Compass faces first downturn amid pressure to cut costs

This is the third in a series of 10 reports on the challenges the country’s largest brokerages, portals and iBuyers face in 2023. Check back as Inman dives into the biggest obstacles of the new year for Anywhere, Opendoor, eXp and more all this month. And look back at the challenges they faced in 2022 here.

It’s hard to think of a company that has had a more spectacular run than Compass.

Founded a decade ago as “Urban Compass,” the company grew rapidly over the years to become the largest firm of its kind — dethroning much more established industry players along the way. Compass has built a reputation for handling luxury properties, recruiting the best agents and integrating technology in ways that rivals were slow to try. The brokerage made some enemies along the way, but the fact that bigger and older companies saw Compass as a threat or a worthy adversary was in itself a testament to how far Compass had come.

But like every company in the industry, Compass now faces the dawning of a new era that includes higher mortgage rates, slower or negative home price appreciation and potentially shrinking numbers of real estate professionals. The shifting landscape is a challenge for everyone, but that’s especially true for Compass thanks to the firm’s age; Unlike, say, Keller Williams or RE/MAX, this is the first major downturn Compass is weathering. It’s the first time the company is facing a test of this type.

To understand what this means and how Compass will need to respond, Inman reached out to a group of analysts and industry observers. And the takeaway from these conversations was that Compass does face some pretty serious challenges on the horizon. However, the consensus among the experts was also that Compass is big enough and powerful enough to weather the storm — if it plays its cards right.

The need to cut costs

The topic that came up most frequently in conversations for this story was cost-cutting and specifically Compass’ need to get leaner if it wants to move forward this year.

“A lot of the discussion around Compass has been ‘yeah you’re growing and growing market share, but are you spending too much money?’ ” Justin Ages, an equity research analyst at Berenberg Capital Markets, told Inman.

The issue is that Compass has had the benefit of venture capital in the past — including from Japanese megafund Softbank — and so has not faced as substantial pressure to actually turn a profit as other companies might. And indeed Compass has not been profitable, for example reporting a net loss of $154 million during the third quarter of 2022.

However, the experts were virtually unanimous in saying that the fat now needs to be cut and that the period of spending big to grow quickly is coming to an end.

“It needs to cut to survive,” analyst Mike DelPrete told Inman of Compass. “The cash burn is unsustainable. All brokerages are heading into the winter of real state. Compass has to cut fast enough and deep enough to be able to survive through that downturn.”

Last year, DelPrete also referred to Compass as “the world’s most unprofitable brokerage ever” and argued that for years it has spent “more money than it makes.”

The good news is that most of the experts were fairly optimistic about Compass’ ability to cut costs and pointed to efforts already underway. Among other things, for instance, Compass has made cuts to its technology and development budget and carried out three rounds of layoffs — the most recent of which took place earlier this month. The brokerage also revealed in January that it is exploring the possibility of subleasing its New York headquarters.

Of course, cuts can be a two-edged sword. Observers who spoke out for this story noted that slashing the technology budget too much, for example, could undermine one of Compass’ selling points for agents. But Ages argued that given how much effort Compass has previously put into tech, the company should be able to safely “take their foot off the gas” without making meaningful sacrifices to the platform itself.

“I don’t think it’s a problem for them,” Ages added of Compass’ cuts to technology spending.

Bernie McTernan similarly focused on cost-cutting as a major challenge and opportunity for Compass in 2023, telling Inman that “it really seems like they’ve had a radical change when it comes to the necessary investment level.” And he added that on a recent earnings call, company leaders said they expect to “cut costs even more” in the near future — which McTernan believes is a good thing.

“This is a shift in terms of how the company views necessary investment levels,” McTernan added of Compass’ latest moves.

The takeaway, then, is that Compass faces an urgent need to cut costs and, crucially, that observers see the company as moving in the right direction on that front.

Maintaining and growing agent count

Compass has made a number of cost-cutting moves lately, but the single most eye-catching one was the elimination of its stock and cash-based incentives for new recruits. So, the big question now is if Compass can keep attracting agents without big payouts.

Real estate veteran and current CEO of startup Collabra Technology Russ Cofano told Inman that attracting and retaining agents is one of Compass’ primary headwinds at the moment. And he said that the cutting of incentives is likely to have an impact.

“What attracted a lot of agents in the first place was the equity incentives and some of the cash bonuses,” Cofano said. “If you remove that, then it’s just a logical assumption to say that will impact their ability to recruit folks.”

Compass has only had one earnings report since publicly announcing the end of cash- and stock-based recruiting incentives. In that report, the company revealed that it had grown its average number of principal agents by a little over 300 in the third quarter of 2022 compared to one quarter prior. That represented a jump of 2.58 percent.

It remains to be seen how many agents Compass recruited during the fourth quarter of 2022, though it’s worth noting that in mid November star agent Aaron Kirman left the brokerage and took with him about 160 agents — roughly half of Compass’ gains from the third quarter.

In any case, from the first quarter to the second quarter of last year, Compass grew its agent count by 3.22 percent.

Those growth percentages are respectable numbers and on par with the growth of bigger legacy companies, such as Anywhere and Keller Williams. But they are also much smaller numbers than Compass has seen in the past. From the first quarter to the second quarter of 2021, for instance, Compass’ principal agent count grew more than 8 percent. From the second to the third quarter, it grew more than 9 percent.

McTernan pointed out that Compass’ agent count growth was “decelerating throughout” 2022. But he also praised the end of expensive recruitment incentives, saying it was a positive reflection on Compass’ fiscal discipline. Which is to say, he saw the move as a net positive for the company. And he argued that Compass can continue to grow in the “low double digit range” going forward.

“Really,” he added, “we have that going forever.”

On the other hand, David Trainer — CEO of research and analysis firm New Constructs — said that in the past Compass has managed to “bring in super star agents” but only via “uneconomic business models.” And he speculated that without the old incentives, Compass may have difficulty attracting agents who do as much business.

“I would imagine the agents they brought over were not nearly as high quality,” he said of Compass’ post-incentive recruitment efforts.

It remains to be seen what actually will happen. And DelPrete noted that the graph is still “going up and to the right” for Compass’ agent count numbers, which “is a good thing” for the company. That needs to continue.

“From an agent count standpoint,” DelPrete said, “if the direction of that line changes, Compass is in trouble.”

The push to profitability

During Compass’ most recent earnings report, Reffkin set an ambitious goal for his company: He said the brokerage should be profitable in 2023, with positive cash flow beginning in the second quarter. Achieving that goal would represent a marked turnaround from recent quarters.

Ages was largely optimistic about Compass’ prospects, telling Inman he believes Reffkin’s targets are doable. In addition to cutting costs, Ages said the relatively higher productivity levels of Compass agents should be a major benefit for achieving positive cash flow.

Alternatively, asked about Compass’ cash burn, Trainer said “I don’t really see any way out of it.” He also speculated that 2023 could see a wave of major corporate bankruptcy filings and that “Compass could be one of those.”

Part of the challenge is that cutting costs and hiring productive agents is only part of the story; there’s also the market generally to contend with, and over the last year it took something of a dive. That makes the climb to profitability even harder, and it appears the tough times in the market are likely to continue.

“The first half of the year is going to be awful,” John Campbell, managing director of equity research at Stephens Inc., told Inman. “More so than ever because the market is highly sensitive to rates right now.”

How long the leaner times last is a matter of debate. Campbell suggested they could stretch until at least the third quarter of 2023, though some industry executives have suggested the downturn could go on even longer. Reffkin himself said during his most recent earnings call with investors that the housing market will “remain challenged during 2023 before returning to stability and growth in the future.”

Compass, then, has to make sure that it’s selling homes at a time when — contra recent history — homes are definitely not selling themselves.

Stock market struggles

Despite some eleventh-hour bumps in the road, Compass’ debut on the stock market in April 2021 went relatively well. The company set its share price at $18 to $19, then saw that price pop 11.9 percent with shares finishing their first day of trading at $20.15.

Since that time, however, it has been pretty much downhill for Compass. The following month, the firm’s shares fell to less than $14. By the end of the year, they were trading for barely more than $9. Over the course of 2022, Compass stock declined about 73 percent, ultimately hitting a low point of $1.84 per share in November.

Shares have since recovered somewhat and were trading in the upper $2 range as of early January, though that’s still a long way from what they were fetching way back in April 2021. Compass currently has a market cap of $1.2 billion, down from more than $7.3 billion after it debuted on the stock market.

Part of the problem for Compass was that 2022 generally was a bad year for the stock market. And on top of that, investors cooled on real estate stocks in particular, sending them falling more than the market generally.

But Compass has had a rougher time than many peer organizations with its losses outpacing those of rivals, such as Anywhere, eXp World Holdings or Zillow.

How much of a challenge this reality is for Compass going forward remains to be seen. DelPrete, for instance, noted that “everybody’s stock price has been absolutely hammered” lately and said he didn’t see Wall Street’s reduced appetite for Compass shares as meaningfully impacting the brokerage’s day-to-day operations.

“I don’t think it’s going to limit their ability to function as a company,” he added.

Still, a falling share price can reflect concerns about a company’s financials, and Ages noted that when it comes to Compass, some investors have “rightly been concerned that they were buying market share.”

Moreover, a depressed share price can make it difficult to raise funds for new initiatives or acquisitions. And if a company’s share price drops below $1, it risks getting booted from the market — a prospect that iBuyer Offerpad is facing right now. Compass is not currently at risk of delisting, though it cannot weather another year like 2022; a 73 percent drop from the company’s current share price would take it below the $1 threshold.

The task at hand, then, is to reverse the overall trajectory that Compass’ share price has experienced since the company went public. It’s a task that is tied up with the challenges mentioned above, such as cutting costs and achieving profitability. And ironically, it may involve leaning into the less sexy parts of the business; Ages pointed out that tech companies’ evaluations suffered more acutely in 2022, while brokerages faired somewhat better. Compass has generated interest in the past for being tech-enabled, but in the end, it may benefit more in investors’ minds from the fact that it is ultimately a brokerage.

The paradox of perception

For many years, one thing has been true: People talk about Compass. Some are fans, others are not. But the company has managed to dominate the conversation about the future of brokerages, real estate and technology and disruption. In other words, a big part of the Compass story is a debate about how the company is perceived.

That’s still true, but after a bruising year for real estate, it’s less clear now than ever how exactly the Company should be perceived. Is it more like the iBuyers, with their tech focus, huge cash burns and abysmal stock market performances? Or is it more similar to a techie brokerage like Redfin? Or at the end of the day, is Compass more like the legacy brands?

The answer depends on who you ask, but perception does matter — especially when it comes to boosting stock prices and recruiting agents. And in the latter case, Cofano suggested that Compass is facing a headwind in the form of “a perception of instability. Whether right or wrong.”

Cofano said that media reports have contributed to the perception of Compass’ alleged instability. But either way, if Compass wants to continue attracting and keeping top talent, it will have to ensure that outsiders perceive of it in a positive light.

Doing that will involve tackling all of the above challenges, but most of the analysts who spoke with Inman were optimistic about Compass’ ability to ultimately do that. Ages, for instance, noted Compass agents’ larger-than-average help both the company’s bottom line and its appeal to would-be recruits. And Campbell concluded that for all of real estate’s tumult in 2022, Compass still emerged with its reputation intact.

“I think Compass has a very good brand name,” he said.”And I think Compass will be fine.”

Email Jim Dalrymple II

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