Will Zillow gobble up these real estate startups before they can become billion-dollar businesses?

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On November 8, Compass announced that it had raised $100m at a $1.8b valuation. With Fidelity Investments, IVP and Wellington Management participating, it is a question of when not if Compass goes public. In addition to signalling that Redfin will soon have company as a publicly-traded “technology-powered residential real estate brokerage,” the announcement served as an opportunity for many to continue to question Compass, its tech bonafides, and its valuation.

The RealReal noted that “Compass’ valuation continues to vex rival real estate firms” who view it as unrealistic, while Bloomberg suggested that “questions linger about Compass’s technology,” and Axios said “the valuation looks rich for [a company] that uses software to augment, rather than disrupt, traditional (and profitability-challenged) business models.” We don’t necessarily buy into the “tech-enabled criticism.” An aside: if tech enables defensibility and growth, it should warrant a high valuation.

For Radicle, the funding announcement served as a convenient catalyst to highlight the work we have done on both residential real estate brokerages (11 venture-backed startups such as Compass, Yopa, and eMoov) and residential rental real estate platforms (a disparate group of companies that range from Flip to Spotahome). And to wonder, what models will truly disrupt residential real estate. Open Door, with its capital intense but unique approach, is one we’ll discuss at a later date.

In seeking to identify the next great companies in real estate, we wonder: what problems are ecosystem participants (buyers/sellers, landlords/renters) facing? And who is devising solutions that are novel and defensible enough to enable scalable, sustainable businesses?

Some questions to ponder:

1. What does Compass’ future look like? Where will it trade as a public company? 4x like Redfin today or < 2x like publicly traded brokerages
2. Who’s the most compelling startup in residential real estate?

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The curious case of 10% success

Before diving into some of the novel startups we’ve seen in real estate, one thing that strikes us as particularly interesting: the industry has two massively successful ‘unicorns,’ and yet neither seems to offer a 10x improvement over the status quo.

By most measures, Compass and Redfin have achieved tremendous success. Compass, on paper, is now valued at $1.8b. Redfin has a market cap of $1.9b. While perhaps not 10x experiences today, when Compass launched in 2013, it did aim to disrupt the status quo (see: “Urban Compass cuts rental broker fees in half.”). However, it found that strategy challenging (attracting quality brokers required traditional success-based compensation models) and pretty soon pivoted to providing tools that enable brokers to do their jobs better. Providing broker enabling tools has been a value-creating strategy for the company, but consumers (and competitors) view Compass as one of a number of brokers doing pretty much the same thing.

Redfin has focused on the customer side and, in offering a better user experience and better value (lower fees), has created a differentiated business. In the company’s S-1 it notes “customer satisfaction that is 32% higher than competing brokerages and a customer repeat rate that is 37% higher than competing brokerages.” Unlike Compass it stuck to a lower fee model, and now one of Redfin’s key value propositions for both buyers and sellers is cost-savings, seeking to “save sellers at least 1% to 2% on the sales price.”

How have these companies built such valuable businesses so quickly simply by offering i) broker tools that enable market share gains, ii) better ux, ii) moderate fee reductions? It’s a curious question. We think it may have something to do with the market size. Redfin is a $1.9b business generating $400+ of revenues and it has.. wait for it… 0.6% share of the residential real estate market.

If 10% = $2b, what can 10x enable? And who can deliver a 10x experience?

When people think of drawn-out and inefficient processes, renting a home or apartment is one of the first that comes to mind. Understanding options, visiting homes, and talking over contracts and terms with landlords can be incredibly cumbersome, particularly considering that multiple people apply for homes that only stay on the market for a finite period of time.

Given the complexity of this process, it is no surprise that meta-search companies like Zillow and Trulia (since acquired by Zillow) popped up in the mid-2000s and subsequently achieved enough success to IPO. These companies took a first step in simplifying the demand side of the home buying and renting processes, helping buyers and renters understand their options and compare properties (prices, locations, features, and amenities).

Moreover, these companies offered a Web 2.0 user experience that existing sites like Craigslist and fragmented brokerage websites could not. Craigslist was the primary option for renters searching for homes up until as late as 2010 or 2011. Zillow and Trulia were able to make the search process simpler and more user-friendly, which ultimately helped them become dominant companies. In many ways, Zillow and Trulia were to home buying and renting, what Yelp was to restaurants: discovery enablement. It was a 10x experience over the status quo.

Are there other opportunities for a 10x experience? Yes. First, we don’t think it’s with lower fees. Outside of NYC rentals, real estate fees don’t seem particularly high. As Redfin notes, “consumers selling a home with a traditional brokerage typically pay total commissions of 5% to 6% of the sale price.” Looking at Bill Gurley’s list of startup take-rates, 6% would be close to the bottom.

But there are many other frictions associated with renting, buying and selling. First, the application process is cumbersome and manual and a pain for both sides of the transaction. Zumper allows renters to actually apply to apartments with a single application, integrated into the website. This capability is significant because it changes the function of the aggregator: instead of just being about discovery, these companies can be more integrated into the whole rental process.

Rigid lease terms are another problem. Leases are one or two years, but with more than 35% of Americans working freelance and an increasing number of workers needing to relocate for jobs, these lease terms do not make as much sense as they used to. Flip is a marketplace for flexible and non-standard leases that range from months to years. In addition to the flexibility it enables — subletting, getting out of a lease, and finding a new lease — like Zumper, Flip offers an end-to end solution: qualifying users, approving potential tenants, handling payments, and more.

While Zillow and Trulia improved discovery, Zumper and Flip serve both sides of the market. In addition to enabling renters to apply for apartments through its site, Zumper also has a landlord-facing feature that helps landlords find quality renters, screen them, and better market inventory. Flip’s solution helps landlords that would otherwise have to deal with costs of a broken lease (an empty apartment).

Will these 10x companies be given the space to become billion-dollar businesses?

Our thought: no. While our data science team’s Radicle Anomaly Detection Engine suggests that both Flip and Zumper have a greater than average chance of exit, we see these business ultimately being bought by larger real estate players. Zillow has disclosed 11 acquisitions since its founding. We would not be surprised if Zumper and/or Flip were added to that list.