McNellis: A Broken Compass?

Los Angeles, Dodgers, Compass, New York, Paragon Real Estate Group, San Francisco, Avenue Properties, Seattle, Cow-Calf, Wikipedia, Bay Area, Silicon Valley, Facebook, WeWork

By John McNellis

John McNellis

Does outspending your competition buy you the best talent? Of course. Does it guarantee you the World Series championship? Not so much. Just ask last year’s Los Angeles Dodgers.

Compass Inc., a residential brokerage company that parachuted onto the scene in New York City in 2012, swiped the spend-it-all playbook and bought the finest brokers in Manhattan, luring them with otherworldly commission splits and promises of a breakthrough technology, a black box that would make selling real estate as easy as ordering Harry Potter on-line. Today, with roughly $800 million in VC funding, Compass is going all out, buying brokers and whole brokerage firms by the bushel, most recently, Paragon Real Estate Group in San Francisco and Avenue Properties in Seattle.

First, a word about its ballyhooed technology. When they see AI, readers of Cow-Calf magazine think artificial insemination, not artificial intelligence. Perhaps you should, too, especially when you read in Wikipedia that Compass, “…is an American technology and real estate company.” When your assets stroll out the door every day at 5 o’clock, are you a technology company? Can technology sell a tired condo with a dumpster view?

When they see AI, readers of Cow-Calf magazine think artificial insemination, not artificial intelligence. Perhaps you should, too…

According to a group of industry insiders I’ve interviewed*, Compass’ technology has either yet to emerge from its box or, while mildly impressive, is duplicable by the industry’s biggest players. A senior Bay Area real estate executive said, “The Compass technology isn’t any better than what I’ve seen elsewhere.”

So much for user interfaces. Let’s talk about money. Pre-Compass, a young agent split her commission fifty-fifty with the house and, if she proved to be one of its few winners (87 percent of all agents reportedly fail within their first five years), if her sales volume went big, so did her commission share. It could rise from 60 to 70 to 80 percent and even, in a few superstar cases, to 90 percent of the total commission. It’s simple from the house’s standpoint: You make $50,000 if you split equally with an also-ran whose volume is $100,000 a year. But you make $300,000 on a 15 percent share with a superstar doing $2 million. Easy, right? The more an agent brings in, the bigger her share. But, like condo towers, commission splits cannot grow to the sky.

Exactly where even the brightest star ceases to shine for the house is a bit complicated, depending on whether the company charges incidental fees (desk fees, marketing fees and the like), its overhead structure (e.g. how fancy are its offices, does the firm have an expensive agent training program, and so on) and intangibles like how many 50-50 split brokers are happy riding the superstar’s contrail. The consensus over/under line for profitability was 85-15 among the four company presidents I quizzed. Any more to the agent, the house is losing money; any less, the house is profitable.

And that brings us to Compass. Having adopted Silicon Valley’s tattered battle cry—buy market share now, monetize later—its problem is straightforward: How do you lure away pampered top agents already at an 85 percent split? As long as you’re just telling them how special they are (Compass’s siren song: “To us, the agent is the client”), how special you are and how extra-special your new technology will soon be, they’re thumbing their iPhones during your pitch. To get an agent to even look up, you have to offer her serious money. Compass is doing just that: deals that can include six-figure signing bonuses, 100 percent of all commissions for the first year, 95 percent for the first several years and so on. In short, Compass is signing agent deals that are guaranteed money-losers for the company, using its VC war chest as a bonfire over which its agents can roast their marshmallows.

Skeptical of the company’s technology, one company president put it this way. “Think of typical disruption. Usually, there’s a fundamental change in the way the disruptor approaches the old business—instead of you going to the bookstore, Amazon delivered the books to you. That’s real change. With Compass, nothing’s changed, it’s still the same old business, the only disruption is that Compass is wildly overpaying its agents and on its way to destroying brokerage in general.”

“But once it kills off its competition, can’t Compass lower its commission splits with its agents and be profitable then,” your correspondent asked.

“Top agents are prima donnas, they never go backwards on their splits. They would rather quit and go somewhere else at a lower split than reduce their cut in place.”

I asked a Seattle agent who had been pitched hard by Compass whether knowing the company is hemorrhaging like a hemophiliac piñata would affect his decision to join it. “Nah, man, they’re going to figure it all out. They’re gonna have that end-to-end tech platform where the company runs the whole process from listing to loan to roof inspections to closing. It’s going to be sweet.”

“But they’re not making any money.”

“Dude, that’s what they said about Facebook.”

So they did, and maybe Compass will become another FAANG stock. Maybe not.

*All insisted upon remaining anonymous. What is it about Israeli-led companies (WeWork is another) that makes sources so nervous? Their CEO’s can’t all be ex-Mossad.

John E. McNellis is a Principal at McNellis Partners in Palo Alto, Calif.

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mcnellis-book-coverTo read more from McNellis, please consider his book Making It in Real Estate: Starting Out as a Developer.