A recovery in the housing market could help revive the real estate industry.
It’s been a nerve-wracking August for investors.
After the Federal Reserve closed July by maintaining the benchmark Fed funds rate at 5.25% to 5.5%, where it’s been for over a year, investors have been clamoring for a do-over.
The S&P 500 plunged 6% over the first three trading days of August as a raft of downbeat economic data convinced investors that the economy was weakening faster than expected and the Fed had erred in not lowering rates.
Stocks plunged on Monday as a surprise interest rate hike in Japan led to the unwind of a global “carry trade” in which investors had borrowed low-interest yen to invest in risky assets in the U.S. like the “Magnificent Seven” stocks.
As a result of the sharp three-day sell-off, economists now expect the Fed to cut rates by 50 basis points in its September meeting and at least another 50 basis points before the year’s over.
The economy is likely to remain uncertain, but one thing is clear. Lower interest rates will help to revive a struggling housing market, breathing new life into stocks that depend on real estate transactions.
That industry has been hit hard by the slowdown in the housing market, but a turnaround could be near. One stock that could soar in the recovery is Compass (COMP -1.84%), the nation’s No. 1 real estate brokerage by sales volume.
Image source: Getty Images.
Can Compass get back on track?
Compass went public in the spring of 2021 when the real estate market was booming, and mortgage rates were around 3%. However, that boom did not last long, and by the time 2022 rolled around, revenue was sliding, and the stock was flailing.
With the housing market remaining on ice, Compass has focused on realigning its cost structure, investing in technology, and growing its base of agents, which has helped drive revenue higher even in a challenging market.
Revenue increased 14% to $1.7 billion in the second quarter, and Compass’s number of principal agents rose 24% to nearly 17,000 as it’s luring new agents with an attractive technology platform and a steady marketing push. After two years of declines in total transactions, the business has returned to growth, a sign that the industry is starting to turn around.
Compass is also targeting positive free cash flow this year and is making progress in profitability as adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) jumped from $30.1 million to $77.4 million in the seasonally strong second quarter.
The real estate brokerage industry is in flux after a lawsuit against the National Association of Realtors forced brokerages to amend their business model with more disclosures and information that makes it clear that traditional 3% commissions are negotiable. As a part of the settlement agreement, Compass agreed to pay $57.5 million.
Compass has also assuaged concerns that the agreement would dramatically change the industry, noting in May that in the initial weeks after the settlement, 99% of new listings included offers to pay the buyers agent, and 96% included commission offers of 2% or more. Compass believes the settlement will have little impact on professional full-time agents.
What lower interest rates would mean for Compass
The housing market will probably never return to the heady early days of the pandemic when Americans in cities were plucking up second homes and suburban plots with yards, and mortgage rates fell to less than 3%.
However, there is substantial pent-up demand from homebuyers looking for falling rates to effectively lower prices by bringing down monthly payments and from potential home sellers who may not want to give up their low mortgage rates when current rates are so high.
In June, existing home sales fell to a seasonally adjusted annual rate of 3.89 million, down from a peak of 6.6 million in 2021, a decline of 41%. Reversing that loss would mean a surge in existing home sales of 70%.
Compass doesn’t need that to happen, but even getting back to pre-pandemic levels would mean a 50% increase from current existing home sales, and that should make a significant difference on the bottom line. CEO Robert Reffkin told investors this spring, “We believe when rates come down it will create a massive surge in transactions,” and he predicted lower rates would mean hundreds of millions in adjusted EBITDA and free cash flow, assuming normalized annual home sales of 5.4 million-5.6 million homes.
The business is already moving in the right direction, with revenue up double digits, and growth is likely to accelerate substantially as mortgage rates come down and the housing market picks up again.
Compass stock has already more than doubled from its low last November, trending with hopes of a recovery in the housing market and stabilization in its own business. Down 79%, Compass doesn’t have to recoup those losses to be a winner. The stock could double by only retracing a quarter of those losses.
If the Fed cooperates and the housing market shows signs of life, a double for the real estate brokerage stock from here certainly seems within reach.