Five Omissions in Compass IPO

Compass public offering in 2021 reveals five distinct omissions of facts, deeply rooted in broken real estate industry practices

(Note: This editorial is written for curiosity and informational reasons only. You should not construe my personal opinions expressed as legal, investment, financial, or other advice. I don’t have any personal short or long financial interests in the companies mentioned, or any financial dealings with Softbank Vision Fund, or Compass. The views expressed herein are my personal opinions and do not reflect onto others.)

Compass is a tech-enabled real estate brokerage that has recently begun trading as a public entity on the NYSE. The company’s Form S-1 filing filed with the Securities and Exchange Commission on March 1, 2021.

The following are five things that struck me, and may not be readily understood outside of the context of many broken real estate industry practices.

These practices, in turn, hurt Compass as otherwise a very good company, which is unfortunate. At the end of this article, there is a solution that argues that Compass may be still able to succeed and to become profitable in the long run, despite all this, if the stakeholders begin to accept the reality of the problem of collusion present within the industry due to the wide use of referral fee networks.

First Omission

Commission revenue. We earn revenue from commissions we receive from clients when they are represented by our agents in a home transaction. The total commissions generated is the product of the Gross Transaction Value — the total dollar value of transactions closed by agents on our platform — and the commission rate paid by clients upon the closing of a real estate transaction. Commission rates for buy-side and sell-side transactions typically range between 2.5% and 3.0% of a home’s sale price. The commission paid is based on the terms of an exclusive listing agreement that is signed between Compass and the client. In addition, we generate a small portion of commissions revenue from rentals, new development projects, and commercial real estate transactions.

In this statement, Compass does not disclose the fact that an agent is “expected” or “accustomed to” paying blanket referral fees into “paper” brokerage schemes. Compass agents routinely use these networks to gain leads and are, effectively, slushing their gross commission to 70% of what they should be earning independently of these schemes. Broker referral fee networks systematically abuse consumers into using them. Agents who collude with these schemes end up losing most of their profits in the long run. A Compass agent is systematically asked to offer competitive rates while paying 30% of their gross commissions to a third party. How big is the problem? Well, below, you will see in real numbers how Compass is missing as much as a quarter of a billion USD on their books, annually, because of this practice.

Second Omission

A significant change in consumer sales that eliminates or minimizes the role of the agent in the real estate transaction process could have an adverse effect on our business, financial condition and results of operations. These options may include direct-buyer companies (also called iBuyers) that purchase directly from the seller at below-market rates in exchange for speed and convenience and then resell them shortly thereafter at market prices, and discounters who reduce the role of the agent in order to offer sellers a low commission or a flat fee while giving rebates to buyers. Consumer preferences regarding buying or selling houses and financing their home purchase will determine if these models reduce or replace the long-standing preference for full-service agents.

In this statement Compass, subtly, implies that full-service agents do not offer seller commissions savings or rebates to buyers. All Compass agents are independent contractors and must negotiate their rates independently by law, which they do…. most of the time. What does this mean, most of the time? Well, some Compass agents systematically use broker referral fee networks, and some of these networks price fix commission rates for Partner Agents as means to gain a referral fee from a transaction. Products like Zillow Flex, Rocket Homes, HomeLight, UpNest, Raltor.com ReadyConnect (Opcity), OJO Labs, Sold.com, Better.com, mellohome, Clever Real Estate, Opendoor Brokerage, and many other schemes establish “paper” brokers and collude with Compass brokers via blanket referral agreements. Some of these referral fee networks also require a Partner Agent, a Compass agent, to offer a certain commission or a rebate to entice consumers, which is a price-fixing scheme between two or more brokers. Compass is correct to argue that full-service agents will not be easily replaced. The real threat Compass omits here is the way consumers hire Compass agents via these referral fee networks and the concept that someone else is able to set commission rates for the work performed by others, such as Redfin Partner Program.

Third Omission

We estimate that agents drive approximately $95 billion of commissions in the U.S. and sit at the center of substantial additional spend directly and indirectly related to the home transaction. Our long term market opportunity is comprised of brokerage commissions (paid by clients to Compass), spend from other components of the real estate ecosystem, including closing services (title, escrow, and mortgage), paid marketing services and other real estate services. We view our serviceable addressable market, or SAM, in the United States to be over $180 billion and our total addressable market, or TAM, globally, over the long term, to be over $570 billion.

Compass calculates SAM as a platform, but Compass is not a platform. Compass is a broker. The real SAM, for Compass claiming to be over $180 billion, is only 4% of that in real numbers. The reason is that there are so many other competing brokerages in the United States in so many areas, that to claim an entire revenue for commissions as SAM is absurd — Compass would HAVE to hire all of them. Compass SAM is only about 7 billion. Compass is likely to enjoy a stable market share in residential real estate markets, yes, but Compass will never join the Big Tech valuations because it is unable to aggregate massive markets around it. Compass is not a media company in real estate, it is a real estate company that utilizes e-commerce as media. The thing is, one can argue for almost any SAM they want, but it does matter to distinguish Compass as a tech-enabled service that must operate locally, subject to real hard costs, and the best way to do so is to become highly critical of the SAM figure. This is especially true because Compass used massive amounts of cash to buy competing brokerages in the past, and it no longer able to do so — as of right now, Compass brokerage has lost money systematically buying others. Buying competition is not a sustainable practice that can justify a SAM of $180 billion either.

Fourth Omission

In 2020, Compass reports $3,720,000,000 in revenue but also spends $3,056,000,000 on broker commissions paid due to Compass agents working as independent contractors. These two numbers represent the problem of the blanket referral fees in the industry to the full extent. To merely multiply this revenue by what is a “25% standard referral fee” yields a $930,000,000 figure, or almost a billion.

I am grossly assuming here that all Compass agents pay blanket referral fees on all their transactions, which is false, but this is not too far off from the reality either. Either way, a large chunk of revenue for Compass (lets say, realistically, around a quarter of a billion USD) is lost into “paper” broker referral fee schemes. This loss does not serve either Compass agents, Compass brokerage, or consumers. These massive commission kickbacks schemes only serve the referral fee networks that operate them.

Fifth Omission

We are subject to a variety of federal and state laws, many of which are unsettled and still developing, and certain of our businesses are highly regulated. Any failure to comply with such regulations or any changes in such regulations could adversely affect our business. Our real estate brokerage business, our title and escrow business and the businesses of our agents must comply with RESPA and a variety of similar state regulations. RESPA and comparable state statutes prohibit providing or receiving payments, or other things of value, for the referral of business to escrow service providers in connection with the closing of real estate transactions involving federally-backed mortgages. Such laws may to some extent impose limitations on arrangements involving our real estate brokerage, escrow services, and title agency. RESPA and related regulations do, however, contain a number of provisions that allow for payments or fee splits between providers if certain requirements are met, including fee splits between title underwriters and agents, brokers and agents, and market-based fees for the provision of goods or services and marketing arrangements. In addition, RESPA allows for referrals to affiliated entities, when specific requirements have been met. We rely on these provisions in conducting our business activities and believe our arrangements comply with RESPA. However, RESPA compliance may become a greater challenge under certain administrations for most industry participants offering escrow services, including brokerages, because of expansive interpretations of RESPA or similar state statutes by certain courts and regulators. Permissible activities under state statutes similar to RESPA may be interpreted more narrowly and enforcement proceedings of those statutes by state regulatory authorities may also be aggressively pursued. RESPA also has been invoked by plaintiffs in private litigation for various purposes and some state authorities have also asserted enforcement rights. In addition, title and escrow services are highly regulated. Our title agency services business also is subject to regulation by insurance and other regulatory authorities in each state in which we provide title insurance. State regulations may impede or impose burdensome conditions on our ability to take actions that we may want to take to enhance our results of operations.

For Compass, RESPA is troublesome. First, it has recently purchased a title service called Modus, originally funded by Trulia founder Pete Flint and NfX, which is now under an investigation for kickbacks in the State of Washington. Bad call, maybe, but the purchase itself is irrelevant, and so is Modus, specifically.

The real issue here is that Compass cannot claim to become an impartial brokerage resource if it begins to steer consumers toward products that serve brokerage interests, and not consumers’ interests. A consumer must be able to shop for all closing services independently of each other, and in a competitive setting.

Compass cannot possibly steer consumers toward title and other auxiliary services, while also serving consumers as a broker who is very much bound by RESPA. Good and unbiased advice is free, or at least, offered for a fee negotiated competitively. Another way of saying, Compass is a broker, not a marketplace and it cannot be trusted if a hidden revenue is earned self-interest, other than the direct benefit from a competitive commission after the home sale.

To steer consumers toward some closing services and not others is a bad way to run a brokerage, especially one that wants to build itself as an honest brand. Online marketplaces and online brokerages are not the same thing.

A solution is worth 1,000 words

So, why am I critical of Compass brokerage, while also asking Compass agents to join my platform? Well, simply because I know that good real estate agents did not agree to any of these referral fee schemes — they are forced on the industry, fueled by the greed. These products do not serve any Compass agents, even if it may have felt like some “free” leads came out of them.

Eventually, all blanket referral fee schemes degrade Compass agents’ services and they degrade Compass agents’ relationships with their clients. These price-fixing practices and consumer allocation schemes hurt all Compass agents even if they correctly choose not to participate in them. Why? Because other agents actively choose to pay these kickbacks and they get rewarded for it with “free” business while constantly paying a massive chunk of their gross revenue.

These schemes directly violate Section 1 of the Sherman Act, they violate RESPA, and they prevent agents from offering their best service to consumers. Consumers’ most important transaction ends up being steered away from good agents because some other agent simply kicks in 30% of their commissions.

This is why my criticism merely addresses the proposition for both Compass brokerage and Compass agents to stop serving interests of someone else.

Why use Open Marketplace™

HomeOpenly is a 100% free service for agents and consumers and many Compass agents are already using this platform. Why? It does not cost anything to either you or your client on the back-end.

We do not cut into agents’ commissions, but merely ask what your savings are so that we can show your information to consumers.

HomeOpenly does not sell leads, it is not a referral scheme, we do not steer consumers — it is an Open Marketplace™ established as an e-commerce solution. This product receives revenue from ads for auxiliary sources, such as mortgages, refinance, insurance, bridge loans, home maintenance, etc. In effect, agents can never pay HomeOpenly, by design.

What is the value of HomeOpenly platform to a Compass agent? Consumers do not buy the services of an agent by shopping for commission rates alone, consumers are looking for a valuable service and savings as an incentive.

When matched with a consumer on HomeOpenly, Any Compass agent can offer, at the very least, a “standard” referral fee back to their client, as an added value to both participants to a transaction. These are real savings that keep Compass agents competitive on our platform, the fees end up in the right hands, consumers. On HomeOpenly, a Compass agent can set their custom listing commissions and buyer rebates (in 40 states where rebates are allowed by law,) opt-in, opt-out, nearly instantly.

There is absolutely no reason why any quality agent should not use HomeOpenly, zero reasons, as far as this author can name.

Open Marketplace™ works for all quality agents because it creates genuine trust between an agent and their client, and it removes the haggling over fees. All fees on HomeOpenly are competitive by design.

Agents define their fee schedule, which is what makes it so versatile and compliant with federal antitrust price-fixing and consumer RESPA regulations. HomeOpenly is not a broker and does not compete with brokers. As a marketplace, our mission allows us to establish a solid and open foundation for agents to be able to serve their clients and for consumers to regain confidence in the industry. This is a long-term investment into a completive industry that rewards good real estate practices and good e-commerce.

It takes a good marketplace to deliver savings to consumers from the right vendors, and a good agent to help people find a good home. HomeOpenly is a marketplace where quality competitive agents are always welcome, by design, from almost any brokerage.

I think that Compass remains a highly competitive tech-enabled company in the US housing sector.

“If you realize that all things change, there is nothing you will try to hold on to. If you are not afraid of dying, there is nothing you cannot achieve.”

HomeOpenly makes all homes, more affordable, everywhere, little by little.

Author: Litesand

Antitrust, real estate, e-commerce, fintech, proptech, bigtech

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