If you managed to make it all the way through the massive post that was Part 1, let me thank you first of all and congratulate you on your powers of focus and concentration. I must warn you that this Part 2 is quite likely to be very, very long as well.

We might start with why we care about what might be seen as a minor business decision. A massive real estate brokerage decides to shutter a few office locations and offer positions in its larger operation to the agents there. Like, who cares?

Here’s why I care.

First, Realogy is the only publicly traded traditional brokerage. It is one of two publicly traded franchise companies, with RE/MAX being the other. It is either the most important company in residential real estate, or one of the five most important depending on your analytical framework, and it gives us all a read on what is going on with the real estate industry.

Second, as anyone who has been reading this blog for a while knows, I have a soft spot in my heart for Realogy because that is really where my real estate career started. That doesn’t mean I won’t call it like I see it, but it might explain my interest in Realogy even though I have no financial position in the company.

This Part 2 involves no reporting, no interviews with people on the ground (all of that has already been done), no trying to find out the truth of a story. This is just my take on what the decision means for Realogy specifically, and for the industry more generally. It is, if you will, pure speculation based on analysis of what’s known already. Let me re-emphasize that word: speculation.

Let me also emphasize that I am not a Wall Street analyst; I have no position in Realogy long or short and do not do what financial analysts do. I am an industry analyst, and if my thoughts are helpful to finance people, they can make up their own minds about Realogy as an investment. I’m looking at Realogy as a company, as a player in the industry.

Caveats done, let’s get into it.

The Questions from Part 1

Let me start with the questions with which I ended Part 1. I have received no answers to any of them, but they form the basis of my thinking.

The Narrative According to Realogy

In Part 1, I spent a ton of time teasing out and constructing the narrative from Realogy’s perspective. Adding the Gorman interview with the email answers from Trey Sarten, we get something like this:

We bought Climb in 2016 to learn all we can about the culture of innovation, about experimentation, about failing fast to drive ultimate success. We learned all of that, have deployed it across Realogy, and no longer needed Climb for that.

Franchising the Climb brand would have taken years to get to scale, and we didn’t want to hurt the Climb agents who didn’t have access to the full range of value that Coldwell Banker could provide. Plus, Climb was never intended to be the first new brand; Corcoran was. So it’s really no big deal that we chose not to pursue Climb as a franchise brand.

We shut down Climb the brokerage in order to give Climb agents all of the wonderful tools at Coldwell Banker, which they could not get as a small brand/division of the NRT. And now that those agents know just how much we have changed, and just how awesome our value proposition is, they’re excited and positive about the future.

We’re not shutting down Corcoran because it provides “legendary agent support” and is one of the largest brokerages in NYC with an awesome international reputation. Plus, it has 2,300 agents which is more than 10x what Climb had.

Makes a lot of sense, that story, at first glance. Maybe even on the second glance.

But it didn’t make sense to me, and I have spent hours trying to figure out why not. I’ll explain why, and then give you an alternative narrative that I think makes far more sense.

The Itch I Can’t Scratch

There’s an itch I can’t scratch with the Realogy narrative: just how much was Climb costing Realogy every year?

In my post about Realogy’s earnings release from Q3/2019, I noted that despite its problems, Realogy turned in a pretty strong EBITDA number at $245 million, and $174 million in free cash flow. Realogy paid down some more debt, to the tune of $163 million.

You can’t tell me that Climb was costing Realogy $100 million a quarter. I don’t know that Climb — a 5-office brokerage with 200-ish agents that was making revenue (if not profit, although I don’t know as I’m not privy to Climb’s financials) — was costing Realogy that much money.

I happen to have financials of other traditional brokerages with multiple office locations and a few hundred agents from my consulting practice. They don’t make much money, but we’re talking tens of thousands of dollars a year, not tens of millions.

NRT as a whole posted $31 million in EBITDA in Q3/2019. With NRT having 50,227 agents at the end of 2018, Climb is maybe 0.4% of the agent base of NRT. There is no way that Climb was costing NRT millions of dollars a quarter. I just can’t see how the math works out like that knowing what I know about traditional brokerages.

But let’s say it was costing NRT/Realogy a ton of money. How much? Who knows, but is it even reasonable to think that NRT was losing $10 million a year with Climb? Not to me; that doesn’t smell right. Maybe, maybe, due to profligate spending on expensive San Francisco real estate, Climb was losing Realogy $5 million a year. A big number, and one that I think is on the extreme end of possibilities, but let’s say it was $5 million for the sake of discussion.

Investment into the Future?

Recall that when Realogy announced the Climb and Corcoran brands in Q3/2018, Ryan Schneider positioned both as the key to long-term growth:

“Realogy serves more aspects of the real estate transaction than any other entity with an incredible legacy of shepherding and growing some of the most well-known and respected brands in the industry,” said Ryan Schneider, Realogy CEO and president. “The decision to add two new franchise options to our portfolio is critical to Realogy’s long-term organic growth strategy, and we believe demand for Corcoran and Climb will help us unlock additional franchisee opportunities, drive productive agent recruitment, and, ultimately, capture more share of the market.” [Emphasis added]

This wasn’t positioned as a test, or a trial, or “let’s throw something on the wall and see if it sticks.” This was positioned as being critical to Realogy’s long-term organic growth strategy.

Even if you’re losing $5 million a year on one half of that initiative that is critical to long-term growth, isn’t that an investment worth making when you’re generating $174 million in free cash flow in a quarter?

Consider for a moment why Realogy, the largest real estate company in residential real estate, has a market cap of $1 billion (as of this writing) when small-ish upstart eXp has a market cap of $633 million. Broadly speaking it’s because of (1) debt, and (2) lack of growth.

As we saw throughout 2019, Realogy is doing something about the debt; it is paying them down as quickly as it can. But on growth? We got the same old same old “we’re focusing on recruiting and retention” spiel that literally every single brokerage throughout North America says. All of the initiatives announced by Realogy for the past couple of years — RealSure, RealVitalize, Turnkey, Listing Concierge, etc. etc. — are all in the nature of “this will help us recruit and retain more agents.”

The one clear example of Realogy doing something about growth was the two new brands: Corcoran and Climb.

And now Realogy is abandoning half of that initiative? Over a couple of million bucks a year (hypothetically)?

That makes no sense to me. None at all. And that’s the itch I can’t scratch.

Speaking of Growth… Where is Corcoran?

So Climb is shut down, okay. No investment there, okay.

What about Corcoran? The golden child of New York City with its amazing international brand?

It now seems odd to me that after the Q4/2018 earnings call, when Schneider mentioned that Corcoran will go first, and that Climb’s FDD’s had not even been filed, there was not a single mention of Corcoran as a franchise brand throughout 2019. There has not been a single press release anywhere celebrating the sale of the first Corcoran franchise to anybody.

Note that in 2018, Schneider specifically called out launching Corcoran in early 2019 as an investment:

Second, on the strategic side. We are proactively investing in the business to strengthen our position over the medium term. Some examples of our new investments in 2019 include: launching Corcoran in early 2019 as a franchise brand, investing in new technology and data products for both agents and franchisees, starting new lead generation partnerships, and expanding our suite of new marketing products to enhance our agent value proposition.

Well, 2019 has come and gone. No announcement. No word.

Has Realogy sold a single Corcoran franchise in the course of an entire year? Did they just forget to mention such an important long-term growth event to anybody?

If anything, that deafening silence on the Corcoran front concerns me deeply.

Core Competencies

Every company large or small, great or bad, has core competencies: Google is good at coding, Exxon-Mobil is good at extracting oil and gas, Audi is good at building cars, etc. What are Realogy’s core competencies?

Whatever else Realogy is good at, its core competencies have to be (1) recruiting and retaining agents, and (2) selling franchises, don’t they? Those two things are the foundation for the whole company existing: NRT recruits agents, and RFG sells franchises. This is the blocking and tackling upon which the rest of the enterprise is built.

The silence on the Corcoran brand front, combined with the shutting down of the Climb franchise brand, have to make you wonder if Realogy has lost a step in its core competency of selling franchises.

Go back and re-read the announcement from October of 2018. Go re-read in Part 1 what Trey Sarten said about Corcoran being this amazing brand with a great international reputation.

Now then, the lack of action on the Corcoran front suggests one of two possibilities:

  1. There was little demand for a Corcoran brand, no matter its international reputation in global megacities; or
  2. There was enormous demand, but Realogy couldn’t close the sale for whatever reason.

Which possibility is more concerning for Realogy? That brokerage demand for real estate brands is low? Or that Realogy’s franchise sales team couldn’t get the ball over the line from brokers who inquired?

My Narrative

Taking everything into account, I think this is the narrative that makes more sense. I’ll explain how and why I came to this narrative as well.

Realogy acquires Climb back in 2016 to be a new franchise brand for Realogy, focusing on younger consumers and agents, as well as urban markets other than NYC (where it already owned Corcoran). It makes perfect sense for Realogy, which has two of the most popular brands in real estate in Coldwell Banker and Century 21, but neither are exactly “youth brands” that the rising Millennial consumers and agents will find awesome (especially back in 2016, prior to all of the evolution Ryan Gorman discussed.) To a 30-something REALTOR, they are your father’s real estate brand.

There is a change in leadership from Richard Smith to Ryan Schneider, who comes in from day one talking about the size and scale of Realogy. Climb is tiny, and it was the prior regime who acquired it, so he has no special affinity for Climb. Frankly, he has bigger fish to fry.

Compounding the problem, there is no one in New Jersey who is a champion of the new young urban brand. Sherry Chris, the CEO of BHG, was put in charge of the brand at some point but it’s not her baby; she has her own main brand to worry about. She did the best job she could do, but again, her priority is BHG.

Somewhere along the line, a business plan is produced for the Climb franchise brand and is approved. There is no way that Realogy makes the October 2018 announcement without somebody somewhere approving some kind of a business plan. So there is an initial set of assumptions, plans, numbers, etc. that makes sense to Realogy senior management at some point before October of 2018.

Right after the announcement is made, they look more carefully at the Climb business plan (that comes from the Mark Choey interview). They — which apparently does not include the Climb leadership — decide to nix the launch or at least delay it. Corcoran will go first as the new franchise brand. The FDD’s are not even filed for Climb.

More I think about it, more I am inclined to believe that the Climb franchise must have been a different business model from the standard Realogy franchise model. If Climb, a little-known regional brand out of San Francisco, were going to have any traction with brokers looking to affiliate, it doesn’t seem logical that it could go out with the same pricing structure as the rest of Realogy brands: high initial fees, 6% royalties, 2% National Advertising Fund, etc. etc. If I’m a broker and I’m paying that much money for a brand, then I’d rather have one of the more established brands like Coldwell Banker or Sotheby’s or whatever.

I believe Climb was likely a low-cost model designed to appeal to younger brokers and agents who perhaps didn’t have the financial ability to buy a “normal” Realogy franchise. That likely means it was aimed at growth instead of profitability. That was likely what they (whoever that might be) saw that soured them on Climb. Why?

It has been clear for a while that Schneider emphasizes profitability over market share or even growth. For example, in the Q3/19 earnings call, he says, “Given the choice between profitability and market share, we do choose profitability and you are seeing the market share impact of that choice in our results.”

Later in the call, in obliquely talking about Compass, Schneider says:

During this whole time, we’ve stayed focused on recruiting profitable agents and not making unprofitable decisions. While big revenue headline numbers are interesting and no one has bigger revenue numbers than ours in our industry, we operate for profitability.

The fact that Climb, along with everybody else in the San Francisco area, got hammered by Compass in 2018 does not help its cause if the emphasis at corporate is on profitability.

So Realogy enters 2019 with Climb on the shelf and Corcoran its lead horse in selling new franchises. Corcoran, a more upscale brand with a good international reputation in global megacities and vacation hotspots (think Vail, Aspen, Palm Beach, etc.), is a premium brand at a premium price. That’s more in line with Realogy’s existing franchise model. A premium brand is also more likely to generate more of a profit.

For whatever reason, Realogy is unable to sell Corcoran franchises. Who knows why? Maybe it’s the price, maybe it’s the lesser known brand, maybe it’s that major luxury independents (the only brokerages that would find Corcoran intriguing) don’t feel they need a franchise brand. Maybe it’s that Realogy Franchise Sales lost people and couldn’t replace them. Who knows?

What we do know is that Realogy made zero announcements about selling a Corcoran brand to anyone throughout 2019. I think that was fatal for Climb.

Consider: Climb is an unknown regional brand, that likely sells at a discount to prevailing Realogy franchise models, to brokers and agents that Realogy has little experience in selling to. The franchise sales team likely doesn’t even have contacts and relationships with such smaller companies, younger brokers, or agent teams. So if the franchise sales guys had trouble selling Corcoran to their core audience of established brokerages, what chance would they have selling Climb to a whole new set of brokers and agents? Time to put Climb out of its misery.

When the decision to kill off Climb is made, Sherry Chris would have had to go to bat for the brand. But as mentioned above and by Choey, Chris has her own brand (and after the organization changes of 2019, all Emerging Brands) to worry about. A tiny unproven brand with alternative business models was not likely her top priority.

Hence, the shutdown of Climb.

That’s the narrative I’ve come up with to explain why Realogy did what they did. I’m not going to pretend like that’s the truth. But I will say that it might be like one of those movies “based on a true story” that ends up with more than a grain of truth in it.

Implications for Realogy

If my “based on a true story” narrative is correct, what are its implications for Realogy?

I’m afraid none of them are particularly good for the grand old company.

Luxury of Time

The first implication is that Realogy in 2020 is willing to sacrifice long term growth for profitability and cash flow. The question is why.

I think the answer has to be debt. Realogy knows that one of its core problems is the massive debt it is carrying around. The debt is depressing stock prices, limiting the kinds of moves it can make, and is a serious albatross around its neck. Realogy has to do everything in its power to pay down that debt as quickly as possible.

Long-term growth is nice and all, but not if you never get to the long-term.

That in turn implies that Schneider and the rest of the senior management at Realogy do not believe they have the luxury of time. Who knows why? Perhaps they’re on a hot seat of some kind, or there’s something else behind the scenes we’re not aware of. But the episode makes me think that Realogy does not think it has time; whatever it tries to do, it has to make an impact sooner rather than later.

Realogy = General Motors

The second implication is that Realogy might be like General Motors of the 90s-oos. The similarities are a bit eerie.

What is clear in retrospect is that the old GM simply was not competitive. It had enormous quality control issues, while newer competitors like Honda and Toyota did not. It was churning out giant Cadillacs and stodgy Buicks, while competitors like BMW were putting out E36 3-series cars that were on the Car and Driver’s Ten Best list every single year it was in production. GM only had three cars make the Ten Best List from 1990 to 2008: the Chevy Corvette in multiple years, and for one year, the Chevy Malibu and the Cadillac Seville.

What Mark Choey said about politics at Realogy echoes the “big bureaucracy” problem at GM. The CEO might want to drive a fundamental change in culture, and some of the organization changes will eventually help with that effort, but… I’m not sure that Realogy is quite there yet. Just like with GM, it might take a real wake-up-and-smell-the-coffee event of some kind for the numerous Realogy managers whose fundamental loyalty was to their brands instead of to the company as a whole to change the culture. Just like Chevy’s brand managers had to understand that the real competition isn’t Buick and Cadillac but BMW and Toyota, Realogy’s people might have to really internalize the fact that the real competition isn’t Century 21 or BHG but Keller Williams and eXp and Redfin.

GM tried rebranding, but a brand is not what you tell other people it is, but what other people think it is. Just like it didn’t matter how much Oldsmobile tried to brand itself as something new and fresh, because its brand was what consumers perceived, it doesn’t much matter that Coldwell Banker is trying to rebrand itself as a young, urban, diverse brand if the agent population doesn’t perceive a 100-plus year brand as that. And frankly, it doesn’t help that every single brand at Realogy is trying to do the exact same thing and position itself as the younger, hipper, more techie, more diverse, and more urban. I mean, have you looked at the rebranding efforts at Century 21 recently?

Seems to me that the answer to my question of “Who is the youth brand at Realogy?” is “Everybody.”

And just like GM back in the day had problems with its core competency (building good reliable cars), I can’t help but wonder if Realogy has problems with its core competencies: recruiting agents and selling franchises. The lack of news about Corcoran franchise is deeply concerning in this light.

Might Be Time for Surgery

The third implication is that the problems at Realogy might not get solved with the initiatives it has underway today. Corporate reorganization doesn’t solve the core problem with Realogy: debt and lack of growth. The various initiatives do not solve either problem, at least not in the short to medium term, and as I’ve already said, it doesn’t look like Realogy thinks it has time to wait to see them work out.

So the core problems of Realogy might require a high-risk, high-reward maneuver.

In my Seven Predictions for 2020 post, I wrote that Realogy might file a strategic bankruptcy.

This remains a great company with great people, great assets, great capabilities, and great resources. So what’s the problem with Realogy?

As I see it, it’s simple: Realogy is carrying an albatross around its neck in the form of $3.3 billion in net debt as of its Q3 earnings report. Very little of that debt is Realogy’s fault. Most of it was incurred back in 2007 when the private equity fund Apollo Global Management took Realogy private in a leveraged buyout, borrowing $6 billion. It’s kind of amazing that Realogy is still alive, actually. You can read this brief history from the NY Times to get a sense of what was happening in the early 2010s.

So what we have is a pretty healthy company, financially speaking, with strong cash flows, a giant footprint, strong leadership team, making moves… but burdened with enormous debt that it did not incur. That debt limits Realogy’s ability to make major investments or major acquisitions.

Strategic bankruptcy makes a ton of sense, in particular if Realogy can manage a pre-packaged Chapter 11 filing.

Now, those predictions are guaranteed wrong… but in light of the narrative above, I’m not sure if maybe I stumbled onto something.

If Realogy = General Motors of real estate, then let’s look at GM’s recent moves.

GM filed bankruptcy in June of 2009, and was out of bankruptcy by July of 2009. Knowing what I know about Chapter 11 bankruptcies (bankruptcy was my specialty at NYU Law, and I summered at the top bankruptcy firm in the country, Weil, Gotshal & Manges, under the great Harvey Miller, before deciding law practice was not for me), that’s lightning fast, and it means that the whole thing was strategic, set up way in advance, and executed brilliantly.

And the backstory of the bankruptcy strategy mirrors one critical concern for Realogy as well. That comes from Jay Alix, a consultant whose strategy saved GM, who wrote about it in Forbes:

I knew [Rick Wagoner, CEO of GM] believed GM could not survive a bankruptcy. Studies showed consumer confidence would crash. No one would buy a car from a company that was bankrupt. However, what I knew about the economic crisis and GM’s rapidly deteriorating liquidity position told me the company had no choice but to prepare for a bankruptcy.

Yet I agreed with Wagoner. For a global company as big and complex as GM, a “normal” bankruptcy would tie up the company’s affairs for years, driving away customers, resulting in a tumultuous liquidation. It had happened to other companies a fraction of GM’s size. It would mean the end of GM.

“I don’t think the company will survive a bankruptcy,” he told me. “And no one has shown me a plan that would allow it to survive a bankruptcy.”

“Filing bankruptcy may be inevitable, Rick. But it doesn’t have to be a company-killing bankruptcy,” I said. “I think we can create a unique strategy that allows GM to survive bankruptcy.”

Similarly, the biggest concern for Realogy with filing bankruptcy is that its agents could flee the NRT, and its franchisees could flee RFG, and brokers and agents would never go to work for a “bankrupt company.” That would be the end of the company.

However, the GM story tells us that there is a way to do a strategic filing that gets you in and out in 30 days and saves the company without brokers and agents running out the door.

It might be time for Realogy to consider the same.

Implications for the Industry

I was going to write this, but… given that we’re over 4,000 words already, let me save it for Part 3. If you have thoughts on what this means for the industry, please let me know in the comments or privately.

The Wrap-Up

Let me repeat what I said in the intro to this post: everything in here is speculation and my narrative based on what I know and what I heard and saw. None of this might be true. I could be dead wrong. But that’s my narrative to make sense of something that doesn’t make a lot of sense to me.

I think the implications for Realogy are pretty dire…. But then again, it could be pretty good if Realogy can successfully execute whatever major surgery it needs to execute. As the Chinese saying goes, within crisis, there is opportunity. So if Realogy is indeed in a crisis, here’s to hoping they make the most of their opportunity.

-rsh

3 Responses

  1. ROB,

    Do you think Millennials will be buying real estate franchises in a structure anything close to the current one? The answer to that question hits one of your concerns on the head…..

    We’ll see. 🙂

    Thanks,
    Brian

  2. A very well written and thought-provoking followup post. As a side note, don’t express any guilt for the breadth of your articles — those of us that are following these relevant happenings would ardently devour 10k words. ✓

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