[FREB] Cut the Crap With Two Numbers

Sunny and I got into a discussion earlier today over breakfast. Yeah, we do that in the Hahn household. Yeah, we’re real estate nerds. In our defense, we also talk about zombie apocalypse (we’re watching The Walking Dead marathon style), farmhouse furniture, and trail running so… we’re not total dorks.

In any event, we got to talking about some recent products we looked at, strategies we heard of, blogposts and columns we’ve read, and people we’ve talked to. And you know, there are a LOT of words in real estate talking about this or that. [Editor: Are you serious right now? YOU? Talking about a lot of words?]

What we don’t have is a lot of clarity. Well, as Sunny and I were talking, we realized that there is a way to force clarity on the industry, on brokers, on agents, on everybody — ourselves included. And it’s quite simple.

Focus on two numbers. Do that, and you cut through the marketing-speak, the double-talk, the generalities, the platitudes, and the outright bullshit and find the real gems, the real stuff that actually matters.

Those two numbers: Company Dollar and EBITDA.

Let me explain.

The First Number: Company Dollar

We all know what Company Dollar is, but I’m not certain that we all understand what Company Dollar is.

Put very simply, Company Dollar is the amount of revenues that is left after Cost of Revenue (or COGS, if you will, even though real estate brokerages are not selling any goods) is deducted. In the vast majority of the cases, we’re talking about how much you have left after the agent split.

It’s the rough equivalent of Gross Profit for companies other than real estate brokerages: top-line revenue, less the cost of that revenue.

When we studied the brokerage industry seriously for the Future of Real Estate Brokerage Black Paper, we quickly came to realize that this is the first all-important number. In a way, it’s even more important than the second number, EBITDA. Why?

Because the brokerage controls everything that happens below this number. They control very little of what happens above it.

That is, all of the operating expenses of a brokerage, from lease payments to staff salaries to technology platforms to travel and meals and agent education all get deducted from Company Dollar. Company Dollar is the total pool of money a brokerage has to invest, to spend, to play with.

The traditional split-based brokerage actually controls very little of what happens above Company Dollar — the Cost of Goods Sold or Cost of Revenue, or in the brokerage world, Agent Split. Sure, you have your complex comp plans with multiple tiers and desk fees and transaction fees and all that jazz, but when you get right down to it, competitive pressure dictates what your COGS is going to be, not what you decide what your COGS is going to be.

When brokers talk about value, as in, “We deliver so much value to our agents that it’s never about the split,” what they’re really saying is that they can earn a higher Company Dollar by keeping COGS (or Agent Split) low because their agents are willing to pay it.

Hell, I’ll go so far as to suggest that Company Dollar is the “real revenue” of the brokerage, not its Sales Volume, Gross Commission Income, Market Share, or even Agent Count numbers. Who cares about those? Show me Company Dollar, and Gross Profit Margin (aka, Company Dollar margin).

The average for residential brokerage in North America is 15% Company Dollar, meaning that they keep 15 cents of every dollar of GCI produced. Average means just that: average. Half are above 15%, and half are below it.

The Second Number: EBITDA

I prefer using EBITDA, instead of Net Income, because there are a lot of games you can play with accounting to generate Net Income or a Net Loss. Most of these games have to do with interest, taxes, depreciation and amortization. EBITDA, of course, means Earnings Before Interest, Taxes, Depreciation and Amortization.

It represents, if you will, as close a picture of the profits from operations of a company as you could get. Cash flows from operations would be the other one where you get a pretty good picture of what’s going on.

Since many brokerages are setup as passthrough tax vehicles (i.e., the company itself is not taxed, but the owner is on his/her profits from the company), taxes are rarely a big part of the analysis. Depreciation, Amortization, and Interest are. Since many brokerages really don’t have huge amounts of depreciation and amortization, because they don’t own giant plants or physical assets or expensive equipment, the EBITDA number is often the Net Income number as well. But not always.

I think EBITDA is the second key number because it represents the actual profitability of the brokerages operations. Take your Company Dollar, subtract all of your expenses, and voila, there’s your EBITDA.

And this number is within the broker’s control, subject to the demands of reality. The brokerage’s spend on technology, marketing, office space, staff, coffee in the break room, and lightbulbs all impact EBITDA. If you run a lean and mean operation, then your EBITDA margin will be higher; if you spend like a drunken sailor, then it will be lower, and you might be operating at a loss.

Some expenses are unavoidable, like MLS dues, while others are discretionary, like travel and entertainment.

The average for residential brokerage in North America is 3% Net Income, meaning that only three cents of every dollar of GCI produced ended up as profit for the brokerage company owners. Average means just that: average. Half are above 3%, and half are below it.

Now, here’s the thing: when we say half are above 3%, that doesn’t mean half are sitting at 30% profit margins. It means more like, the best most cost-efficient brokerage operators might hit 5% or 6% profit margin. That’s double the average, but it’s still pretty damned pitiful for an ongoing business concern, isn’t it?

Why Two Numbers? Why Not Just One?

We thought long and hard about trying to reduce everything down to one key number, like Agent Count is for traditional brokerages, and we simply could not.

Company Dollar might be the more important one, because that speaks directly to the value of that brokerage. It means agents are willing to pay more for that brokerage’s products and services. But not really, because EBITDA speaks to the quality of management and operations of that brokerage.

If you have amazing Company Dollar numbers, but your EBITDA sucks, then you’re going bankrupt. If you have crappy Company Dollars, but your EBITDA rocks, you can hang on a bit longer.

So they’re both really, really, really important. They’re both the Key Numbers.

Cut the Crap

So how would one use this insight in a practical sense?

Say a vendor wants to sell you some sexy new software tool with all the right buzzwords. “We leverage AI and Big Data with enterprise cloud SaaS to drive efficiencies in your marketing efforts, so that you can make your agents more successful!”

The question you should ask is, “Will this lift my Company Dollar? Will it lift EBITDA?” If the answer is unclear, then well, you know what to do.

If you’re sitting at 11% Company Dollar (below the average), you have to ask whether whatever you’re spending will move that needle at all. An extra deal for your agent means 11 cents on the dollar; is that worth the investment? That’s your call, obviously, but you have to ask.

Or if it’s some sort of an efficiency gain, does it move the needle from your 2.4% EBITDA margin? If not, why should you care, like ever?

Because the brokerage industry obsesses about different numbers — Agent Count, Sales Volume, and Transaction Count — all manner of tech companies, gurus and consultancies, coaches, marketers, and so on thrive. Hell, I’m one of those #VendorWhores myself! But at least I’m telling you to look at numbers that matter, to cut through the BS.

Consider this: Recruiting a top producer with a team who does $50 million in production is a BIG WIN for any brokerage today, right? I mean, brokers take out ads in local papers celebrating the win. Overnight, that broker’s market share goes from a big nothingburger to third in the market. WOOT!

Except, that team is paying 90/10 splits, with a cap after $30K, plus you gotta pay them marketing concessions and office lease concessions, so the reality is that your Company Dollar went from 15% to 12%, and the impact on EBITDA is -1.5%, depressing it from an above-average 3.5% to 2%. Woohoo! Big win!

No. Not at all. You just lost, and bigly. Think about it.

I am finding myself doing this more and more these days. When someone gets on stage and says, “Well, being an indie broker, we can be so much more nimble, and have such great relationships with our agents that we’re so very selective about our hiring!” I want to ask, “What’s your Company Dollar and Profit Margins?” Because if they’re 15% and 3%, I’m not interested in the least bit. If they’re 35% and 9%, okay, tell me more!

The reverse is also true, in a sense. I’ve had the opportunity to have a lot of conversations with brokers and agent team owners in recent weeks asking about our 7DS Firm Model. We always start with those two numbers. If they’re sitting at 40% Company Dollar and 12% Profit Margins, you know, you keep doing you — what the hell do you need me for? Just keep printing money!

It’s not show friends, it’s show business.

All the talk of cool strategic insights, the cool AI-Big Data platforms, the inspirational leadership you need, the smart recruiting strategies, the all-important culture of the company, the charitable activities… that’s all totally awesome! But first, tell me your two numbers, and I’ll tell you if I care.

It’s simple mathematics.

-rsh

 

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18 Comments

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  1. This industry is so self-obsessed with top line that it’s become a cliche. Agents are put on stage based on top line and brokerages brag ad nauseum about it. It only matters insomuch that doing a number of ENDS garners inquiries and builds experience … certainly of value to the client. But the focus on top line is so intense that it clouds all else, from profitability to “how do we be better at what we do so we can wow more clients and create real loyalty?” Agent-centric models – team or brokerage – say so very little about how we serve consumers. Missed opportunity if the talent and drive is there.

  2. Observation. As it relates to the importance of “top lines and bottom lines.” In no other industry are the sources of the majority of the income of brokerage companies so much at risk. Not recently, forever. These are the people that actually generate the top and bottom lines of brokerage companies, but have not been included in the cap tables – the equity – of the company. In other words, they are the CVC, Chief Value Creators, without a means to participate in the reward of the value creation. These are the top agents. So now enter Compass. It is absurd that traditional brokers have not secured the commitment of their top producers prior to the existence of Compass. What Compass is doing is not brain science. Make the offer of sharing in the equity of something that may be big and then pay to sign the commitment and move the revenue. Easy target because the revenue generation of the brokerage industry has been left unprotected! Note to brokers. My strong suggestion for you. Brokers really need to create an ICSOP for your top producers now. As in yesterday. An Independent Contractor Stock Option Program. Allocate stock options to the top 20% of your agents in return for a 5 year commitment with a commensurate vesting period. And the good news? There is no need to pay millions of $$ in signing bonuses to agents that already work for you! Think about it. What would your company be worth without the inclusion of the top 20% of your agents and how much more would it be worth if you sold the company and could assure that the same top 20% was under contract to stay – and not “break” – after the sale? In the age of everything “inclusion”, it’s way past the time – for sooo many solid business reasons – to include your top agents in the equity of your company. And as it relates to this one, time is really of the essence.

    1. It’s almost like you read our Black Paper, Ken! 🙂

      1. Sorry to admit. I have not yet read it Rob, but now I certainly will.

      2. I read it 😉 In your black paper model, are the equity partners (lead agents) silent or is everyone with a stake a “managing partner.” To me this creates a ongoing problem of consensus building (re biz decisions), which has in fact been reported back to me on such a model. I’ve seen this in other scenarios also. Messy. Not fun. Too many cooks in the kitchen etc etc…
        Thoughts?

      3. That decision is up to the partnership. 🙂

        I know that sounds like a copout, but it really is not. Good business partnerships are like marriages, in my view, in at least one way: no one outside it can judge it. In some cases, it’ll be equal all the way and consensus is easy. In others, it’ll look like cats and dogs fighting every week, except the family is strong and gets shit done. In others still, it might be one dominant partner and everybody else, but everybody is happy as can be. Who can say?

        I will say this though. You don’t have to like each other to be partners, though it helps. You do have to respect each other. I wouldn’t recommend partnering with anybody you don’t respect.

  3. Excellent! Very timely article.

  4. Excellent post Rob. Everyone wants to be Number One…I’ll take Number One Most Profitable please.

  5. You’ve touched on the true “cancer” of the brokerage industry and why KW and Realogy are scrambling to get out of the brokerage business and re-invent themselves as Big Data Companies or something else…

    Here’s the terminal condition:

    Teams within brokerage Companies have seriously eroded the Company Dollar (CD). For decades, top producers earned their 90% + splits on transactions, and contributed 10% to CD. Lower commission agents earned an average 70% and contributed 30% to the CD.

    As often happens, lower commission agents held top producer listings open, (since top producers had so many); sometimes find a buyer and split the buyer side commission with the Broker, (the classic double end). In these cases, the Broker would keep 10% of the Seller side and 30% of the buyer side commission from two agents. If you do the math, The Company Dollar is $0.40 cents for every gross commission dollar on these transactions. We’ll call these the “good old days”.

    Since 2008, agents and brokers find themselves with far less inventory to sell, and buyers who easily find homes to buy on the internet. Real Estate values in California have doubled since Y2K and so have agent fees. As a result, buyers are approaching listing agents directly at open house events without representation more frequently resulting in a surge of double end transactions. This surge has also been accompanied by a surge in the number of teams forming within brokerages.
    Today, many “lower split” agents are now members of top producing teams. Gross commission from double end transactions are flowing through top producer splits before flowing to the CD. Under these scenarios, the Company Dollar shrinks to $.10 cents for every commission dollar, 75% less than in decades past. Brokers are reluctant to confront top producers about the issue for fear they would leave…which most do in my experience. This is a recipe for failure…

    Some top producing agents are now demanding referral fees from their lesser team members for transactions resulting from the sale of “team” listings. So now, the top producer earns 90% + off the top, plus an additional 25% of the team members side of double-end transactions. The CD stays at $0.10 per gross commission dollar, but the top producer increases their take by 25% of their “teammates” commission.

    Another amazing trend in some markets are top producing agents “employing” licensed team members, paying them a salary, and retaining the entire commission for themselves, then writing off the cost of the employees…shocking!

    This doesn’t bode well for the industry…it’s simply unsustainable. Forget competitors, Brokers are now competing against their own licensees for revenue. The industry is truly doomed unless we re-discover the true purpose of why we’re in this business: consumer protection and not money grubbing.

    1. Excellent points all, except that the W-2 employee model is the one that saves us all from this. So don’t hate on agent teams employing licensed team members; they really ought to do that, since most of them are actually in violation of labor law the way they’re currently doing it. 🙂

  6. I 100% agree with all of this, particularly the idea that you need to look at both numbers in conjunction. You can’t just look at company dollar, because a firm might have a superficially miserable 10% company dollar but have a pretty good profit margin because it basically pushes all its expenses onto the agents. Conversely, you might have a whopping 35% company dollar but lose money because you’re paying an enormous amount of agent expenses that don’t factor into the split. It’s interesting how different business models can generate vastly different company dollars but be pretty consistent in generating 3-6% EBITA profit margins.

    The only thing I would add is that you should consider how to factor in revenue and profits from affiliate businesses. You can look at them separately, of course, but it’s sometimes helpful to view them in conjunction, especially if a brokerage has evolved basically into a “loss leader” feeder system for settlement services.

    1. Hey Joe –

      An excellent point re: affiliate businesses. I was thinking about adding a paragraph about it, but might as well discuss it here.

      I didn’t add that on purpose. Because so many companies run their brokerage operations as a loss-leader or flat-at-best, and make it all up on affiliated businesses which are their true profit centers. At that point, though, I have to consider that company as something other than a real estate brokerage. It’s more like a mortgage broker or a title insurance company, with a brokerage lead-gen operation.

      It really would be no different than Quicken Loans owning a few brokerages at break-even. That is a valid corporate strategy, for sure, but I do not consider that company a real estate brokerage.

      I would prefer that brokerages generate ~9% in net income margins prior to taking affiliated businesses into consideration, because at 9%, that’s a going business concern worth owning and operating. And I want my broker friends to make some damn money for all their hard work and pain-in-the-ass and risk.

      Related thought: the next time Congress takes up whether to allow banks into real estate, how in the world are we going to fight that off if all of the larger brokerages in the country are actually mortgage companies with brokerage lead-gen operations? I am more than a little bit uncomfortable with that.

  7. I’d want to know what you look at when you factor in Mortgae, Title and Insurance? That’s a big ? source for those who do it right?

    1. Hey Ken,

      See my response to Joe Rand right above your comment. 🙂

  8. Hey Rob…not intending to be a math snob but in your article your “average” is actually the “median” I believe (half above-half below/middle/mid point). Though the distinction may not change the point of your story.

    1. I was going to say the same thing… If you are achieving average results, it doesn’t mean equal numbers of competitors are doing better versus worse. A tiny handful of insanely profitable outliers could skew the average, clouding the fact that your “below average” performance is actually better than a majority of others.

    2. You and Isabel both are correct. But I know of no way of getting “median” numbers unless the government somewhere has processed tax returns of all real estate brokerage companies.

      I would be happy to compile the information for the industry, if brokers want to send me their annual P&L statements. 🙂

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