The real estate industry has certainly suffered as a result of the U.S. Federal Reserve's aggressive hike in interest rates to tamp down outsized inflation. The central bank increased the federal funds rate from a historic low of 0%-0.25% up to 5.25%-5.5% in just 18 months between March 2022 and August 2023.
It crimped consumers' borrowing power, and it also forced existing homeowners to rethink their plans to sell, because they would have to give up their low fixed-rate mortgage to take on a much higher rate when buying a new property. Those factors slowed the housing market to a crawl. The most recent U.S. existing home sales data (May 2024) reported 4.1 million annualized units, which is down 37% from the 2021 peak of 6.6 million.
Real estate technology company Redfin (NASDAQ: RDFN) operates one of the largest real estate brokerages in the country, and it has been under serious pressure since 2021. Fortunately, recent favorable inflation and employment data triggered a shift in sentiment. Analysts surveyed by the CME Group's FedWatch service now forecast as many as three interest rate cuts from the Fed before the end of 2024, sending Redfin stock surging 41% this month alone. Here's why it's not too late to buy.
Image source: Getty Images.
Positioned for a comeback in the real estate market
Up until the end of 2022, Redfin generated half of its revenue from its iBuying program, which involved purchasing homes from sellers and trying to flip them for a profit. It's a fruitful endeavor when house prices are consistently rising, but soaring interest rates forced Redfin to reevaluate the business.
The company decided to ditch iBuying to focus on its portfolio of services instead, which include brokering, mortgages, rentals, and title services. Redfin employs 1,658 lead agents, who handled 0.77% of all real estate sales around the country during the first quarter of 2024.
Redfin will charge a 1.5% listing fee to sell your home -- or 1% if you're a repeat customer -- which is far cheaper than the industry norm of around 3%. The company said over one-third of its deals came from repeat customers during Q1, and those organic acquisitions help to keep costs down.
Plus, a record-high 30% of consumers who bought a home through Redfin during March used the company's mortgage service, and those add-ons help generate more revenue from each transaction. Overall, brokering and mortgage lending have higher gross margins than the iBuying business, which often ran at a loss, so growing those segments could make Redfin a profit-generating machine when the housing market bounces back.
Sluggish growth but an improving bottom line
Redfin generated $225.5 million in revenue in Q1, which was only a 5% increase from the year-ago period. The fact it's producing any growth at all is a positive given the existing home sales figures mentioned earlier, but the company is using this tough period to trim costs and push the business toward profitability.
Its Q1 gross profit rose 22% -- much faster than revenue -- because of those cost cuts, which included a new compensation structure for some agents who give up salaries in exchange for higher commissions. But Redfin uses adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) as its preferred measure of profitability, and it still came in at a $27.6 million loss during Q1.
That was a solid improvement from the $63.6 million loss in adjusted EBITDA it delivered in the year-ago period, so it's trending in the right direction. Redfin could report up to $2 million in positive adjusted EBITDA when it releases results for the second quarter in August, according to management's guidance. The company also expects to deliver a positive result for the full year.
Hitting that milestone will be very important because Redfin is low on cash. It has just $107 million on its balance sheet, with a further $165 million in loans held for sale that should convert into cash in the near term. The company could sustain negative EBITDA for a couple more quarters, but it will likely need a cash infusion if it can't achieve profitability by then.
Why Redfin stock remains a buy following its 41% surge this month
Redfin stock might be trading up 41% this month, but it still trades 91% below its all-time high, which was set in 2021. As it stands, the company has a market capitalization of $988 million, and since it could generate over $1 billion in revenue this year, its stock trades at a price-to-sales (P/S) ratio of less than 1.
In other words, the housing market is so challenging right now that investors value Redfin at less than one year's worth of its revenue, which is practically rock bottom. When interest rates were at historic lows in 2021, Redfin's P/S ratio reached 7.7. Even if it regains half of that level to trade at 3.8, that will translate into a near-300% gain in Redfin stock from here.
That doesn't factor in any revenue growth, which could also boost the shares' valuation. The CME Group's FedWatch tool predicts a 90%-plus chance the Fed will cut interest rates at least two times before the end of 2024 (in September and November) with a 50% chance of a third cut as well (in December), which could reignite the housing market. Any uplift in home sales would directly translate into more revenue for Redfin.
As mentioned, it's critical for Redfin to achieve profitability soon because of its dwindling cash balance. If the company is forced to raise more money by selling additional shares at the current price, it could lead to significant dilution for existing stockholders. That's a key risk investors should keep in mind when buying this stock.
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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Redfin. The Motley Fool recommends CME Group and recommends the following options: short August 2024 $11 calls on Redfin. The Motley Fool has a disclosure policy.
