- Valuations for brokerages are as high as they have ever been.
- Standard valuations today are five to six times trailing EBITDA (earnings before interest, taxes, depreciation and amortization).
- NRT, Realogy and HomeServices are very active acquiring brokerages. Regional franchisors, like Howard Hanna, are also doing deals on the buy side.
- There are two buckets of sellers: older broker-owners and younger companies who need capital to “go to the next level.”
- The brokerage business is getting more complex, with new technology that creates uncertainty.
- Brokers are feeling downward pressure on margins, higher splits to agents and regulators like CFPB over marketing services agreements.
- Teams that act like businesses are creating asset values that may be saleable in the future.
Brad Inman talks to Steve Murray, who owns Real Trends Consulting and has handled more than 2,250 client assignments for realty firms over the past 28 years, with more than 660 merger and acquisition (M&A) assignments, totaling $11.8 billion in aggregate value.
A 37-year real estate veteran, Murray publishes the Real Trends 500 and the Wall Street Journal/REAL ranking of the nation’s top sales professionals. He is the co-author of four books on the valuation of residential real estate brokerage.
Brad Inman: I’m so excited today to have Steve Murray, who is going to talk today about brokerage M&A — mergers and acquisitions — what’s going on in this hot, hot M&A market for real estate brokerages. Welcome Steve.
Steve Murray: Nice to be with you.
Where are you traveling?
Today in Nashville, Tennessee.
So, Steve, tell me this — I think a couple months ago, you and I chatted about trends. Your specialty is M&A and brokerage, and you were telling me that it’s hot as a pistol. Are there a lot of sellers, a lot of buyers or both?
It’s both, Brad. The usual companies that people would think of — the Berkshire Hathaway HomeServices and the NRT unit of Realogy are both extremely active as active as I’ve ever seen in all the years I’ve been on the other side of the table from them, and they’re both looking at companies all over the U.S. — medium-size, small companies if they’re in an existing footprint — and looking at new markets and new acquisitions.
But regional brokers are also very active. We saw last year the Howard Hanna company — a good example — bought Nothnagle, the no. 1 firm in Rochester New York. That is an example of some of the larger regional firms around the U.S., whether they’re independent or with a franchise organization, out looking at acquisitions both in their existing marketplaces and in some new markets.
On the sales side, you see two companies in two basic categories. One, those who we would say are toward the last few years of their ownership and career owning a brokerage company.
So those are the personal owners, the guys that have started the company and have been around a while.
Yes, and they survived the downturn. And they’ve rebuilt their balance sheets and earnings statements, and they’re doing extremely well profitability-wise.
But, you know, in some cases the value of their brokerage is a significant part of their family’s assets. And while there is liquidity, which there is today, they’re interested in checking to see what the market will pay them for their firms.
You also have some younger companies owned by 40-year-olds, as an example, some really good companies that have been at it 10, 15 years, have built really nice independent brokerage firms, but they understand that to get to the next level, they’ll have to begin to reinvest significant sums of their earnings in building staff and structure and brand. In some cases, it’s not really what their passion is. So we have a number of those clients as well.
Is there any evidence that brokers are trying to get out of the business because of any fear factor? Zillow, technology, the broker model not working — any evidence at all that there’s a fear factor or a market fear factor?
If there’s a reason for selling that has to do with fear, it is more in two or three areas.
One, the business is getting more complex. Zillow, Trulia, realtor.com, the abundance of new technology firms, SmartZip, BoomTown, technologies coming at the industry nonstop. It’s not that so much they fear them, it’s that they really haven’t been able to understand or get firm about what will be the end pack three, five, ten years from now.
That’s a little bit of it — and probably a bigger part is downward pressure on gross margins, the amount of money a broker has left after the agents are paid, splits. You have to pay more and higher splits to the agents.
You have the CFPB (Consumer Financial Protection Bureau) wading into the industry last fall and basically firing a cannon across the whole industry’s bough concerning mortgage marketing service agreements. And so hundreds of brokers have discontinued those. For many firms, they weren’t a huge — but they were an important — part of their profit, and now that’s gone.
So it’s more of the financial pressures of the business from several different directions. And the fact that the market is extremely good, and none of these people wants to wait around or try to time the market and wait for the next downturn.
I assume the last downturn was serious punch in the guts for some of these guys, just like every business in America. Hanging on was tough, right?
We saw unit sales decline by, depending on which report you read, 35 to 40 to 45 percent decline in units — the average price of what was selling was declining. It was a 50, 60 percent drop in the volume of business that they were able to do. We know from our own REAL Trends 500 rankings, the top 500 firms and brokers in the country — one quarter of the firms that were on the 500 in ’05 did not make it to 2011. And they went out of business — mainly merged with other companies.
What are you hearing from brokers about the market? We had a horrible, horrible downturn, but you could arguably say we’ve had four or five good years. That’s pretty deep into the traditional cycle.
Are brokers nervous? Things like the election to things like Wall Street? What makes them nervous? We hear “shortage of listings” — are there any market indicators that they’re listening to from their agents or consumers?
No, I think the thing that worries them, and even something I think about is, “let the good times roll.” We’ve had now four-and-a-half years of a significant increase in units and prices. Most markets are short of inventory. Prices are increasing steadily. Unit sales were up very strongly in January, February across the country. It is in the back of their minds — and in in my CEO group, there will be discussion about how long we think this will go.
Now they can look at fundamentals and say that household are back, being formed at 1.3, 1.4 million new households a year in the U.S., and that doesn’t include illegal immigration coming into the U.S., which is something near a million people a year — many of them with good educations and capital, and they’re moving to America.
You have foreign offshore buyers — although it’s backed off some from a couple of years ago, it’s still high single digits of all the home sales in the country are being bought by families from overseas from various regions. But yes, to answer your question, everybody in the back of their mind goes — because I get asked that question all the time — “how much longer do you think this has to go.”
And my answer just points out — the mortgage industry still has tight grips on the underwriting process, so people who shouldn’t get a mortgage aren’t getting one. The rates are still extremely low. Household incomes, while the last five or six years have been somewhat anemic compared to prior recoveries, it’s still growing at 2 to 2.4 percent a year. And the stock market seems to be recovering again somewhat.
Up, down, all around.
It’s no great immediate concern, but a real knowledge that, OK, five years, six years is pushing it. You’ve got age on the one hand, you’ve got the requirements of the business, the knowledge you have to have to be successful in this business, some of the regulatory pressures in the business — those are causing people to think, you know what, my profits are back to very strong, there are buyers out there, this may be a good time to do it.
Go play golf in Florida. Back to M&A specific — tell me about multiples. I assume the good old days for a broker selling his or her business would have been 2005, 2006 before the crash. Was that the peak in your experience, and if that was the peak how are the multiples looking today?
And for the young, smart brokers out there building businesses that have been involved, where they should focus to create their business, should they decide to sell? Is it in margins, is it top line, is it EBITDA, is it overhead, is it agent count, is it product, and what of the factors factors here do you think are most important to creating value?
First let’s address the big question, which is “where are multiples in terms.” You know there’s two parts of a transaction — the price and the terms — in our industry. The multiples were at a peak level from ’01 right to the end of ’05 and ’06 to some extent. And they, of course, declined quite a bit in the downturn. They’re back at that same level today.
I told an audience recently of large independent brokers, I said, ‘Look, if you are a very, very large independent record in a very large metropolitan area, there may be only 10 or 12 companies in the country that fit that profile.” You could get a five-and-a-half to six multiple of your last 12 months’ EBITDA (earnings before interest, taxes, deductions and amortization), which is the basis for valuations in our industry.
You’re saying five to six multiple on a trailing EBITDA, or forward?
Trailing 12-month EBITDA.
So that means that a company that’s doing $10 million in EBITDA last year, 2015, could conceivably get $50 to $60 million dollars. Is that the math?
Yes, that’s the math.
How many fit that deal? How many firms actually generate …
Oh, there’s only maybe 10 to 15 brokers — maybe that many — in the whole country. Independent, privately owned brokers that generate that kind of EBITDA.
So using my example’s not a representative example. Are there quite a few firms making a million bucks a year where they could get taken out by the $6 million and sit on their profits?
Well — But a firm doing $1 million in EBITDA is not likely not that large, and they’re not going to get a five or six, they might get a four to four-and-a-half.
For the last 18 months, we’ve had a record number of valuations and merger or acquisition clients at our company, a double in both categories that we ran before the beginning of 2015. The typical client — we occasionally get a large one, that $40, $50, $60 million in gross revenues with EBITDA of $3 to $6 million — that’s a really good-size firm.
But typically, the largest number of firms we represent are those firms that are doing $10 to $25 million of gross revenues, and their EBITDA is $600,000 to $2.5 million. And there is a really, really good market for those companies.
But those guys aren’t going to retire on that, are they? It’s the end of a chapter, but it’s not the end of them going out and making money unless they’ve stashed away some dough, right?
That’s correct. Most of these people have other wealth, they own real estate, they have cash and marketable securities. This is an important part, but mainly even though they know it’s not a huge number — maybe it’s a $3 million or a $4 million dollar deal. And they’re not going to to get all cash, which I’ll get to in a minute. They’ve got to stay around for a couple of years to earn the rest of the payments. They don’t want the liability and the pressure of being an owner anymore.
Especially, I guess, at certain times when things are changing.
I was at one of my CEO groups, a very large firm, last week, and at our dinner table — the talk at our dinner table was two things you should never talk about among your business friends, religion and politics. And the political side particularly was as lively as could be because at a table of eight, we had people who were passionate about, on both sides — especially on the Republican and Democratic side of this election — about their particular guy, and everybody was was in favor of somebody else, so it was a really good discussion. We had a lot of fun, laughed a lot, nobody took it too personally.
Obviously, the political situation in an election year — yeah, it’s a natural concern. But I don’t think it’s causing anybody to decide whether to buy or sell a brokerage company.
Tell me this. Preparing my company for sale, I’m a young, hotshot broker. What I need to do — focus on top-line, bottom-line?
Profit is what will drive value. Now behind that, you want to make sure that if you’re planning a sale that you’re going to stay around for two or three years to maximize your sale. Because typically — these are never all cash. That just does not happen if it’s a decent-size firm to a large firm. We might see 55 to 75 percent of the price in cash, but the rest — you’ve got to get in what we call an “earn-out.” You’ve got to keep your company operating.
So you’re not going anywhere when you sell your company — golf in Florida’s probably not in the cards.
Who do you represent, Steve — the buyer, the seller?
We’re almost always on the sales side.
So you’re always sitting across the table from someone in New Jersey, Minnesota, Ohio, Seattle, all those places.
Yeah, but you know, the interesting part is, this is a deeper trend. Because more and more we’re seeing — I’m working on right now, merging, for instance, some Re/Max companies. Or one Keller Williams acquiring another one. Or a Keller Williams or Re/Max buying an independent firm. The smallest client we have right now is five agents. And we’re working to get a woman a reasonable proposition for her business.
The other interesting things happening in M&A is we are starting to see — I think we’re at the front end of — large agent teams have now started to come to us and want guidance on how they build real value in their business.
Is there a market for that yet, Steve?
Not a big market, and particularly if it’s a personality-driven team where 60 or 70 percent of the business is sphere, personal relationships and referral — there’s a market, just not really a good price market or terms market. But we seeing these teams now — they’re what we call business chains — where 50, 60, 70 percent or more of their business is generated by cold-calling, direct mail, online marketing, online lead generation, which is not attached to a personality or a particular person. Those have some real value to them.
And we’re starting to work on that — we have a couple deals we’re working on now, and we think that market will get more active as some of these teams organize themselves more in a business way than just a really good agent who has a huge number of leads and hires agents to help with a personal business.
So they’re creating asset value that you could start to put a price on, conceivably. That’s interesting.
Let’s wrap up with one last thing. One of the things that flummoxed me — Robert Reffkin is a smart guy at Compass and Glenn at Redfin is a heck of a smart guy. But they’re basically traditional brokerages with some tweaks here and there, with some killer technology. But a lot of good brokerages have technology.
How is it that these guys command valuations that are insane? No one judges them on EBITDA because I’m not sure either one of them are even profitable. Is that just Silicon Valley math and not Steve Murray math? What’s going on there?
I wrote a column about this stuff going on, and I called it “The Crazy Valuations,” and I made this simple point: For the last 20 years, Wall Street and Silicon Valley have had this infatuation with combining their talents money and technology to disrupt industries one after the other — bang, bang, bang. They look at our business, they think it’s highly inefficient, highly fragmented, and this year there were $70 billion dollars of commission revenues floating around out there.
The largest brokerage in the firm, owned brokerage, is NRT — they have 4 percent share. The largest franchise network in terms of closed transaction is likely still Re/Max and they maybe have got 9 percent share.
And so you get the money and the technology guys — and you’ve seen it, Brad, in your career in the last 20 years. They just throw money at this and keep trying to unlock the secret. When will housing consumers change their habit of how they buy and sell a home, and how can we get them to do it by using technology to make it easy? Right?
That’s Redfin. I think I’ve interviewed some of the senior people, some people running a region. Gosh, they’ve got a great system; they’ve got a great platform; I’m very impressed with their people as well. And I think recently they’ve backed off offering rebates to consumers. I think Glenn will find that he doesn’t need to have offered rebates; he can still build a good business, but is it a business that’s worth 60 percent more than Re/Max International?
Hard to imagine.
Or you look at the second round — I read somewhere, I never verified it, I read somewhere their second round of fundraising valued them at $800 million, which I told an audience is $250 million more than Re/Max’s market cap.
Of course, we won’t talk about Zillow. I actually myself think Zillow’s business model, in another few years, will get them to where they’re reasonably priced. I don’t know if Redfin or Compass will get there.
Compass is doing a lot of technology, but bottom-line, what they’re doing — which has been done a dozen times in the past — is they’re buying good managers, good agents, literally buying them.
I wish them well; we always wish new competitors well, but the jury’s out on whether that ever gets to where it’s worth $800 million.