Musings on Defining Fundamental Problems

I was on a conference call earlier with a client discussing an upcoming strategy planning session, and one of the people raised a very interesting and a very good point. He said that if we don’t clearly define the problems, it’s very difficult to do good strategy.

I couldn’t agree more. But as we kept talking, it occurred to me that all of us (myself very much included) tend sometimes to focus on immediate and urgent problems because we can see them, feel them, and are affected by them rather than the underlying fundamental problem. So we so often end up treating (or at least trying to treat) the symptom rather than the disease.

One thing I’m pretty good at doing is seeing beyond the symptoms and identifying those fundamental problems. I don’t really know how I do it; I just kind of… see it and it makes sense and it makes the whole thing hang together.

So I thought I would muse on a few industry segments to try and figure out how I think of problems, and maybe along the way, provide something useful and valuable to you, the most educated readership in real estate.

The Fundamental Problem of the Agent

It’s not easy being a real estate agent in 2019, no matter what HGTV says. At least, that’s the overwhelming impression I get from my wife (a recovering agent and broker) and from my friends who are still in the trenches. Lead generation isn’t getting any easier, converting leads is difficult, buyers are liars and sellers are unrealistic. Appraisals come in low, loans get denied, there are multi-billion dollar corporations seemingly after you, and everybody wants a piece of your commission from your broker to the REALTOR Association to the MLS to the dozen tech vendors you use for everything from CRM to transaction management to websites… but you don’t feel like you can do without them.

So. Many. Problems.

If I pause, take a step back, and think about why the modern agent has so many problems, though… it seems to me that everything leads back to one fundamental problem: too much competition.

There are roughly 5.5 million homes sold in the United States each year, or 11 million transaction sides. There are 1.3 million REALTORS, and maybe double that number in licensed real estate agents. The math doesn’t really work out, does it? Even if we keep it just to REALTORS, that’s 8.5 transactions per year per REALTOR.

Except that we know that’s not the reality. The top 5-10% of the agents might be doing 80-90% of the transaction sides. I recently looked at the Real Trends Tom Ferry The Thousand list, and computed that the top 250 individual agents did 35,011 transaction sides in 2018, while the top 250 teams did 140,473 transaction sides. That’s over 175K transactions from just 500 people/teams. So 0.3% of the REALTOR population did 16% of the transactions?

It’s a lot like being a single guy at a nightclub filled with other guys… in Alaska. Or being a heterosexual male in the world of online dating, where 80% of men are rated as “below average” in looks by women.

I think I arrive at that conclusion by asking, “What problem leads to behavior XYZ?” Because people are rational economic actors for the most part. So when agents spend huge amounts of money on online advertising, or tens of thousands of dollars on professional websites, and so on, I have to ask why. “Buyers are liars” doesn’t lead to that behavior, nor does appraisal falling through.

Hypercompetition, combined with what is obviously a pareto principle situation, does.

In that situation, you have to try very, very hard to stand out from the crowd. Furthermore, you have to somehow overcome the negative stereotypes created by the crowd.

There are various root causes of the hypercompetition, of course, such as the low barrier to entry, but those aren’t the fundamental problem, I think. There’s a pretty low barrier to entry to becoming a garbage collector, but I don’t see that being talked about much. So the root causes might be barriers to solving the problem, but the problem itself is too many agents.

The Fundamental Problem of (Traditional) Brokerage

I’ve written this elsewhere, but the fundamental problem of brokerage is a simple one: it is the only business in the entire world where more productive a worker is, less profitable that worker is. Productivity is inversely correlated to profitability.

And yet, brokerages everywhere are convinced that they can recruit their way out of their problems. It’s what they have always done, and it’s what they know how to do. So they figure, we’ll recruit more agents, retain more of our agents, and then somehow… profit!

In order to recruit and retain agents, brokerages spend millions on a variety of goodies — call them, “value propositions” for the agent. Training, personable managing brokers, office space, and of course, technology. Oh, yes, technology.

When those goodies fail to result in a line of agents out the door clamoring to sign up for the sweet 70/30 splits, the brokerages often look for someone to blame. It’s discounters, it’s the 100% shops, it’s Zillow, it’s the MLS, it’s loss of data, it’s Jupiter in the house of Pisces, it’s global warming.

Thing is, even if the brokerage recruits more agents… its profitability doesn’t improve. Here’s a chart from Realogy’s NRT unit, the only traditional brokerage that reports its numbers:

Again, the root causes may be things like the independent contractor business model, but there are plenty of other industries that use independent contractors without the same production-up-profit-down dynamic. Maybe it’s the graduated compensation plans, but if they didn’t offer it, a competitor will, so….

I came to this conclusion by looking at the numbers. When I help companies with business plans, I always say there are two business plans: one in words and one in numbers. They both tell a story. So brokerages will say a bunch of things in public, like how they only recruit the best and most productive agents, offer the best training, and have amazing cutting edge technology… but their numbers tell a very different and very sad story.

The Fundamental Problem of the REALTOR Association

I get called into do this one quite a bit in my day job. I get to hear a lot about lack of member engagement, about lack of professionalism, about the Code of Ethics and so on.

The fundamental problem of the Association is simple: the REALTOR brand is meaningless to consumers.

I have long said that the Association is the victim of its own success. Because if you watch this very good video on the history of the Code of Ethics, you learn that the early REALTORS wanted to differentiate themselves from “curbstoners:”

Those early REALTORS lobbied hard for many of the reforms we all just simply take for granted now, as well as government regulation of the real estate profession.

Thing is, as each law was passed, each regulation promulgated, the Association didn’t think it needed to raise its own standards for membership. Nor did the Association ever think to limit its members to the Chosen Few, as did CCIM or SIOR or CPA or CFA organizations.

So like Xerox, REALTOR became a generic term, no matter how much advertising NAR does. In most cities and counties, every single person who can help you buy and sell real estate is a REALTOR. So why would it be meaningful? There is zero differentiation in the brand, because everybody has it.

The REALTOR Association is not a social club. It isn’t a charitable organization. It is a trade organization, which means that all of its members are in it for business reasons. If the REALTOR brand is meaningless to consumers, then it can not be meaningful to businesspeople who want to work with those consumers.

Every problem of the Association stems from that fundamental problem. If the REALTOR brand carried the same weight with buyers and sellers as does CPA for accountants or CFA for investment advisors, everyone would want it and jump through hoops to get it. If the ideals of membership were meaningful, then you don’t have “member engagement” problems. Look at churches for example.

There are root causes here as well, but they’re sort of shrouded in the past and mystic chords of memory. Those may prove to be barriers to overcome as well, but the problem itself is a simple one: the REALTOR brand is meaningless to consumers.

I came to this one slowly, over time, through multiple client engagements where we were trying to address the symptoms. When those “solutions” fail to do anything, you have to look at why they didn’t work… which leads to things like fundamental problems.

The Fundamental Problem of the MLS

Closely related to the Association issue, I have come to believe that the fundamental problem of the MLS is broken governance. This one, I’m most squishy on, as there are other major  problems. Let me list a few:

  1. Lack of money
  2. Old, outdated technology because of #1 above
  3. Too many and too small
  4. Core value proposition (cooperation and compensation) being eroded
  5. Looming government regulation

The result is widespread unhappiness with the MLS by its customer base: real estate agents and brokers. Yes, they all say the MLS is the most important tool in their toolkit for doing business, and most of them are utterly reliant on the MLS… but that doesn’t mean they’re happy with it. People use the DMV website but that doesn’t mean they’re happy with the DMV website.

Thing is, all of those problems are solvable. They’re not easy to solve, perhaps, but they are solvable… if those in power want to or can solve them.

Far too often, the MLS CEO knows what to do, when to do it, and why to do it… but can’t do it because his/her Board won’t go along for a bewildering array of reasons. You have board meetings in many an MLS where people are making multi-million dollar decisions, and those people don’t know how to read a cash flow statement, but they sure do know how to pound the table and insist on “member benefit.”

If governance can be fixed, and the CEO allowed to operate the MLS properly, there are real opportunities for improvement, growth, and gain. Look at most of the top, well-operated MLSs and you’re likely to see a Board that knows to stay in its own lane and let the CEO do his/her job. Look at a bad MLS and you are quite likely to find broken governance rife with internal conflicts, micromanaging Directors, and ginormous egos more suited to a U.S. Senator than a volunteer REALTOR leader.

I used to think that the fundamental problem of the MLS was that it was owned by REALTOR Associations, with diametrically opposed interests. But broker-owned MLSs are also subject to the same governance problems, so it isn’t that.

There are a lot of root causes to this one: revolving door on the Board (1 year terms are not uncommon), how a Director is named (often a popularity contest within the REALTOR Association that is the shareholder/owner), that decisions are made for political rather than business reasons, and the fact that allowing the customer to dictate corporate policy inevitably leads to disaster. You want to listen to the customer, really understand the customer, and give the customer what he wants… but you cannot let the customer run the business — for example, setting pricing and making product decisions.

As I said, I am the most squishy on this one. There might be a different fundamental problem that leads to this broken governance problem, but as of now, I think if an MLS solves this problem, all of the other ones can be addressed effectively. Without solving this problem, however, none of the others can be dealt with as politics will trump business inside the boardrooms.

The Fundamental Problem of Real Estate Tech Vendors

Finally, there is a bewildering variety of real estate technology companies. I am speaking here of what is commonly called the “vendor community” instead of those who are consumer-oriented like Zillow, Redfin, and Opendoor.

I don’t know how to properly distinguish between the two, but one rule of thumb I’ve been using is to put companies who make money from real estate agents, brokers, MLSs and such into the vendor category. (Yes, this means that big bad Zillow was a vendor until very recently, when Rich Barton pivoted the company.)

The fundamental problem of the real estate tech vendor is a tiny total addressable market.

Yes, having a successful SaaS company with 100K users paying you $25/mo is a fantastic business. That’s a $30 million a year business. Who wouldn’t want that, right?

But the problem is twofold.

First, let’s say a company gets 100% market share (which nobody has). That SaaS company above tops out at around $400 million a year in revenue with all 1.3 million REALTORS paying it $25/mo. That would make the company something of a small-cap stock, depending on profit margins, dividend payments and the like, since growth is now completely capped. Investopedia defines small-cap companies as those with capitalization between $300 million and $2 billion. It’s really difficult to see how a real estate tech vendor gets over $2 billion in valuation, y’know?

Second, there may be 1.3 million REALTORS and tens of thousands of brokerages. But as we saw above, we have something like a super pareto principle going on in real estate where a small cadre of super agents and agent teams are doing most of the business. Further, brokerages are getting hammered on profitability and are in no real position to invest into technology (although many do out of the hope that it will help with recruiting and retention).

So in reality, the tech vendors are chasing 10-30% of the total agent population and an even smaller percentage of brokerages. Now what’s the TAM? And it isn’t as if they don’t have competitors, right?

I think this is a fundamental problem because vendors simply can’t get to massive scale like the consumer-oriented tech companies can. The TAM is too small. You can develop the best damn product for this niche audience and make a pretty good living from it, but you cap out pretty fast, and the competition for that industry dollar is stiff indeed. That in turns makes it difficult to raise capital, which gives a massive advantage to the consumer-oriented real estate tech companies who can then provide industry-facing technology sort of as a sideline without needing to bet the company on that.

That’s kind of what Zillow has done and is doing, offering a reasonably decent CRM platform with its Premier Agent app. But a better way to think about it might be to imagine if Redfin were to spin off its software platform and sell it to other brokers and agents.

There are ways around this TAM problem, and I’m reasonably confident that smart technology company operators will figure them out and try them all. But as you think about real estate technology, keep the problem of TAM in mind.

Defining Fundamental Problems

As I read over what I’ve written so far, I am struck by a couple of things.

First, most fundamental problems are like a keystone in a dam: it blocks the flow of progress, of business, of growth. Remove it, and the entire dam bursts in a cascade of effects.

Second, that keystone is enormously difficult to remove. Looking over the list of fundamental problems, it isn’t surprising that very few people and organizations have been able to overcome them. Moving that keystone means moving the mountain of rubble surrounding it as well.

Third, the keystones are interlinked and interrelated. For example, the fundamental problem of the agent (too much competition) is deeply interlinked with the fundamental problem of the REALTOR Association (loss of brand meaning) which is often interlinked with the governance problems of the MLS which in turn is interlinked with brokerage profitability issues which in turn is linked with the TAM problem of technology vendors. It’s a giant web, where pulling on one strand affects many other strands, but that strand is supported by those other strands as well.

Fourth, underneath/stemming from each keystone fundamental problem are an array of other problems and issues that may be symptoms, but that fact doesn’t make the problem any less of a problem. Take something like “lack of professionalism” as an example. It’s a symptom of multiple keystone fundamental problems but that doesn’t make it any less of a problem.

I think this web-ecosystem character of real estate is why the industry is so difficult for outsiders to understand and analyze. At the same time, this web-ecosystem nature of the industry may be why it is so susceptible to disruption. Internal reform is not impossible, but very, very difficult because of the interlinked, interrelated and mutually supporting keystone problems. The way through is to be disruptive of the entire thing and take a radically different take on things (e.g., Opendoor, REX, Redfin).

Well, let’s wrap it up here. It’s an interesting look at the fundamental problems in the industry, and I learned a bit about myself. If these musings helped you figure anything out, well, that’s fantastic. If they didn’t… well, you got what you paid for them.

Have a fantastic day, everybody!

-rsh

 

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Picture of Rob Hahn

Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

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4 thoughts on “Musings on Defining Fundamental Problems”

  1. Great post Rob. Really, really insightful. One of your best yet. I think your TAM comments under the Agent section are right on. I would also include agent churn as well. I heard reports as much as 30% per year. Having such a transient membership is also part of the overall challenge in organized real estate.

  2. Another fundamental problem is that something like 75% of all of the complaints that the real estate code of ethics actually address… Have to do with Realtors sniping at other realtors regarding ads. The cultural mandate they you can’t say something negative about another realtor perpetuates Fraud.

  3. Thanks Rob for the thought provoking piece. These are real issues a lot of people have on their minds, but often overlook/oversimplify the interdependent relationship between them all.

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