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Does a brokerage model that can generate market profitability exist?

Thursday, August 4, 2011  
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By Jeremy Conway

Of the several challenges currently facing our industry, few will have the long-term ramifications or impact of its current shortage of investment and working capital. The business and market traumas of the last decade have rendered many, if not most, firms unable to do anything but satisfy the most basic of month-to-month needs. With each month that goes by, many firms find themselves further and further away from the ability to invest in even the most basic of technological or service updates. Moreover the ability of brokers to either sell their company, in the ordinary course of business, or to expand through the purchase of "healthy” firms (as opposed to shotgun arrangements), is equally in question. For a long time now, with the possible exception of the upcoming Zillow IPO, the industry has been a "non player” on Wall Street and other financial markets.

The solutions to this level of financial reality will probably not come from internal sources, such as cash flow or increased productivity, at least not in the next few years. Not only are cash flows not likely to reach these levels for the next two years but, the fact is, the "mind set” or psychology of many in industries that have gone through long term downturns is likely to call for the creation of "rainy day” funds until they feel that they can trust their industry and its marketplace. With the average age of brokers exceeding 62, this may be the financial equivalent of the now famous
"IDX buy in” theory.

Given these factors, the financial rebirth of our industry will probably come at the hands of investors who determine that real estate can be made to generate market level profitability and productivity. Whether these investors make loans for working capital, mergers, or acquisitions will ultimately depend upon their confidence in both the real estate market itself and the individual brokerages’ ability to design, develop, and implement a contemporary brokerage business model that can generate market level profitability.

It is, therefore, incumbent upon the entire industry to do whatever it can to support the design of brokerage business models that can attract the working and investment capital that is going to be so critical to its immediate future. There are few, if any, existing industry organizations that individually have such resources, and those that do are not likely to invest them in the traditional business model.

The very suggestion that this reconfiguration process be undertaken will likely raise two immediate responses, both of which must be rejected at any cost. The first response is that, in a fully operational and healthy market, the traditional brokerage business model will work just fine. In order to prove such a statement, one must go back to the early 1990s. It is sufficient to say that way too many changes have occurred to the specifics of the industry, the marketplace, and the transaction to take this idea seriously. We cannot go backwards.

The second response is the idea that such considerations are competitive in nature, and that these solutions must arise out of the competitive environment, one player at a time. This response also ignores the realities of the past several years. With very few exceptions, the traditional competitive environment no longer exists. In its place there is now a wildly unpredictable and largely immeasurable tangle of transitioning business arrangements, most of which are not driven by design or common sense but, rather, by a sense of panic and unfunded desperation. Moreover the activities that have lead to the reconfiguration of banking, the U.S. automobile industry, and several other industries over the past 10 years clearly demonstrates that even the term "competition” has evolved.

These realities strike, like explosive shells, when upfront exploratory energies are engaged with potential funding sources.

Over the past year we have been working with a number of "non-industry” funding sources that were brought together through a belief that the time to invest in the industry is fast approaching for those who want to be in good positions when the industry makes its comeback. Unfortunately the scenarios of these interactions are becoming increasingly predictable.

In 2009 and 2010 the issues, related to this capital problem, stemmed from the inability to project market levels that would support appropriate returns on investment. Today, at the midpoint of 2011 the market projections are finally demonstrating the ability to support the cash flows necessary to generate both appropriate returns on investments and pay-back schedules. Now the potential lender’s attention turns to the realities of the potential borrower’s business model.

The investor’s questions are predictable:

  • How does the existing business model generate cash flow?
  • What business systems are in place and how are they managed?
  • What benchmarks and metrics are being used to manage these systems and what standards are being used to measure brokerage value propositions for consumers?
  • What is the nature of the relationship between the brokerage, its management team, and its primary producers (agents)?

The discussions very seldom extend beyond these simple and basic inquiries. The fact is that few firms today can answer these questions in a manner that is consistent with even the most lax of loan standards or equity expectation. For those sources that are interested in an equity position the questions are even simpler; "How could an investor possibly win in the current management environment,” or "who has claimed a financial victory from their real estate brokerage ownership position over the past six years using the traditional model?”

There are simply too many other more positive investment opportunities, even in today’s stressed and uncertain economy. The fact that the real estate industry may no longer be an acceptable risk for lenders and investors is an industry-wide problem that must be both addressed and engineered through a joint effort. At the very least a series of critical elements must be developed thus allowing for the individuality in implementation deemed so critical by the competitive set. In any event the discussion must be launched and the effort must be made while sufficient energy and resources exist. Who will step forth and lead this important effort?

Jeremy Conaway, RECON Intelligence Services, is a frequent organizational consultant to the Orlando Regional REALTOR® Association.


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