Real estate has been one of the hardest-hit sectors over the past 18 months, since the U.S. Federal Reserve embarked on its most aggressive campaign to raise interest rates in its history. Higher rates reduce the borrowing power of consumers, which lowers housing demand and forces prices to move lower.
But there might be some good news on the horizon. First, inflation appears to be cooling, which might prompt the Fed to rethink future interest rate increases. Plus, on the back of the recent crisis in the U.S. regional banking sector, some economists are now calling for the Fed to start cutting rates in 2023.
That could reignite shares of beaten-down real estate technology companies such as Zillow Group (Z 1.87%)(ZG 1.75%) and Redfin (RDFN +0.00%), which have plunged 79% and 91%, respectively, from their all-time highs. Here's why.
NASDAQ: ZG
Key Data Points
1. Zillow wants to become a real estate one-stop shop
Zillow can be described as the Swiss army knife of real estate, because it wants to fully service buyers and sellers at each step of their transaction. It's doing so using technology -- its digital platforms are the most visited in the entire industry, with 220 million monthly active users.
This strategy is a substantial pivot following the company's decision to wind down its industry-leading iBuying segment in 2021, through which it used to purchase homes directly from sellers with the intention of flipping them for a profit. As the housing market began to slow, Zillow found itself with much of its housing inventory falling in value, and the result was a loss of $881 million in that year.
Now, the company is leveraging its market-leading online presence to bring seller services, buyer referrals, mortgages, and closing services -- to name a few -- to customers. Zillow believes there's an opportunity to earn $17,500 per transaction if both sides are using its services, and at the start of 2022, it was capturing only $4,100, which left plenty of room for growth.
It's gradually making progress, but iBuying was the company's largest driver of revenue, and it's a large hole to fill.
For context, Zillow generated $8.1 billion in revenue during 2021, $6 billion of which was iBuying. That figure fell 76% to $1.9 billion in 2022, and Wall Street analysts are estimating it will bring in $1.8 billion this year.
It's taking some time for Zillow's financials to bottom out after disposing of the remaining iBuying homes on its balance sheet, which is a key reason its stock fell 79% from its all-time high. However, the company has outlined a path to $5 billion in annual revenue by 2025 by doing two things: growing the number of transactions on its platform, and earning $5,200 per deal.
It's a profitable path forward because services are typically capital-light, which points to long-term value creation for investors. But if economists are correct and the Fed begins to cut interest rates in the back half of this year, it could be an opportune time to buy Zillow stock ahead of a new wave of growth.
NASDAQ: RDFN
Key Data Points
2. Redfin is trading at a rock-bottom valuation
Redfin's business isn't quite as broad as Zillow's. While it has expanded into rentals and mortgages and is building a strong online presence with 50 million monthly website visitors, Redfin's core focus is still real estate brokering. But there's one thing it does have in common with Zillow: It closed its iBuying business, RedfinNow.
This difficult economic environment forced the company to restructure and play to its strengths. Redfin's brokering business employs 2,022 lead agents who cover 98% of the U.S. real estate market, geographically speaking. It's an unprecedented level of scale that allows the company to charge listing fees of just 1%, compared with the industry standard 2.5%, saving sellers more than $1 billion since inception.
Redfin ended 2022 with a market share of 0.8% of all U.S. homes sold. It was an all-time high on an annual basis for the company, placing it in a great position to benefit if interest rates do begin to decline and the housing market picks up steam.
Wall Street analysts predict Redfin will generate $1.1 billion in revenue in 2023, but that's a 50% reduction from last year because of the closure of RedfinNow. The full value of every home sold under that segment was counted as revenue, hence the substantial drop. However, since RedfinNow wasn't a profitable business, the company expects to become much healthier, financially speaking. It might even achieve positive earnings before interest, tax, depreciation, and amortization (EBITDA) on an adjusted basis this year.
Plus, some of Redfin's smaller segments are beginning to heat up. The company originated $4.3 billion in mortgages during 2022, a whopping 337% more than 2021, and it now attaches a loan to 17% of the homes it sells.
After the 91% decline in Redfin stock from its all-time high, investors currently value the company at $877 million. That means the stock trades at a price to sales (P/S) ratio of less than 1, which is the cheapest level since the company listed publicly in 2017, and far below its peak P/S of 7.7. This might be a chance for investors to buy in at a rock-bottom price, ahead of a more favorable environment for real estate in the medium term.
