With the housing market cooling off in the second half of 2022, led by sharply declining existing home sales from the same period of a year ago, we expect investors and purchasers of residential brokerage firms to largely stay on the sidelines to see what the final impact on profitability for brokerage companies and their related entities will be for 2022.
In discussions with many purchasers and investors, we sense that they may shift their valuation basis from a multi-year average, which is what most have been using since mid-2021, to the more traditional trailing twelve months basis which would only include 2022’s results. This would be a meaningful change in how residential brokerage firms are valued.
Eventual return to a vibrant M&A market
There are several factors in favor of a return to a vibrant market for residential brokerage firms and their related entities. First, there are many active purchasers and investors that are eager to continue to grow their footprint in the industry.
Second, there are a limited number of high-quality brokerage firms available at any given time and for that matter, there are not that many large quality brokerage firms left in the market.
Lastly, organic growth continues to be a challenge for the majority of brokerage companies, regardless of their brand, business model or location.
These factors would tend to indicate that purchasers and investors will return to the market in 2023. Their aggressiveness will be based as much on their desire to grow as it is the competition for the remaining smaller number of high-quality brokerage companies.
Waiting on the sidelines
For now, most purchasers we’ve spoken with have confirmed that, in their view, 2020 and 2021 were bullish one-time events in terms of housing sales and profitability. They have commented that brokerage firms through the boom, while having record profitability, were also seeing measurable erosion in gross margins.
Further, they have commented that the profitability of related entities, particularly mortgage, have also seen a significant erosion in profit margins.
More than one brokerage purchaser has commented that the total impact of these changes will not be confirmed and fully understood until the full year of 2022 results are tabulated. While several intend to be back in the market in 2023 to continue their growth through mergers and acquisitions, how aggressive they will be is yet unknown.
Some have indicated that the general structure of their offers will still contain significant cash at closing with some form of contingency-based earn-out over a period of time.
The percentage of cash at closing remaining at levels that were seen in 2020 and 2021 is of course unknown, as are the earn-out structures we’ll see.
Scott Wright and Steve Murray are partners in RTC Consulting, a residential real estate brokerage consulting firm specializing in brokerage and team business valuations, mergers and acquisitions and business planning.
