On surface level, Redfin (NASDAQ:RDFN) appears to be the perfect disruptor. For decades, prospective homebuyers had few choices but to employ the services of traditional real-estate brokers. By adopting emerging technologies, Redfin advanced an aging industry into the 21st century. As a result, Redfin stock has performed well relative to its initial public offering last summer.
Redfin’s appeal is easy to understand, especially if you’ve ever dealt with home-buying stress. Under the traditional approach, you must first rifle through the litany of real-estate agents sending you often unsolicited advertisements.
Next comes the seemingly eternal search for the perfect home and then the back-and-forth negotiations. All in all, it’s a tiring process.
Better yet, buying or selling with Redfin is significantly more cost-effective than the traditional route. This is one of the reasons why Redfin stock found quick success after its IPO.
Today, against its first day of trading, the next-generation real-estate company isn’t as impressive. On July 28, 2017, Redfin stock closed at $21.70. Based on the time of writing price, the tech-centric firm has gained less than 2.5%. No matter how you look at it, the disruptor is getting disrupted where it matters the most.
Furthermore, RDFN stock has been very disappointing this year. Since its January opener, shares are down an alarming 29%. To start off this week, the company dropped over 7% in market value as Goldman Sachs downgraded Redfin to “sell.”
Is that the end of the road for Redfin, or does a contrarian opportunity exist?
Few Bright Spots for Redfin Stock
I really love the impact that Redfin imposed upon this slow-to-change industry. I might even consider using its services when I go through the home-buying process again. But as great as the company is, Redfin also proved that disruption alone doesn’t guarantee success.
I can think of few investments that have as many fundamental challenges as Redfin. Market participants weren’t necessarily spooked about the Goldman Sachs downgrade. Rather, they panicked because of the reasons why the famed institution presented its bearish case.
No company is above its underlying sector, and Redfin is no exception. The biggest impediment to Redfin stock is soaring home prices. Not only does the housing market put inventory out of the reach of many first-time buyers, sellers practically can’t sell. That’s because you have to live somewhere, which defeats the purpose of selling your residence.
This dynamic necessarily restricts supply. I’ve witnessed firsthand how San Diego transitioned from an affordable metropolitan area into “San Francisco 2.0.” Sure, more companies are doing business in America’s finest city, but we’ve also seen an unsustainable population influx. Builders can’t keep abreast of demand. One way or another, the situation will come to a head.
Needless to say, tight supply leads to higher prices. But San Diego is hardly unique as several cities across the U.S. experience the same challenges. Frankly, this problem alone should weigh heavily on Redfin stock. But Redfin has another dilemma: rising mortgage rates.
The popular 30-year fixed mortgage averaged 3.54% exactly two years ago. Today, that average spiked to 4.62%, or more than a 30% increase.
For homebuyers, the 30% difference is huge. A $100,000 30-year mortgage at 3.54% interest roughly translates to $452 monthly payments. At 4.62% interest, the payments jump to $514, or a $22,500 total difference.
Redfin’s management team exudes confidence, so I’m not worried about their attitude. But as a potential investor, I’m concerned about its business structure, which hurts under current conditions.
Unlike rival Zillow (NASDAQ:Z, NASDAQ:ZG), which provides real-estate resources and information, Redfin is a legitimate broker. Thus, its primary revenue source comes from transacting home sales, not ancillary sources such as selling advertising space.
When real estate is booming, Redfin stock is your go-to investment. But when it’s not, I find it difficult to justify risking a heavy position. Just look at Zillow shares; year-to-date, they’re up nearly 57%. Clearly, having a business structure that’s less levered to real estate’s cyclical nature helps significantly.
But the nail in the coffin is that both Redfin and Zillow face upstart competitive threats. Thanks ironically to lower technology costs, new companies can disrupt the sector incumbents. In other words, what Redfin and Zillow is doing is no longer unique. That puts serious pressure on Redfin , on top of everything else the company deals with.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.