Compass Vs WeWork
WeWork and Compass are two online real estate platforms that enable clients to easily find suitable workspaces and apartments. There are two main similarities between the two companies; both are heavily invested in by Softbank, and both are generally weak investments with low margins.
While we love the WeWork model if executed properly and plenty of other companies are doing it well, such as IWG on the big end and smaller firms in NYC like Workhouse, WeWork spends far too much money on leases and production.
WeWork functions by owning their primary leases with their properties as assets (not the leases with their customers). These leases at scale have significant risk in down markets, as even a three to five percent fluctuation in the market can cripple their profit margins for a given location or property.
Most of these leases are long term leases, and therefore a trending down market can rapidly create a substantial downside for them. Ironically, this very issue is why there is a market for short-term office leasing that they provide in the first place. From a top-down view, the very things that they are showing on paper as assets are in fact potentially huge liabilities if the market goes down by even a few percent.
Compass acts more as a traditional brokerage. While they try to play the tech card, all brokerages are trying to improve their search functions and agent features in order to compete with companies like Zillow, which are trying to create the same tech but provide it free to consumers. Since their tech is largely worthless due to the fact that many companies are providing it and some companies are even producing it for free to consumers, Compass had to resort to one thing to create assets on their books: GCI (Gross commission income) from their agents.
Compass' tactic was to buy up as many agents as possible so the books show high volume coming from their agents. They did this in spades, but at a serious cost of upfront cash incentives, stock, and high promotional agent splits to entice them. Similar to the margin risk of the WeWork model, which can work with proper margin management, but with the same thought process, Compass has an impending issue with their own margins with market conditions. They spent all this money luring in agents and providing very high broker splits which crushes their margins, in order to increase their volume to show large transactional volume.
After spending significant sums of money they ranked second in sales volume last year in the US, just behind Realogy, which has a current market cap of $2b. Realogy outpaced Compass by almost 20%, was actually profitable, and had a market cap of $2b. Compass lost over $200m and had a current market cap of $5b. For perspective, Compass tried to IPO at $12.5b and then $10b and eventually did so at $7b. Softbank last invested at $6.4b.
Now with all those data points, we see the specific issue facing Compass. Real estate agents go where the money is best for them for splits and incentives, with very little brand loyalty.
The terms of the incentives a lot of their agents have are going to start to burn off within the next 12-24 months and they will then leave and go to the next firm that gives them a promotional split and signing bonus.
Many of these agents will leave and have made Compass zero profit due to their upfront incentives and high splits never having paid off. When they leave, Compass’ sales volume, which has been used to pitchrop up the stock’s value, will drop. as will profitability which is already negative. If the market dips, their revenues of course will drop as the current volume in the US is not sustainable. Even at these numbers, the company for Q1 2021 beat 2020 by 80%, yet the quarter’s losses were over $200m, and $150m of those losses were attributed to stock, cash options, and incentives.
In short, when the agents start to leave for better offers, Compass will be left having paid out all of these incentives to buy market share. Even in the hottest quarter on record for residential properties, they can't obtain profitability. Brand loyalty in sales is limited, regardless of the industry.
You go where the money is best for you. So once one’s 100% split or sign-on bonus or stock option vests with Compass, you move on. Realogy has been in this business forever; they do the exact same thing. Not to mention they're currently valued at $2b, are profitable, and have 20% more volume than Compass. It’s simple to see that they are reinventing the wheel. It's not so simple how that compares to WeWork, but both companies are very tied to market conditions in ways that can cripple them unless they can improve margins and spend less money on creating production.
Written by Lika Mikhelashvili
Edited by Benjamin Binday, Ryan Cunningham, Jay Devon & Paul Griessel Jr