t invest millions, never mind billions, in that “opportunity.” Would you?
What Can We Conclude? Anything?
As I wrote up top at the start, it’s impossible to conclude anything solid without far more detail. Sub-segment information, breaking out brokerage operations from mortgage, title, insurance, etc. would be a start. But I don’t see the giant that is BHE doing that to satisfy a little blogger.
But add up the hints, the drips of information:
- Core revenues up only $100 million, or 3.6%, prior to acquisitions;
- A mere $2 million increase in operating profits after adding the #3, #12 brokerages in the country to the #2 brokerage;
- A decrease of $9 million in net income;
- All due to “lower earnings at acquired and existing brokerage businesses”
I don’t know what else to infer, and I don’t know how else to say it, but here’s what I am forced to conclude: traditional brokerage in the United States is in trouble. Agent team economics, competition from low-cost operators, competition for top-producers (best exemplified by Compass, but let’s not pretend that Compass is the only player in that game), competition from tech-hybrids, competition from change-the-whole-damn-game guys like Opendoor and Offerpad and Knock….
Add into this mix the fact that Realogy’s NRT unit had 4.2% EBITDA margins, and Keller Williams has pivoted to be a technology company… and one other factor….
This is happening during one of the strongest real estate markets in recent history, with home prices up 6.2% year over year. The only knock on the market today is low inventory, but economists are saying there’s no sign of a bubble. The economy is strong, demand is high, houses are selling like hotcakes!
And brokerages are doing that in this market?
Let me make a point here in closing. Because I know some of you are going to do some triumphant chest-puffing thing here, and say something along the lines of, “Well, that’s because HomeServices is badly mismanaged by a bunch of has-beens who don’t get it!” or some such. I know somebody is thinking, “That’s because the culture sucks there, unlike at my awesome 8-person brokerage where my agents just loooove me!”
Tap them brakes a bit. Like Realogy, HomeServices is filled with some incredible leaders and talented operators. Sure, they likely have some who aren’t amazing, like any large company, but people like Jeff Detwiler, Candace Adams, Larry Flick IV, Greg Mason, Rosey Koberlein, Mary Lee Blaylock, and all of the company managers under them didn’t fail their way to the top of the industry. They’re all smart, successful, personable leaders widely respected by people who work for them and with them. Ron Peltier and Dana Strandmo did not get to where they are because they’re incompetent. They’re really, really good at this brokerage thing.
Maybe I’m wrong about that, but having met many of them in person, I really don’t think so. I think these are very smart businesspeople, very astute operators, who really understand the brokerage business, who are turning in results like the above. The problem isn’t incompetence. The problem is structural.
There’s something going on, and I think we’re close to an inflection point of some sort. What that is, I don’t know, and when it “inflects,” I have no idea. But pay attention. The sign flashes out its warning, in the words that it was forming.